One common disclaimer stands out when planning a stock market investment: “Investments are subject to market risks.” One such inherent risk is price fluctuation. Investors analyze the extent and frequency of these price movements to navigate this uncertainty. This is where volatility comes into play, measuring the degree of market fluctuations.
A key tool for assessing expected market volatility is the India VIX. But how exactly does it help investors? And is it the same as an Indian stock market index? Let’s break it down.
What Is India VIX In Share Market?
India VIX, or the Volatility Index, measures how much the stock market is expected to fluctuate over the next 30 days. Unlike indices like NIFTY50 or SENSEX, which track stock price movements, India VIX is based on NIFTY options contracts—financial instruments that allow traders to buy or sell NIFTY at a set price in the future.
The index is calculated using the best bid and asking prices for these options. The bid price is the highest price a buyer is willing to pay, while the asking price is the lowest price a seller is willing to accept. The difference between these prices helps determine the expected volatility.
India VIX is expressed as an annualized percentage, meaning the 30-day expected volatility is scaled to reflect an entire year. Suppose the India VIX value is 20. This means investors and stock advisory services providers expect market prices to fluctuate within a ±20% range over the next 30 days. Theoretically, India VIX moves between 15 and 35. A value around or below 15 indicates lower volatility and a relatively stable market, whereas a value above 35 signals higher fluctuations and uncertainty.
Although India VIX is called an “index,” it differs from stock market indices. While NIFTY50 tracks stock price direction, India VIX measures expected price swings based on options market data. It is denoted as an annualized percentage, not a numerical value like NIFTY.
How Is India VIX Computed?
Is the calculation for India VIX done using financial calculators? India VIX is calculated using real-time NIFTY option prices, focusing on the best bid-ask quotes of out-of-the-money options (currently have no intrinsic value). The methodology follows the CBOE VIX model with adjustments for the NIFTY options market.
Here’s how the computation works:
- Time to Expiry: India VIX measures time in minutes instead of using days for greater accuracy.
- Interest Rate: The risk-free interest rate is derived from the NSE MIBOR (Mumbai Interbank Offer Rate) for relevant tenures (30 or 90 days).
- Forward Index Level: The at-the-money (ATM) strike price is determined using the latest price of the NIFTY futures contract. Options with strike prices above the ATM are considered for call options, while those below the ATM are used for put options.
- Bid-Ask Quotes: The best available bid-ask quotes of out-of-the-money NIFTY options are used. If suitable quotes are unavailable, they are estimated using Natural Cubic Spline Interpolation.
- Variance Calculation: The implied volatility is computed separately for near and mid-month option contracts. Each option’s weight is based on its bid-ask spread and strike price.
- Final Computation: The two variance values are interpolated to a constant maturity of 30 days. The square root of this variance is then multiplied by 100 to derive the India VIX value.
Formula for India VIX
India VIX = 100 × (∑(Weighted Implied Volatility Squared) Total Weight)
where:
- Weighted Implied Volatility Squared = Sum of squared implied volatilities weighted by option prices.
- Total Weight = Sum of the open interest of all options used in the calculation.
- Weighted Implied Volatility Squared = Sum of squared implied volatilities weighted by option prices.
- Total Weight = Sum of the open interest of all options used in the calculation
Know More: SEBI Registered investment advisory | Stock investment advisory
Market Applications of India VIX:
- Risk Assessment: India VIX helps you measure market risk levels. A high VIX signals uncertainty, encouraging cautious investment strategies, while a low VIX suggests stability.
- Option Pricing: When VIX rises, expected market fluctuations increase, leading to higher option premiums. You can use this insight to decide whether to buy or sell options.
- Hedging Strategies: If VIX trends upward, consider increasing put option positions to protect your portfolio from potential downturns.
- Asset Allocation: During high volatility, shifting toward defensive assets like bonds or gold can help reduce risk exposure.
- Predicting Market Trends: VIX typically peaks when markets bottom out and declines when markets rally. Tracking this inverse relationship can help you analyze probable market trends.
- Portfolio Management: If you’re managing portfolios, tracking VIX can help you decide where to invest. When VIX is low, you might focus on growth stocks with higher returns. When VIX is high, safer investments like stable, well-established companies may be a better choice to reduce risk.
How Different Investors Use India VIX?
Equity Traders:
India VIX acts as a volatility indicator, helping intraday and short-term traders anticipate market shifts. A rising VIX suggests heightened uncertainty, prompting traders to adjust their risk exposure.
Intraday Traders:
Sudden spikes in VIX can trigger stop-loss orders (a predefined price level at which a trade is exited to limit losses), leading to increased risk. Traders often modify leverage or widen stop-loss levels to adapt to volatile conditions. If a trader has set a tight stop-loss at 1.5% on a stock and VIX surges, they may widen it to 2% to avoid premature exits.
Long-Term Investors:
While long-term investors are less affected by short-term volatility, a rising VIX may prompt them to hedge their portfolios using put options or other risk management strategies.
Options Traders:
High volatility increases option premiums because larger price swings make options more valuable. This benefits buyers as their contracts gain value with increased price movement. Low volatility reduces premiums, favoring sellers by minimizing losses from time decay.
So, if the VIX jumps from 16 to 28, an options trader expecting further volatility might buy options early to benefit from rising prices. Conversely, a seller anticipating a drop in volatility may wait for premiums to rise before selling, aiming to profit when the VIX stabilizes or declines.
Volatility Traders:
Traders expecting increased volatility can use strategies like buying straddles (simultaneously buying a call and a put option at the same strike price) or strangles (buying a call and a put option at different strike prices).
Bottomline:
Understanding India VIX can help you navigate the stock market more effectively. It helps you anticipate volatility, refine strategies, and manage risk effectively. You can adjust trades hedge positions, and align investments with market conditions by tracking VIX movements.
Making India VIX a part of your research framework ensures informed decision-making, helping you optimize returns and stay ahead of market fluctuations, whether trading equities or options. Using India VIX as a volatility gauge enhances market awareness and strategic planning.
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Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as a recommendation or investment advice by Equentis – Research & Ranking. We will not be liable for any losses that may occur. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL & certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.
What is NIFTY?
NIFTY is the benchmark stock index of India’s National Stock Exchange (NSE), representing the performance of the top 50 companies across various sectors.
What are high-beta stocks?
High-beta stocks are more volatile than the market, moving up or down sharply. They carry higher risk but also the potential for greater returns.
What is the bid and ask price?
The bid price is the highest price a buyer is willing to pay for a stock, while the asking price is the lowest price a seller is willing to accept. The difference between them is called the bid-ask spread.
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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.
