Understanding what is India Vix, its meaning & importance: Ever heard of India Vix? If you’re involved in the market for some time and particularly active in the share market during the COVID19 Pandemic, 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 news channels and websites.
In this post, we are going to discuss, what exactly is India Vix, its meaning, and how exactly it is important for the traders and investors to understand this term. Let’s get started.
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 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 volatility. India VIX was introduced by NSE in the year 2008, but the concept of VIX is quite old and 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, for example, if the current index is trading at 9,000 and India VIX trading at 20. Then, expected volatility over next year over 30 days will be:
- Index spot: 9,000
- 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 (7,200 and 10, 800) for that index.
Quick Note: Before moving further, let me mention that one should not confuse India VIX with Market Index. Market Index gives information about the direction of the market. However, on the other hand VIX measures the volatility of the market.
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 a 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.
Similarly before COVID-19. India VIX had stayed below 30 (Since 2014). But since the epidemic disease broke out, the VIX has crossed the 30 level and is trading near 50 levels (trading above 80 for few days) and we have seen the Indian equity Index losing nearly 40 percent of its value and is trading near 8000 levels.
Overall, India VIX plays a major role in understanding the sentiment of the market.
But be aware of the fact, India VIX does not give any indication of the directional move in the market, it simply indicates the volatility in the market. So, anyone with a huge investment in Equities should keep a close eye on the movement of India VIX coz a similar movement in the shares of his portfolio cannot be ruled out.
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 the India Vix chart for the last 10 years. During the break of the global crisis of COVID-19 (March-April 2020), the global markets have faced a lot of heat and extreme volatility, and all the major global indices have lost nearly 35% from their recent highs and Indian equity market was no exception. With this level of volatility, India VIX had climbed up to all-time high levels of 90 for those couple of days.
Later, it seemed to stabilize after June-July 2020. For stability to return, the global factors will have to improve and the India Vix level should ideally come around 20 levels. The Current VIX level is 22 (March 2021) and the market seems to be stabilizing for now. But for the long-term stability of the market, sub 20 levels of VIX is desired.
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.
For Example, the stock price of XYZ shares is Rs. 300, and a trader has sold 280 put option contract (2,000 shares) for a premium of Rs. 10 and the contract has still 7 days to expiry. So, with current volatility, the share price can come to Rs. 240 in 2 trading sessions. So the loss for option writer with still 5 days to expiry will be:
- Strike price: Rs. 280
- Spot price: Rs. 240
- Premium Earned: Rs. 10
Here, the loss for option writer: Rs. (240+10-280) i.e., Rs. 30 loss per lot, which is a loss of Rs. 60,000 (2000*30) per lot. Therefore, ideally, the option writer should avoid writing contacts and even if they do, the premium charged should also be higher.
To summarize, India Vix is the volatility index that measures the market’s expectation of volatility over the near term. 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. Even the option pricing, the premiums charged also increase or decrease because of the Vix level changes.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!