If you are a relatively new investor to the market and are still familiarising yourself with the various terms you come across in the marketing world, you would surely have come across the term India VIX. Like any other marketing term, India VIX is important to understand for any investor in the market. So what does the term India VIX really mean and why is it so important to know? A short form of India Volatile Index, India VIX, indicates the volatility and swings in the market, which is important to know for investors and buyers. So, to understand the importance of this term, let’s go through it in a little more detail.
The volatility index (VIX) is a measure of market volatility, which is why it is called that. The Volatility Index represents the market’s expectation of near-term volatility. The market often moves quickly up or down during periods of market volatility, and the volatility index tends to rise.
As volatility decreases, the volatility index decreases as well. The Volatility Index differs from a price index such as the NIFTY. The price index is generated by considering the underlying stocks’ price movement. The Volatility Index is calculated as an annualised percentage using the order book of the underlying index options.
To grasp the concept of a Volatility Index, one must first travel back to the 1970s, when there was no reliable technique for assessing investor confidence.
The markets were frequently based on guesswork, making identifying the ‘fair price’ of stock extremely complex.
Three economists, Fischer Black, Robert Merton, and Myron Scholes, devised a model in 1973 that revolutionised the option pricing process.
The ‘Black Scholes Model’ is now widely used to assess market volatility worldwide.
In 1997, the three were awarded the Nobel Prize in Economics for their groundbreaking work. Merton, though, had died before that year, and the model is named after the survivors.
The model is represented as follows –
C = StN(d1) − Ke − rtN(d2)
When: d1 = σs tlnKSt+(r+2σv2) t
plus: d2 = d1− σs t
In this model, the legends mean the following –
C= Call option price
S= Current stock price; another underlying price (s) may be considered
r= Interest rate (risk-free)
K= Strike price
N= an ordinary/normal distribution
t= time to maturity
Now that we have understood the concepts of VIX, let us take you through the basics of VIX India. The NSE’s order book of NIFTY options is used to construct a volatility indicator, which is the basis of India VIX meaning.
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 Volatility Index (VIX) index indicates investors’ expectations for market volatility in the short term, i.e., over the next 30 calendar days.
The higher the India Volatility Index (VIX) figure, the more volatile the market is expected to be, and vice versa.
India Volatility Index (VIX) uses the CBOE’s calculation technique, with changes to fit the NIFTY options order book, such as cubic splines and so on.
In order to calculate the India Volatility Index (VIX), the following factors are considered:
The time to expiry is estimated in minutes rather than days to reach the level of precision expected by experienced traders.
The risk-free interest rate for the different expiry months of the NIFTY option contracts is the relevant tenure rate for 30 to 90 days.
Out-of-the-money option contracts are used to calculate the Volatility Index (VIX). The forward index level is used to identify it.
The forward index level aids in determining the at-the-money strike, which aids in selecting the options contract to be utilised in the computation.
The most recent accessible price of the NIFTY future contract for the respective expiry is used to calculate the forward index level.
The ATM strike is the strike price of a NIFTY option contract that is available at a price slightly lower than the forward index level.
Option NIFTY and call arrangements with strike prices more significant than the ATM strike are both viable options.
Out-of-the-money options are contracts with a strike price less than the ATM strike, and the India Volatility Index (VIX) is calculated using the best bid and ask prices for such option contracts.
Values are computed by interpolation using a statistical approach known as the “Natural Cubic Spline” in the event of strikes for which appropriate quotations are unavailable.
Following quotation identification, the variance (volatility squared) for near and mid-month expiry is calculated independently.
Some of the uses of the volatility index are as follows:
1) For equities traders, the Volatility Index (VIX) is an effective and reliable indication of market risk.
Intraday and short-term traders might use it to see if market volatility is increasing or decreasing.
As a result, they will be able to fine-tune 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.
2) For long-term investors, the Volatility Index (VIX) is also a good indicator, and 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 Volatility Index (VIX) signals that volatility is rising.
3) The Volatility Index (VIX) is also a helpful indicator for options traders.
Typically, volatility determines 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 Volatility Index (VIX) drops, there will be more squandering of time value, which will benefit option sellers.
4) It is also possible to trade volatility with it.
If you think the markets will become more volatile, you might buy straddles or strangles.
These, on the other hand, become prohibitively expensive when volatility is predicted to rise.
A better strategy would be to buy Volatility Index (VIX) index futures, allowing you to profit from volatility without worrying about market direction.
5) The Volatility Index (VIX) index can benefit portfolio managers and mutual fund managers.
They can try to raise their exposure to high beta stocks when the Volatility Index (VIX) has peaked, and they can try to increase their exposure to low beta equities when the Volatility Index (VIX) has bottomed.
6) The Volatility Index (VIX) is a very reliable and accurate predictor of index volatility.
If you plot the Volatility Index (VIX) and the Nifty’s movement over the last nine years, you will discover a clear negative correlation.
When the Volatility Index (VIX) is at its lowest, markets often top, and when the Volatility Index (VIX) is at its highest, markets typically bottom.
This is a crucial component of index trading.
The ways in which India Volatility Index (VIX) affects the Indian market are as follows:
If the Volatility Index (VIX) is very high, investors can therefore reasonably expect some crucial announcements or developments in the NIFTY.
To put it another way, a higher Volatility Index (VIX) suggests increased market volatility. Because the NIFTY 50 is a benchmark index, any change might significantly influence the economy as a whole.
To summarise, investors should keep an eye on recent Volatility Index (VIX) movements because they can predict future events. If the index is low, no significant changes are foreseen.
For example if India’s Volatility Index is high, NIFTY’s benchmark index will fall. This benchmark will be much higher if the Volatility Index (VIX) is low.
When one considers the subprime loan crisis of 2008-09 and the following bankruptcy of Lehman Brothers (an investing and financial services behemoth founded in 1847), it is clear that the NIFTY index was in a funk.
The Volatility Index meaning has changed worldwide anytime there has been a massive influence on the global economy owing to unrelated occurrences.
After each event, the formula for calculating this index (seen below) has been tweaked slightly.
Volatility Index (VIX) reached all-time highs in 2001, just after the September 11th hijackings and attacks on the Twin World Trade Centre Towers and the Pentagon.
One of the most significant functions of a Volatility Index is to assist any investor, whether retail or institutional, in determining market sentiment. One can use the Volatility Index (VIX) to determine whether buying or selling certain stocks at current pricing is better.
A good example was an epidemic in 2020. Markets plummeted when the nationwide shutdown was announced in March. Indian equities have lost about 40% of their value, a severe economic shock that will take years to recover.
Most indicators took this as a hint that they should ‘dump’ their stocks at whatever prices they were getting; there was concern that most equities would lose all value in months.
Because companies’ market capitalisations were fast eroding, all trading was temporarily halted.
The financial markets began to rise again around November, resulting in a decrease in the Volatility Index. It also shows that investors believe India’s economy is resilient and strong enough to weather the storm and will rebound shortly.
Low India Volatility Index (VIX) levels in November also suggest that India’s economy is unlikely to enter recession, formally defined as a contraction for three months in a row.
The US economy has already entered a recession, raising fears that its ramifications could dampen all optimistic market emotions in other key global economies.
Before investing considerable sums of money in the market, new or inexperienced investors should exercise caution. It is best to look at a market’s Volatility Index for at least the past 2-3 months before taking action.
The Volatility Index (VIX) in India has taken on even more relevance as the country’s central government intervenes to bolster the economy’s sagging sectors.
In a nutshell, we can conclude that India VIX is a volatility index that is used as a measure to ascertain the volatility expectations of the market.
This volatility index also plays a crucial role in the determination of premium amounts and derivative contract prices.
The past has witnessed a substantial shift in share prices and indices due to high VIX values.
The Volatility Index (VIX) is a real-time market index representing market expectations for volatility over the following 30 days.
Investors use the Volatility Index (VIX) to determine the level of risk, fear, or tension in the market while making investment decisions.
In simple terms, if the Volatility Index (VIX) increases, it means people are bidding up put prices relative to calls, and if the Volatility Index (VIX) lowers, it means people are bidding up call prices relative to puts.
The opposite is true if the price of puts lowers compared to the cost of calls, causing the index to decline.
When the Volatility Index (VIX) rises, so does volatility, frequently accompanied by market fear.
It is a valid strategy to buy when the Volatility Index (VIX) is high and sell when it is low, but one must weigh it against other factors and indicators.
A straightforward way to understand India Volatility Index (VIX) is to look at the expected annual change in the NIFTY50 index over 30 days.
For instance, if the India Volatility Index (VIX) is currently at 11, traders can expect 11 per cent volatility over the following 30 days.
When investors are under financial stress, the Volatility Index (VIX) begins to rise and then steadily falls as they gain confidence. It is the most accurate predictor of short-term market volatility on the market.
It does not reflect the index's actual or historical volatility but rather the degree of price volatility predicted by the options markets.
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