Have you ever observed a very high fluctuation in the prices of stock/index? Most likely the answer will be a yes. But we all have different definitions of “very high”. So how to standardize price fluctuations and measure them all on the same scale? To measure this fluctuation we have an indicator known as VIX (Volatility Index). VIX measures volatility and gives a fair impression as to where the market may be headed in the near future.
Before moving ahead let us first understand that volatility index is different from price index. The price index reflects the market movement considering, change in the prices of a particular stock or index. And Volatility Index suggests the volatility in the prices.
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How India VIX came into existence
- VIX was introduced by Chicago Board of Option Exchange (CBOE) in 1993 and was based on S&P 100 Index option prices.
- The same was revised in 2003 and the new index was based on S&P 500 Index options.
- NSE considers the prices of NIFTY Index Option to determine the values of India VIX.
- India VIX follows the computation method of CBOE with subject to certain changes.
- Considering the best bid-ask prices of NIFTY Option contracts a volatility figure (%) is computed.
How India VIX works
Fluctuation in the stock market tends to move the market prices either very low or high. During this period of high fluctuation VIX tends to increase, denoting fear or uncertainty. And during the time of low fluctuation the VIX tends to decrease, indicating greed or confidence. The index VIX is sometimes called as Fear Index. We have to be cautious when VIX rises as the market can make a significant move in any direction.
Now let us take a look at the plausible relationship between VIX and Nifty for the period of last two years. This will help us understand VIX better.
VIX does not forecast the market but only gives us an indication. If we are to summarize the above data below is what one can observe.
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