If you’ve been investing in the stock market for a while, you’ve probably heard of the term “India VIX.” However, what does the India VIX actually tell us?
What is India Vix?
India VIX is the abbreviation for the India Volatility Index. It shows how much volatility or variation traders foresee in the Nifty50 Index over the next 30 days. The NSE created the India VIX in 2008, but the concept was first presented in 1993 by the Chicago Board Options Exchange.
The NSE’s order book of NIFTY options is used to construct the India VIX, which is a volatility indicator. This is done using the best bid-ask quotes of near and next-month NIFTY options contracts traded on the NSE’s F&O sector. The India VIX index indicates investors’ expectations for market volatility in the short term, i.e. over the next 30 calendar days. The higher the India VIX figure, the more volatile the market is expected to be, and vice versa.
The India VIX is calculated using five factors: strike price, stock market price, time to expiry, risk-free rate, and volatility. Using the best bid and ask quotes of out of the money, current, and near-month Nifty option contracts, the VIX calculates the volatility expected by market participants.
A higher India VIX number suggests higher Nifty volatility expectations, whereas a lower India VIX value indicates lower Nifty volatility expectations.
- For option traders, the VIX is a useful indicator. Typically, volatility is used to evaluate whether to buy or sell an option. When volatility is projected to increase, options become more appealing, and buyers are more likely to profit. When the VIX drops, there will be more wastage of time value, which will benefit option sellers.
- For equities traders, the VIX is an effective and reliable indication of market risk. Intraday and short-term traders might use it to see if market volatility is rising or falling. As a result, they will be able to perfect their strategy. Intraday traders are at risk of stop losses being triggered prematurely when volatility is projected to surge significantly. As a result, they can either reduce their leverage or increase their stop losses.
- Portfolio managers and mutual fund managers can benefit from the VIX index. They can try to raise their exposure to high beta stocks when the VIX has peaked, and they can try to increase their exposure to low beta equities when the VIX has bottomed.
- VIX is a very accurate and dependable indicator of index fluctuation. You can find a clear negative link in the charts if you plot the VIX and the Nifty movement for the last 9 years since VIX’s introduction. The VIX tends to peak out when the markets are bottoming out, and the VIX tends to peak out when the markets are bottoming out. For index trades, this is a useful input.
- For long-term investors, the VIX is also a good indicator. Short-term volatility is usually unimportant to long-term investors. Institutional investors and proprietary desks, on the other hand, are subject to risk and MTM loss limitations. They may increase their hedges in the form of puts to play the market both ways if the VIX signals that volatility is increasing.
Before investing in India, it’s vital to grasp the market’s turbulent nature. Because all large directional market movements are preceded by market choppiness, India VIX is an important indicator of investor confidence or anxiety. A lower VIX indicates low volatility and a consistent asset price range.
A higher VIX indicates significant volatility and a lack of investor confidence in trading within the present market range. It’s usually a hint of a big directional shift in the market, as evidenced by the present range widening.
Volatility and India VIX have a positive relationship, which implies that when volatility is high, so is the value of India VIX. For example, prior to COVID, India VIX was consistently low, hovering around 30 since 2014, showing stability. However, India’s VIX has risen to 50 since the start of the pandemic. During the same time frame, the equities index lost nearly 40% of its value and was trading near 8000.
The India VIX index gauges volatility over the next 30 days in India. As a result, investors with a long-term perspective who aren’t concerned with short-term price fluctuations are less affected by changes in the India VIX. The profitability of long-term investments may not be affected by day-to-day swings in India VIX.
However, if the volatility index continues to rise over time, this could be cause for concern for investors who don’t understand the concept of margin of safety in valuations. When the India VIX rises, even over a lengthy period of time, it is interpreted as an indication of increasing uncertainty. Such uncertainty can create opportunities for Deep Value Investors who understand the Margin of Safety in valuations.
India VIX is a useful tool for option traders. Options are financial instruments that allow you to buy or sell a certain security at a predetermined price in the future. Options become more lucrative as volatility rises. As a result, an options trader may pay special attention to India VIX swings.
India VIX is a useful tool for stock traders as well. When volatility rises, it’s possible that stock traders’ stop losses will be triggered soon. This is due to the fact that during moments of high volatility, prices can shift quite quickly. As a result, they may need to adjust their stop losses in response to the volatility shift.
Option writers who trade at high VIX levels take on infinite risk for a restricted gain (Premium).
If the stock price of X shares is Rs. 300, and a trader has sold a 280 put option contract (2,000 shares) for a premium of Rs. 10, with the contract expiring in 7 days. As a result of the current volatility, the stock price could reach Rs. 240 in two trading sessions. So, with 5 days left till expiration, the option writer’s loss will be:
280 rupees is the strike price.
240 rupees on the spot
Rs. 10 in premiums earned
Option writer’s loss is Rs. (240+10-280), or Rs. 30 per lot, for a total loss of Rs. 60,000 (2000*30). As a result, the option writer should try to avoid writing contacts as much as possible, and if they do, the premium charged should be increased as well.
The VIX index is a number that goes from 15 to 35 in theory. However, there have been outliers as low as 8 (very narrow range) and as high as 90. (extreme volatility). If VIX gets close to zero, the index may theoretically double or come to zero. VIX, on the other hand, has a propensity to revert to mean.
IndiaVix and Safe Zones for Short to Medium Term Trading
Short to Medium Term Traders Should Avoid Taking Trading Bets Once IndiaVix is above 22, Logic being, Above 22 Denotes Fear in the market and price based entries and exits based on technical analysis doesn’t work properly. When there is fear, people are willing to sell their stocks in panic at any price, if one trades during these phases,chances are high that a trader will be whacked out of the markets multiple times creating frustration.
However, for a Value Based Investor,Volatility can bring great long term investing opportunities during such panics, because an investor ignores short term volatility if he has bought with enough margin of safety in valuations.
The India VIX index provides useful information about market volatility. It is critical for traders to recognise changes in market volatility and adapt their methods accordingly. While short-term variations in volatility may not have an impact on the profitability of long-term investments, if volatility rises over time, they may need to rethink their stock investments and apply stringent value investing principles like Deep Value Investing, Margin of Safety, Circle of Competence to benefit from the volatility.
The VIX is a real-time market index that represents market expectations for volatility over the following 30 days. Investors use the VIX to determine the level of risk, fear, or tension in the market while making investment decisions.
In simple terms, if the VIX increases, it means people are bidding up put prices relative to calls, and if the VIX lowers, it means people are bidding up call prices relative to puts. The opposite is true if the price of puts lowers in comparison to the price of calls, causing the index to decline.
Because the India VIX fluctuates between 15 and 35, any value above 35 indicates a significant level of volatility. The value of the India VIX rises during moments of increasing market turbulence caused by fear.
One simple way to understand India VIX is to look at the expected annual change in the NIFTY50 index over a 30-day period. For instance, if the India VIX is currently at 11, traders can expect 11 percent volatility over the following 30 days.
There is a strong negative link between India VIX and NIFTY. NIFTY declines whenever India VIX increases. When VIX declines, NIFTY rises, and investors gain confidence as a result of lower volatility.