Explained: What is India VIX or India Volatile Index?

Have you heard of India Vix before? If you've been following the stock market for a while, and especially during the COVID19 Pandemic, I'm sure you've seen the word "India Vix" referenced on a few various financial news channels and websites.

To understand the VIX. Let's take a look at volatility and index independently.

Volatility – Volatility means the unpredictable period when the prices of security witness rapid fluctuations. Due to factors like Political, Economic, Industry, and Company performance. Volatility is Unavoidable as it depends on numerous internal and external factors.

Index- An index is an indicator or measure of something. In finance, it typically refers to a statistical measure of change in a securities market. In the case of financial markets, stock and bond market indexes consist of a hypothetical portfolio of securities representing a particular market or a segment of it. India has 2 major Indices, Nifty – which consists of 50 stocks and Sensex with 30 Stocks.

Similarly, to measure market volatility, we have a volatility index known as the VIX or Fear Index.

Volatility Index (VIX)

It measures the market’s anticipation of volatility in the near term. During Moments of market volatility, the market typically moves sharply up or down and the volatility index tends to climbor fall.

Consider a situation like, lockdowns, monetary policy, elections, and geopolitical concerns.

Tension or dread frequently rises when investors are unable to foresee the result of an event. The volatility index is expected to climb at this time. After the outcome is disclosed, the VIX will calm down.

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 determine 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.

India VIX was introduced by the NSE in 2008, but the concept was originally introduced by Chicago Board Options Exchange in 1993.

The VIX, formally known as the Chicago Board Options Exchange (CBOE) Volatility Index, measures how much volatility professional investors think the S&P 500 index will experience over the next 30 days.

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 in the Nifty Index.

Further, for example, if the current Index is trading at 15,000 and India VIX trading at 20. Then, expected volatility over next year over 30 days will be:

Index spot: 15,000

India VIX: 20(%)

The expected downside for the year = 12,000 (20% of 15,000 = 3,000)

The expected upside for the year = (15,000+ 3,000 = 18,000)

Here, the expected range for the year is between (12,000 and 18,000) for that index.

Difference between the Price index and the Volatility Index

The volatility index is not the same as the price index like the nifty. The price is calculated by taking the price movements of underlying equities into account.

The volatility index is calculated as an annualized percentage using the order book of the underlying options and is represented in the form of a percentage.

India VIX has a strong negative correlation with Nifty. When the India VIX falls, the Nifty is seen to rise and vice versa.

How VIX is Calculated

The India VIX Index is calculated by the NSE, from the Order book of nifty options. The best bid-ask quotes of the near and next month nifty options contracts traded on the NSE’S F&O.

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, the market price of the stock, time to expiry, risk-free rate and volatility.

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 that 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 Importance of VIX

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 (2008), 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 levels and traded near 50 levels (trading above 80 for a few days) and we have seen the Indian Equity Index losing nearly 40 per cent 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.

How option writers use VIX

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.

Trading India VIX

India VIX is an Index, and very similar to Nifty, you cannot really trade an index unless you have derivative (F&O) contracts on them. With the introduction of India VIX futures, we can use the India VIX to hedge the volatility risk to our portfolio and/or use it to speculate.

Lot size: 550

Symbol: INDIA VIX

Tick size: India VIX will be calculated up to 4 decimals with a tick size of ₹0.0025 (for example, India VIX today is 17.0025)

Quotation price: India VIX * 100 (multiples of 100). If a trader wants to buy or sell contracts of India VIX futures at 14.1475, then the price that shall be quoted would be Rs.1414.75.

Trading hours: 9.15 AM to 3.30 PM

Expiry Day: Tuesday (Every Week)

Contract Cycle: 3 weekly contracts

Final Settlement Price: Closing Price of the underlying India VIX Index

Final Settlement procedure: Cash

Margin: Initial Margin of 9% + Exposure Margin of 5% = 14% of the contract value.

To conclude, the India VIX is a volatility Index that represents market expectations for near-term volatility. India VIX is a silent but very powerful indicator for gauging the range play for the Index, which gives us a clear picture of the predicted share price movement.