What is India VIX | Meaning, Calculation & How it’s Works

Every Trader or investor, while trading, keeps an eye on the NIFTY50. Everyone thinks about why the market fluctuates like this.

To overcome the situation, let's discuss in this blog in detail, which helps to understand easily what the factors and challenges are, to simplify this problem

Quick Summary

As we know, India VIX is a parameter to check the market’s price, which is expressed as a percentage. It was launched by the NIFTY-VIX correlation in 2008. 

Investors use India VIX for portfolio hedging, option trading strategies, risk management,  and to present overall market sentiment.

Our focus in this article

• What is India VIX 

• Key variable used in India VIX 

• Importance of India VIX

• Application of India VIX in financial markets  

• Limitations of India VIX

 

India VIX Overview

India VIX (India Volatility Index) is a measure of how much the stock market is expected to move up or down. It is calculated by the National Stock Exchange (NSE) and shows the level of market volatility.

Instead of quantifying the increasing or decreasing stock prices, VIX measures the extent to which the prices may vary. 

High VIX is an indicator of increased uncertainty, whereas low VIX indicates stability and tranquility. 

What is the India VIX Index?

The India VIX is also called the India Volatility Index. VIX measures the price movement investors expect in the market based on important news items relevant to the market. On the contrary, a higher value means a rise in uncertainties and fear factors.

History of India VIX

India VIX began as a project inspired by the CBOE Volatility Index (VIX),  which measures the volatility in the market according to the index-option price of the S&P 500.

 During 2008, the National Stock Exchange adapted the VIX to the Indian market. VIX futures were started in NSE in 2014; the instrument also enables the market players to hedge against volatility risk.  

India VIX in the share market

The India VIX chart shows how the market is feeling during normal trading hours.

When the VIX rises sharply, it means investors are nervous and uncertain. When it goes down, it shows the market is calm and confident.

Investors and traders use this index to see when risk is going up or down. It doesn’t tell them which way the market will move, but it shows how strong or weak the market feels.

Calculation of India VIX

Understanding how India VIX is calculated is crucial for traders and investors who want to get the benefits of using India VIX.  

Key variable used in India VIX

1. Strike Price (K)

The NIFTY 50 Index can be exercised at a predetermined price, which is calculated using out-of-the-money call and put options.

 To make the calculation precise, the National Stock Exchange applies a weighted average of the implied volatilities from the selected option strike prices.

2. Market Price of the Stock (S)

This variable is the prevailing price of the NIFTY 50 index in the market, which is normally the latest price. 

The level of the forward index is calculated based on the NIFTY futures contracts and is used in determining the at-the-money (ATM) strike price, and is used to select relevant options contracts.

3. Time to Expiry (T)

Time to expire is the amount of time that the NIFTY options have before expiration. 

 In the case of India VIX, this time frame is normalized such that it relates to the 30 calendar days moving forward, since it is an index that is used to measure the volatility expectation in the short run.

 To get the accuracy needed by the professional traders, this time is perceived in terms of minutes and not in terms of days.

4. Risk-Free Rate (R)

The risk-free rate is meant to denote the risk-free interest rate on riskless investments, usually government bonds with specific maturity periods.

 In the case of India VIX, NSE assumes that the risk-free interest rate of the different expiry months of NIFTY option contracts is applied at a tenure rate of 30-90 days.

 This rate is used to compare and acts as a reference point to the theoretical value of options.

5. Volatility (σ)

The most essential variable in the calculation of the India VIX is volatility, which is interpreted as the perceived levels of price variations within the next 30 days of the NIFTY 50 index.

 In contrast to other variables that would be directly measured, volatility is implied by the market prices of the NIFTY 50 index option-derived volatility.

Applications of India VIX in Trading

India VIX serves as a versatile tool for different types of market participants, each utilizing it according to their specific investment objectives and risk tolerance.

 Understanding how various traders and investors apply India VIX can help you determine the most effective way to incorporate this volatility indicator into your own trading strategy.

For long-term investors

Helps to focus on extended Investment horizons and is generally less concerned with short-term market fluctuations.  However, India VIX still provides valuable Insights for this investor category in several ways. 

With Dhanarthi's news alerts, I can react instantly when the market gets volatile. This lets me quickly adjust my trades to turn uncertainty into profit.

For Institutional Investors

Mutual funds, insurance companies, and pension funds also operate under strict regulatory frameworks and strong risk management policies.

An increase in India VIX indicates the possibility of finding portfolio volatility that may be below these limits. The compliance of most institutional investors with the procedures of risk management is required.

Options Trader

India VIX is especially useful to options operators since volatility directly affects the price of options and option trading.

 Premium Pricing Insights: Greater VIX in India will signify advanced implied volatility, which correlates to greater option premiums. 

The benefits of options buyers in high VIX conditions are that they can make bigger profits due to larger price changes, and premiums are also higher than when VIX is low, supporting the higher entry cost.

Trading Volatility

Advanced traders can trade volatility directly rather than taking directional bets on market movements.

VIX Futures Trading India: VIX futures allow traders to take direct positions on expected volatility changes without worrying about market direction.

This approach is particularly useful when traders expect volatility to increase but are uncertain about whether markets will move up or down.

Correlation with NIFTY

One of the safest relationships in Indian markets is between the India VIX and NIFTY performance, which inversely correlates.

Historically, for the last few years, India VIX has remained in an inverse correlation with NIFTY movements. 

When VIX is lower, NIFTY goes up to higher levels, which represents market stability and investor confidence. When there are high VIX readings, usually NIFTY levels are lower, representing market fear and volatility.

For Portfolio Managers

Portfolio managers use the India VIX to inform tactical asset allocation decisions that maximize risk-adjusted returns.

 Portfolio managers vary their exposure to high-beta and low-beta stocks in accordance with VIX readings.

Importance of India VIX

India VIX stands as one of the most significant financial indicators in the Indian stock market, serving as a comprehensive barometer of market sentiment and future volatility expectations.

India VIX Formula :

NSE uses a modified version of the CBOE method. VIX calculation starts by gathering the best bid and ask quotes for a wide section of NIFTY Options

The formula is described that weights Implied volatilities from these prices and annualizes them for a clear, percentage-index-based.  

India VIX = 100 * √((Sum[Weighted Implied Volatility Squared])/Total Weight)

Predicting Volatility and Managing Risk

One of the primary importance of India VIX lies in its ability to predict market volatility and facilitate effective risk management strategies.

Unlike traditional indicators that rely on historical data, India VIX provides a forward-looking perspective on market risk. 

It captures the collective wisdom of thousands of options traders who are essentially betting real money on future volatility levels. 

Helps Traders Decide on Options Strategies

India VIX is a key factor in the selection of options strategy in a direct way, affecting the profitability and risk profile of trading strategies.

• Volatility Environment Assessment Options: The traders rely on the India VIX to assess the volatility environment at hand

•  High VIX environments (> 25): The implementer should consider selling options or setting credit spreads as the best approaches in high VIX environments (> 25).

• Low VIX Environment (Less than 15): Favors strategies of volatility expansion, including the purchase of options or the application of debit spreads.

• Minimal VIX Competitors (1-15): Minimum VIX is more flexible with its selection of strategies regarding directional perceptions.

Signal for cautious or aggressive investing.

India VIX is an important indicator of investment strategy and positioning. Market Sentiment Interpretation India VIX readings give definite indications about market sentiment:

• VIX Above 30: Signifies intense fear and insecurity, and usually gives counterintuitive purchasing chances to those investors who plan long term.

• VIX Below 15: Implicates complacency and possible overvaluation, should be handled with care.

• VIX 15-25: Reflects the normal market conditions that can be in terms of normal investment activities.

 

How are India’s VIX and Nifty related?

The connection between India VIX and NIFTY exhibits one of the consistent and reliable relationships in the financial markets of India. 

Historical Inverse Correlation: India VIX and NIFTY are negatively correlated with each other. Statistically, NIFTY and VIX are negatively correlated, which means NIFTY tends to rise when VIX is below 1.5. 

Studies have quantified the correlation between NIFTY and VIX, and typical correlation coefficients of between -0.6 and -0.8 indicate a strong inverse relationship.

VIX-NIFTY interaction is irregular throughout the market cycles:

• Bull Markets: It is marked by falling VIX values in addition to increasing NIFTY values.

• Bear Markets: Characteristic increasing levels of VIX with a decline in NIFTY prices.

• Market Transitions: They are often characterized by fluctuations in the VIX and NIFTY moves.

Interpreting Movements in India VIX

Understanding the directional movements of India VIX is fundamental for investors and traders seeking to decode market sentiment and anticipate potential market shifts.

1. Rising VIX: The Fear Factor Emerges

When India VIX begins to rise, it signals increasing uncertainty, fear, and expected volatility in the market.

 A rising VIX indicates that options traders are willing to pay higher premiums for portfolio protection, reflecting growing anxiety about potential market downturns. 

We will provide some rising period of India VIX that helps to interpret market conditions. 

2. Falling VIX: Calm Returns to Markets

It indicates decreasing volatility expectations, growing market confidence, and reduced fear among investors. This environment typically supports rising stock prices and more stable market conditions.

Some of the data that help to predict the Falling periods of the market, and how it has evolved :

Volatility in Smallcases

For smallcase investors (theme-based baskets), incorporating measured volatility will have even more significance.

If VIX readings are highly elevated, you may decide to hold back from new purchases, re-allocate, or just hold additional cash.

Conversely, if VIX remains unchanged, you can systematically invest in the smallcase stocks as long as the market stays the same.

How is Volatility Calculated?

In order to have a complete grasp of the volatility calculation of smallcases, investors desirous of measuring risk in a robust way will find this helpful. 

Smallcase platforms have chosen to amend their methodology to provide a greater responsiveness to risk measures that reflect the modern market structure.

For Smallcases Over 1 Year Old:

Volatility = a/b where:

a = [0.7 * Average(Rolling 1y standard deviation of smallcase's daily return for last 1Y) + 0.3 * Average(Rolling 1y standard deviation of smallcase's daily return since launch except last 1Y)]

b = [0.7 * Average(Rolling 1y standard deviation of Nifty's daily return for last 1Y) + 0.3 * Average(Rolling 1y standard deviation of Nifty's daily return since launch except last 1Y)]

For Smallcases Under 1 Year Old:

Because we don't have enough historical data to statistically calculate new small cases, the platform will use asset allocations as a proxy for volatility: 

For example, if the portfolio has the following equity weight:

• Below 40%: Low Volatility label

• Between 40-70%: Medium Volatility label

• Above 70%: Further insights into equity allocation specifically to large-cap equities.

Volatility Ratio

The Volatility Ratio (VR) is your primary metric that can be used to classify your smallcases into a risk range. It helps investors determine, at a glance, whether a smallcase meets their risk objectives. 

When justifying volatility ratio categories, you will want corrected thresholds that are also better for market conditions.

Applications of India VIX in the Indian Market

The India VIX is a great indicator for the Indian market, offering useful information for investors and traders to make better decisions related to their Stock Investment trading. 

Some factors that affect the India VIX in relation to Stock Investment trading: 

Risk Assessment

India VIX serves as a kind of weather forecast for the stock market, indicating the potential for an impending storm. 

The higher the VIX, the more uncertainty and volatility are expected, and this is a signal to investors to prepare for risks in the market. 

Monitoring VIX helps determine when being cautious is warranted versus being more active on the risk spectrum.

Option Pricing

India VIX functions as a weather forecast for the stock market, where VIX indicates the potential for a severe storm ahead. 

As the VIX moves higher, uncertainty and volatility can be expected, which is a risk signal to investors to prepare for risk in the market. 

Assessing the VIX helps choose moments when caution is deserved or more action is required on the risk spectrum.

India VIX Hedging

India VIX is used as a method to protect investors ("hedge") in the event of a large potential market decline. Let's say, for example, that VIX spikes.

 In this case, it may make sense to invest in options or VIX futures as a hedge against a decline in your portfolio. 

By utilizing options or VIX futures, you can potentially limit losses in the event of a sudden market decline as volatility increases, which, in turn, can offset some of the risk in your portfolio.

Asset Allocation

In general, when the VIX goes up, a lot of investors will choose a safer mix in their portfolio; they will prefer steadier sectors like consumer staples or gold.

  Conversely, low levels of the VIX are thought to be calmer periods and provide more allocation in equity positions. 

Overall, you should always check the VIX over periods regularly, and you can increase or decrease your investments based on market mood and your comfort level, based on growth or safety. 

Market Timing

Many traders and investors watch VIX for signals about whether to enter or exit the markets.

 An especially high VIX may signal a better alternative at the moment is to be on the sidelines, while a low VIX may signal a greater alternative is to be more engaged. 

VIX can thus serve as an aid to time purchases appropriately and sales effectively.

Useful for Portfolio & Fund Managers

Yet, professional fund managers will carefully consider using the India VIX as a tool to guide them towards making any big investment decisions, especially if there is a sudden, sharp change in the VIX values. 

They may start implementing defensive stock strategies or even start diversifying the stocks into other investment classes. 

In such a scenario, the VIX can act to give some measure of stability to the manager's portfolio through tough and easy times so that they can shield and grow their investors' wealth.

Factors considered while calculating the India VIX

The India VIX, the Indian volatility index computed by the National Stock Exchange (NSE), measures the level of uneasiness or expectations of volatility of the market for the next 30 days that arise from prices of NIFTY index options. Some important factors considered in its calculation include:

Expiry time :

Time to expiration is one of the major variables in NIFTY index options. India VIX uses near-term index options and next-term index options.

 Near-term ones usually expire in fewer than 30 days, and next-term options expire more than 30 days.

 This weighting of index option prices helps ensure that the index captures a 30-day volatility horizon.

Interest Rate:

This rate does not match the risk-free rate as it is normally understood. It is used in the computation, and it is equal to the interest at which government securities (suppose Treasury Bills) having a maturity near the expiry date of the option are outstanding.

 It is the cost of carry interest of short and long positions that influences the price of options on which VIX is pegged.

Forward Index level :

The forward index level, which is derived based on the ATM strike prices of the NIFTY option, is the expected value of the NIFTY index in the future at the expiry of the option in question. 

It can be deduced as the forward price of the difference in the price of a put and a call option.

Bid-Ask Prices :

The India VIX is calculated by considering the bid and ask prices of out-of-the-money (OTM) call and put prices of the NIFTY index. 

These are market volatility expectations where the midpoint of the bid-ask spread is normally applied to ensure that it is the correct one and represents adequate liquidity.

Limitations of India VIX

• The India VIX calculates future market changes on NIFTY 50 option premiums, although there are some disadvantages. 

• It is pegged on the coming 30 days, thus failing to give any long-term trends or surprises.

• It is also volatile only to the NIFTY 50 options; therefore, it does not capture volatility in another region of the market, such as small caps or small stocks. 

• The index can be affected by events taking place in the world or a change in policies, which may not be represented in the index.

• It also presupposes stability, which may give spurious results in dynamic market conditions.

Conclusion

India VIX is a volatility index that captures the expectation of volatility expressed by the market. 

It acts as a barometer of fear or confidence in the market and assists investors in better judging risk management, portfolio management, and trading strategies. 

As a way of keeping pace in your investment life and enjoying real-time market intelligence, like VIX, download the Dhanarthi app. 

Dhanarthi lets you have a fundamental stock analysis tool on real-time information and have personal strategies to make smarter Investment decisions.

Disclaimer: This article aims to provide general information about financial topics. It is not a recommendation to buy or sell any investment. For investment decisions, please consult a professional financial advisor.

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