Ever heard of India Vix? If you’re involved in the market for some time and particularly active in the share market in March-April 2020, then I’m sure that you would definitely have come up with this term “India Vix” at least a couple of times mentioned on different financial websites and channels.
In this post, we are going to discuss, what exactly is India Vix, it’s meaning and how exactly it is important for the traders and investors to understand this term.
What is India Vix?
India VIX is a short form for India Volatility Index. It is the volatility index that measures the market’s expectation of volatility over the near term. In other words, it explains the annual volatility that the traders expect over the next 30 days in the Nifty50 Index.
The India VIX value is derived by using the Black & Scholes (B&S) Model. The B&S Model uses five important variables like strike price, the market price of the stock, time to expiry, the risk-free rate, and the volatility. India VIX was introduced by NSE in the year 2008, but the concept of VIX is a trademark of CBOE (Chicago Board Options Exchange).
One simple way of understanding India VIX is that it is the expected annual change in the NIFTY50 index over a period of 30 days. For example, if the India VIX is currently at 11, this simply means that the traders expect 11% volatility for the next 30 days. Further, say, if the current index is trading at 9,000 and India VIX trading at 20. So, expected volatility over next year over 30 days will be:
- Index spot: 9000
- India Vix: 20
- The expected downside for the year = 9000 – 20% of 9000 = 7200
- The expected upside for the year = 9000+ 20% of 9000 = 10,800
Here, the expected range for the year is between 7200 and 10, 800
Why is India VIX so important?
All the major directional moves in the market are usually preceded by a lot of choppiness or a lot of range play in the market. India VIX plays a very major role in understanding the confidence or fear factor amongst traders.
A lower VIX level usually implies that the market is confident about the movement and is expecting lower volatility and stable range. A higher VIX level usually signals high volatility and lower trader confidence about the current range of the market. A major directional move can be expected in the market and a quick broadening of range can be expected.
For example, during the sub-prime crisis, India VIX was trading at 55-60 (high of 90) levels and the market was in a state of panic and indecisiveness and hence the moves were erratic and hostile. Volatility and India VIX have a positive correlation. High volatility indicated high India VIX and vice-versa.
Is there an ideal range for India VIX?
Theoretically speaking, VIX ranges between 15-35. But there have been outliers case of as low as 8(very tight range) and as high as 90 (extreme volatility). If VIX moves close to Zero, then theoretically either the index can double or come to 0. However, usually, VIX has a tendency to revert back to mean.
The figure above is India Vix chart for the last 10 years. With the current global crisis of COVID-19, the global markets have faced a lot of heat and extreme volatility and all the major global indices have lost nearly 40% from their recent highs and Indian equity market is no exception. With this current level of volatility, India VIX had climbed up to all time high levels of 90 for a couple of days.
And it seemed to be stabilizing near 50 levels about a month ago. The Vix range is still on the higher side, to attain some stability in the market. For stability to return, the global factors will have to improve and the India Vix level should ideally come around 20 levels.
What do these extreme Vix levels mean for Options Writers?
India VIX also plays a very major role in the pricing of Options. A higher India Vix levels usually signal more volatile prices for options and a stable range would mean that the options are priced reasonably cheaper.
Simply put, high VIX levels expose option writers to unlimited risk with limited rewards (Premium). A deep in out of money Put/Call option can become at the money or even In the money option in a matter of a couple of trading sessions.
To summarize, it can be said that India Vix is a silent yet very effective indicator to gauge the range play for Index, which in turn gives us a clear view of the expected movement of the share price.
Historically, large Vix levels have always been followed by a large movement in the indexes and share prices. And even the option pricing, the premiums charged also increase or decrease because of the Vix level changes.