The India VIX is a volatility index based on the National Stock Exchange's (NSE) index option prices. It is designed to indicate investors' expectations of market volatility over the next 30 calendar days, with a higher India VIX indicating higher expected volatility and vice versa. The popularity of trading volatility has grown immensely over the years, and with the increasing popularity of option trading in India, the India VIX is expected to follow a similar trend.
The India VIX can be used as a tool to hedge against portfolio volatility risk or for speculative purposes. For example, if an investor is worried about market volatility affecting their stock portfolio, they can buy India VIX futures as a hedge. On the other hand, if the India VIX is at the upper end of its historical range, an investor might speculate that it will decrease and short the India VIX futures.
Historically, investment made when the India VIX is high has generated higher returns relative to a 'timing-agnostic' investment approach. For instance, during the coronavirus pandemic, the India VIX soared 42%, and the average alpha generated from investing during this high-volatility period was 234 basis points for equities. Therefore, investors who can tolerate the risk may consider investing when the India VIX is high to potentially benefit from higher returns.
Characteristics | Values |
---|---|
Lot size | 750 (Reducing to 550 effective 2nd July 2014) |
Tick size | Calculated up to 4 decimals with a tick size of Rs 0.0025 |
Quotation price | India VIX * 100 (multiples of 100) |
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 |
What You'll Learn
Using India VIX to hedge portfolio volatility risk
The Volatility Index, or India VIX, is a weighted index that blends several S&P 500 index options, with the idea that the greater the premiums on these options, the more uncertainty about the market's direction. The VIX is often referred to as the "fear index", as rising volatility often signals downside risk. It is also called the "uncertainty index" because there is a strong link between fear and uncertainty on Wall Street.
The VIX is a useful tool for investors to hedge their portfolios against volatility risk. Here are some ways to do this:
Exchange-Traded Notes (ETNs)
ETNs are one of the most popular ways to trade the VIX. Similar to ETFs, ETNs allow investors to buy and sell instruments designed to replicate certain target indices. In the case of VIX, these ETNs hold a collection of rolling VIX futures contracts. They are relatively cheap to buy and sell, and any broker can handle the trades. It is important to note that ETNs are not identical to the spot VIX and can deviate from it during periods of high and low volatility. Leveraged VIX ETNs also exist but suffer from "volatility lag", which hurts performance over time.
VIX Futures and Options
More sophisticated investors can trade options and futures on the VIX index itself. These instruments offer greater leverage and return potential but come with higher commissions and, in the case of futures, minimum margin requirements. There are also different tax treatments on gains and losses, especially for futures contracts. VIX options are European-style, meaning they can only be exercised upon expiration, and they expire on Wednesdays. VIX futures tend to better replicate the movements of spot VIX than ETNs.
Strangles and Straddles
Investors can also use strangles and straddles, which are option strategies that trade on the expected volatility of an index or security. A long straddle involves buying a call and put option on the same security with the same strike price and expiration. A strangle involves buying a call and put option for the same underlying security, with the same expiration but different strike prices. These strategies can be cheaper to buy but may require larger price moves to produce a profit.
Index Puts
If an investor is simply looking to hedge market exposure, index puts may be the most efficient option. Puts are available on most major equity indices and are quite liquid. Investors need to calculate their exposure correctly, but puts are a simple way to hedge against the risk of short-term market pullbacks.
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How to interpret the VIX
The VIX is a volatility index based on the index option prices of Nifty. It is designed to indicate investors' expectations of market volatility over the next 30 calendar days. The higher the VIX, the higher the expected volatility, and vice-versa.
- If the VIX is 16.8025, this represents an expected annual change of 16.8025% in the Nifty over the next 30 days. That is, you expect the value of Nifty to be in a range between +16% and -16% from the present price of Nifty for the next 1 year for the next 30 days. So if Nifty is presently at 6000, the expected range of Nifty for 1 year is between 5000 and 7000.
- If you want to calculate the expected volatility for the near term, let's say a month, then the formula to use is (VIX/Sqrt (T)) %
- If you want to know what the expected monthly volatility of Nifty is based on a VIX of 16.8025, you should divide 16.8025 by the square root of 12 (T = 12, 12 30-day terms in 1 year). So the expected volatility of Nifty using VIX for the next 1 month = 16.8025/3.464 = 4.85%
The VIX is commonly referred to as the market's "fear gauge" as it spikes during market turmoil or periods of extreme uncertainty. A VIX reading below 20 suggests a perceived low-risk environment, while a reading above 20 indicates a period of higher volatility.
The VIX is, by nature, volatile; therefore, trading it is speculative. As such, self-directed investors should do their own research and ensure they are comfortable with the risks of losing some or all of their initial investment.
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How to calculate expected volatility for the near term
The India VIX is a volatility index based on the NIFTY Index option prices. It is calculated using the Black & Scholes model, which considers variables like strike price, market price of the stock, time to expiry, risk-free rate, and volatility. The index is calculated by the NSE using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY option contracts.
The India VIX measures the market's expectation of volatility over the next 30 days in the Nifty 50 index. A higher India VIX level signals high volatility and lower trader confidence about the current range of the market. Conversely, a lower VIX level implies lower expected volatility and a stable market outlook.
To calculate the expected volatility for the near term, one can use the formula: (VIX/Sqrt (T)) %. Here, T represents the number of 30-day terms in a year, which is 12.
For example, if the VIX is 16.8025, and you want to calculate the expected monthly volatility of Nifty, divide 16.8025 by the square root of 12. So, the expected volatility for the next month is approximately 4.85%.
This expected volatility range can be used by traders who deal with Nifty options, especially option writers. For instance, they can consider shorting options above or below the expected monthly range of the Nifty.
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Using India VIX instead of options
Using the India VIX instead of options can be beneficial for a volatility trader as it allows them to trade much more efficiently. This is because, in the real world, factors such as time decay (theta factor) and stock price (delta factor) do not remain constant while volatility is moving. As a result, it becomes challenging for a trader to purely trade volatility using options.
The India VIX, or volatility index, is calculated using the Black and Scholes model, which takes into account five variables: strike price, market price of the stock, time to expiry, risk-free rate, and volatility. The value of the India VIX is determined by the bid-ask quotes of near and next-month NIFTY options contracts traded on the NSE's F&O segment. The higher the value of the India VIX, the higher the expected volatility, and vice versa.
The India VIX is a useful tool for market participants to analyse market movements and gauge the underlying sentiment around volatility. It can also be used as a factor in making investment decisions. For example, if the India VIX is at the top end of its range (around 35), and you speculate that it will decrease, you can short the India VIX futures. On the other hand, if elections are approaching and the India VIX is around 20, indicating potential volatility in the market, you can buy India VIX futures.
The India VIX is also known as the "fear index" because it reflects the level of fear and uncertainty among investors. When the India VIX is high, it suggests that the market sentiment is excessively bearish, and when it is low, it indicates that the market sentiment is too bullish. This information can be used by contrarian investors to time their trades, buying when the VIX is high and selling when it is low.
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Technical analysis and India VIX
India VIX is not a trending data series but an oscillating one. Its range has stayed between 13 and 35. Since the India VIX doesn't trend after a certain point, it is better to use oscillators like Bollinger Bands instead of trending indicators like moving averages. The India VIX has reversed most of the time it has touched either the upper or lower end of the 20-day Bollinger Band.
Other oscillators can also be used to predict the move of the India VIX.
Momentum oscillators and candlestick patterns can also be used to analyse the India VIX.
Moving Averages Crossovers
Moving averages crossover is a technical indicator that helps identify trends and can be used to make informed trading decisions. It involves plotting two moving averages with different time periods on the same chart and observing how they interact. When the shorter-term moving average crosses above the longer-term moving average, it indicates a potential uptrend, while a crossover in the opposite direction suggests a potential downtrend.
Technical Indicators
Technical indicators are mathematical calculations based on a security's historical price, volume, or open interest data. They are used by traders and investors to analyse and predict future price movements, identify trends, and make informed trading decisions. Examples include:
- Relative Strength Index (RSI)
- Moving Average Convergence Divergence (MACD)
- Stochastics
- Rate of Change (ROC)
- Commodity Channel Index (CCI)
- Money Flow Index (MFI)
- Average True Range (ATR)
- Average Directional Index (ADX)
- Bollinger Bands
Seasonality Analysis
Seasonality analysis examines historical data to identify patterns or trends that recur at specific time intervals, such as certain times of the year, month, or day. For example, India VIX has given negative returns in November in 8 out of 14 years.
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Frequently asked questions
India VIX is a volatility index based on the index option prices of Nifty. It is computed using the best bid and ask quotes of the out-of-the-money, present, and near-month Nifty option contracts. VIX is designed to indicate investors' perception of the annual market volatility over the next 30 calendar days.
If the India VIX is 16.8025, this represents an expected annual change of 16.8025% in the Nifty over the next 30 days. That is, you expect the value of Nifty to be in a range between +16% and -16% from the present price of Nifty for the next 1 year for the next 30 days.
If you want to calculate the expected volatility for the near term, let's say a month, the formula to use is (VIX/Sqrt (T)) %.
This information can be used by people who trade Nifty options, especially the option writers. For example, shorting options above or below the expected monthly range of the Nifty.