-By Avinash Kumar
Before 1993 there was no index or mechanism with the help of which investors quantify the market volatility expectations. In 1993, the Volatility Index (VIX) was created by the Chicago Board Options Exchange (CBOE), popularly known as CBOE VIX to fill the gap in how investors understood market risk. Before its creation, there wasn't a way to easily gauge the market's expectation of future volatility. Traditional methods relied on historical data, which only told you what had already happened. The VIX is based on option prices of the S&P 500, a US stock market index.
In 2008, the NSE modeled India VIX to create its own volatility index. It is also termed as ‘Fear Index’ because it represents the level of fear, stress, or risk in the market. India VIX represents expected annual volatility in Nifty50 over the next 30 days. It being a leading indicator simply reflects investors' sentiment about the market. The ideal range of index is between 15%-35%. A higher VIX indicates bearish market sentiments in the stock market, as investors increasingly demand safe-haven assets or hedging strategies. A decrease in VIX implies growing trader confidence, usually resulting in bullish market feelings.
Derivation of India VIX
The India VIX gets its value derived by using the Black and Scholes model, popularly known as the B&S model. This index incorporates five components: the strike price, market price of the stock, time to expiry, risk-free rate, and volatility.
Strike price: This is the set price for options on the Nifty 50 index to be sold or bought. It’s typically based on options that are not yet in profit.
Market price of the stock: It’s the most recent trading price of the Nifty 50 index stocks.
Time to expiry: This refers to how much time is left until the Nifty 50 index options are no longer valid, which is usually a maximum of one month.
Risk-free rate: The VIX calculation incorporates the yield on government bonds, considered the safest investment, as the risk-free rate. The yield of the government bonds determines the index options' yield.
Volatility: This is the key element, and it’s about the expected intensity of price changes in the Nifty 50 index within the next month. The price behaviour of Nifty 50 index options is used to infer underlying market conditions.
India VIX and Nifty50
Nifty50 is a market index while India VIX measures market volatility. While market indices such as the Nifty measure the direction of the market and are calculated by taking into account the price movement of the underlying equities, the volatile index or India VIX is calculated using the order book of the underlying index options and is represented in the form of a percentage. India VIX has a strong negative correlation with Nifty. The Nifty50 rises when the India VIX falls, and it falls when the India VIX rises.
India's VIX, which had remained low at below 30 since 2014, reflecting stability, increased post-COVID. Amid the pandemic, India's VIX value surged to 70. The equity index fell
around 40% to the 8000 level during that time.
Recent Developments
Since February 2024, India VIX has seen a declining trend. Since the start of 2024, the market has recorded uninterrupted growth, with each dip being purchased. India's VIX fell by 2.96%, and 17.60% in February and March respectively, and rose by 0.29% in April. So far India's VIX is down by 11.25% in 2024.
The decrease in geopolitical tensions following Israel's subdued response to Iran's drone and missile attacks may have led to the index falling 19.7 percent to conclude trading at 10.2. This was the deepest correction since May 23, 2019, and the 12th largest single-day decline for the index since 2008. The sharp falls in India VIX occurred only after the general election results were announced. In 2014 and 2019, the stock price decreased by approximately 34% and 30% respectively, on the day of the results. India breathes a sigh of relief following the election results, as uncertainty subsides. Markets may have already priced in a BJP win. Currently, the VIX level is 12.87.
Bottom Line
Market volatility is an unavoidable component of investing and should be a factor in any portfolio. While volatility predominantly depends on the factors of demand and supply, when assets, securities, or financial instruments are high in demand and low in supply, price hikes are common. Conversely, prices tend to fall when there is low demand and high supply.
Therefore, understanding market volatility and India VIX can help traders and investors make informed decisions about their investments. India VIX plays a vital role in conveying the investor's confidence in the market. It is a leading indicator that can help intraday and swing traders by reflecting perceived market direction based on volatility. And most important the VIX doesn't predict market direction, it measures market volatility. Apart from this, it is calculated for an Index and not a stock.
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