If you are a relatively new market investor and are still getting familiar with the various terms that you come across in the marketing world then you most definitely would have come across the term India VIX. Like any other marketing term, India VIX is important to understand for any market investor. So what really does the term India VIX mean and why is it so important to know? India VIX is a short form for India Volatile Index which tells the volatility and fluctuations in the market that are important to know for all investors as well as buyers. So, to make you understand the importance of this term, let us go through it in a little more detail.
What is India VIX or India Volatile Index?
India VIX or India Volatility Index is a volatile index that is calculated by the NSE to measure the market’s anticipation for volatility and fluctuations in the near term. This index was first introduced by the NSE in the year 2003. However, the original concept of a volatile index goes back 1993, when it was introduced by the Chicago Board Options Exchange.
You can see a rise in the volatile index when the market is continuously fluctuating and going up and down. This shows the increase in volatility in the market. Similarly, when the market is more stable and the volatility is less, you can see a fall in the volatility index. This index represents the investors’ perception of the market over the next near term, that is the next 30 days. The rise and fall in the India VIX or volatile index determines the volatility of the market and helps the investors to better understand the market conditions before making their next big investment or while keeping a track of their previously made investment.
It is important to know that the volatile index is in no way similar to the price index like the NIFTY. While the price index is calculated by taking into account the price movement of the underlying equities, the volatile index or India VIX is calculated using the orderbook of the underlying index options and is represented in the form of a percentage.
The India VIX gets its value derived by using the Black and Scholes model or the B&S model as it is popularly known. This index uses five variables including the strike price, market price of the stock, time to expiry, risk free rate and volatility. The India VIX value is determined by the bid-ask quotes of near and next month NIFTY options contracts traded on the NSE’s F&O segment. The India VIX value has a direct relation with the volatility, which means that higher the value of India VIX, higher is the volatility. Whereas, lower the value of the India VIX, lower will be the volatility in the market.
From the above explanation, it is clear that knowing the value of the India VIX helps the market investors to understand the volatility of the market in the next near term, which may prove to be beneficial to them before making any decisions regarding market investments in the coming term.
What elements are considered while calculating the India VIX or the volatility index?
While calculating the India VIX or the volatility index four main elements are taken into consideration. These elements include time to expiry, interest rates, forward index level and bid ask. To understand what role each of these elements play in the calculation of India VIX, let us go through them one by one.
Time to expiry Instead of taking days to calculate the time to expiry, it is calculated within minutes to achieve a level of precision which is expected by the traders.
Interest rate While considering the risk-free interest rate for the respective expiry months of the NIFTY options contract, the relevant tenure rate which is for 30 to 90 days is taken into account and considered as the risk-free interest rate.
Forward index level The out of money options contract which is considered while calculating the volatile index is identified using the forward index level. The at-the-money strike that helps in selecting the said options contract is determined by this forward index level. Thus, the forward index level plays an important role in the calculation of India VIX and is taken into account as the most recent available price for the NIFTY futures contract for the respective expiry date.
Bid-Ask The strike price for the NIFTY option contract is the ATM strike which is available at a slightly lower level than the forward index level. The bid and ask prices for the options contracts are taken into account while calculating the India VIX or the volatile index.
The applications of India VIX in the Indian Market
India VIX is a reliable and sound indicator of the market volatility and fluctuations which informs the intraday traders about the rise and fall in the market volatility. This helps them to determine the market risks for equities. If the volatility in the market is at a rise these traders face a risk of their stop losses being triggered and hence, they might want to lower their leverage or expand their stop losses. To make this decision knowing the market conditions is extremely important which is provided by the India VIX or volatility index.
This index also helps long term investors. Although these investors are not much affected by short term volatility, they may face the risk of MTM loss restrictions. Hence, knowing the volatile index value might help them make the right decision about their market investments.
Options traders are also highly benefited by the India VIX. The volatility index may prove to be a reliable indicator for them to decide whether to buy or sell an option given the market volatility. In a more volatile market, buyers benefit the most, whereas in a less volatile market sellers of the options benefit the most.
India VIX is also an useful index for the portfolio managers and mutual fund managers. The rise and fall in the VIX helps them to decide when to invest in the high beta or low beta stocks to reap the maximum benefits.
What is the Relation of India VIX and Nifty?
Nifty is a market index whereas, India VIX is a volatility index. While market indices such as the Nifty measure the direction of the market and is evaluated based on the price movements of the underlying stocks, a volatility index such as India VIX indicates the volatility of the market and is calculated using the order book of the underlying index’s options. India VIX has a strong negative correlation with Nifty. When the India VIX falls, the Nifty is seen to rise and vice versa.
