India VIX- all you need to know about volatility index of NSE

India VIX is the indication of investor’s perception of the market’s volatility in the near term. This portrays the expected volatility of the market over the next 30 calendar days. Thus, India’s volatility index or the India VIX is the key measure of market expectations of near term volatility of Nifty stock index option prices.

As a matter of fact, technically, you can compute VIX on the basis of the order book of Nifty options. For this, there is a utilization of best bid-ask quotes of near as well as next month NIFTY options contracts. These are basically traded on the F&O segment of NSE. The process goes on like this, the higher the India VIX values, higher will be the expectation of volatility and vice-versa.

Historical background of the volatility index

A few lines about volatility index history. Originally the VIX is – a trademark of Chicago Board Options Exchange (CBOE). They introduce the volatility as an asset class in the form of an index in 1993. After this, they also launch the VIX derivative future and option trading in 2004. In India, the NSE launches the VIX in 2008. They further introduce the NVIX futures in 2014 for trading.

We should not get confused with the market index because it is totally different. The market index is the measurement of the direction of the market while the volatility index measures the volatility of the market. The calculation is also different such as, market index is calculated by the price movement of the market whereas VIX is calculated by making use of order book of the underlying index’s options.

There is parallelism among volatility and the value of India VIX. With Nifty there is a strong negative correlation with India VIX. The number of times India VIX falls, Nifty rises and also Nifty falls when India Vix rises. If we see historical data, India VIX floats to peak a few days before NIFTY touches the bottom post-Lehman crisis.

Advantages of the volatility index in India

The following are the advantages of volatility index for a trader or investor –

• VIX option is an exceptional mechanism for traders. Especially for those who plan to take a position on expected implied volatility.
• These volatility indexes can be traded during normal stock market hours through a securities broker.
• There is no such specific direction of VIX. The main focus of the trader can be whether the underlying asset is expected to be more volatile in future or not.
• There is also an advantage of standardized implied volatility calculation.
• Moreover, these index based on VIX derivatives will enable implementation of complex strategies. For say, volatility arbitrage.
• Therefore, in India, VIX is used to measure volatility in the market.

Disadvantages of the volatility index in India

The very concept of volatility index in India is constantly evolving. Currently, as a trader/investor in the stock market in India, you may experience any of the following or all as a disadvantage of using volatility index as a measure of volatility in the market:-

• The major shortcoming is illiquid in the options markets in India. Liquidity is – the state of a security or other asset that cannot easily be sold or exchanged for cash without a substantial loss in value.
• The above point can be justified by saying that the VIX value can be biased due to illiquidity. This means lower the volume and non-continuous strike prices.
• There is a lack of transparency in the NSE manual regarding the VIX calculation.
• There is a lower volume for far-month options as well as a high bid-ask spread.
• The methodology of the NSE VIX is MIBOR (Mumbai Interbank Offer Rate) as a risk-free rate. Therefore, it does not mention the term duration that is to be used.

How India VIX is useful to Indian traders and investors?

Here will show up the usefulness of India VIX from the traders and investors point of view. Traders now have volatility index as an instrument to earn more from such an occurrence. Basically, volatility is independently known as the measure of change. The higher value of volatility shows the rapid change in prices as compared to the immediate past. The following are the benefits to traders and investors –

Benefits of India VIX to traders and investors

• In India, NSE computes the VIX value. It is based on out-of-the-money (OTM) option prices of the Nifty. Therefore, the value of VIX can never be below zero or more than 100.
• India VIX has a mean of 26.65 and median of 23.83, now these statistics are important for option writers and traders. This is because the VIX has a tendency to revert to the mean.
• Volatility is much easier to predict that prices are. If we take any organization into consideration, then the trader/investor will not know the price after the financial result announcement. But here you can easily know the volatility that may increase immediately after profit and guidance number announcement.
• If we talk about VIX futures, it gives better hedge than index futures. The reason behind is VIX indices are more volatile and offers three to four times more returns than an index. For instance, statistics show that it is a 5.4 percent drop in Nifty between 23rd January 2014 and 13th February 2014with a 14.8 percent change in the volatility index.
• The attraction of speculators towards VIX is specifically the gains. NSE will, therefore, has to keep the lot size for each contract of around Rs. 10 lakhs and will then attract a margin of Rs. 2 lakh. Hence, this will make the product more expensive for retail investors.

As a stock market player why you must care about India VIX?

In simple words, the volatility index is a hedging instrument through which the investors can minimize the risk fluctuations. Currently, NSE calculates the value of an index based on the option prices. Or to elaborate, you can calculate it by order book of the nifty options. The instrument used to offload the risk can be like if the investor has the portfolio more likely as the Nifty index. Thus, volatility is the measure of risk or uncertainty of prices.

For instance, there are chances that events like election result or major policy announcement will broadly affect the prices. This usually results in a lot of upside and downside price movement of both shares and indices. Therefore, the investors can move towards volatility index for buying it. This would also help the investor in minimizing the risk.

This is the time or the situation where one can experience the higher price of the index. So, if the value of the portfolio of the investor falls then the investor will get balanced with the amount one earns from the increase in VIX. The foremost feature is that unlike other hedging instruments it never cuts earnings that the investor receives from the original portfolio.  The investors earn an original portfolio that they own when the prices rise up. In addition to this, the investor will VIX price appreciation as a bonus.

About Author