It was the Chicago Board Options Exchange which originally came up with the term VIX in 1993 and the NSE, with the CBOE’s permission, kicked off the India VIX a few years ago.
What is India VIX
India VIX (https://www.nseindia.com/live_market/dynaContent/live_watch/vix_home_page.htm) is a volatility index , also called the Fear Gauge, based on the index option prices of Nifty.
The VIX calculation is based on the Black Scholes Model which is used to price options contracts. The Black Scholes model uses five key variables to arrive at the ‘fair price’ of an options contract: the strike price of the contract, the market price of the stock, the time to expiry, the risk-free rate and volatility. The VIX arrives at the volatility expected by the traders in the market by back-working from buy-sell prices of Nifty options contracts.
India Vix uses 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 expected annualised market volatility over the next 30 calendar days. Higher the India VIX, higher the expected volatility and vice-versa.
For example, if India VIX is 14.60, it implies an expected annual change of 14.60% in the Nifty over the next 30 days. That is, you expect the value of Nifty to be in a range between +14.6% and -14.6% from the present price of Nifty for the next 1 year for the next 30 days. So if Nifty is presently at 10,000 the expected range of Nifty for 1 year is between 8540 and 11460.
If you want to calculate expected volatility for the near term using the VIX, say a month then formula to use is (VIX/Sqrt (T)) %.The formula for that is VIX divided by the square root of T. If you want the volatility for “x” days then T would be “365/x”. So for example if you want to calculate the expected range of Nifty for one month then T would be 365/30 which is approximately 12. Based on the value of India VIX which was taken above 14.6, the expected variation in Nifty for the month would be 14.2/Square Root(12) = 4.2 %.
Past Behaviour of Vix Vs Nifty
1. A negative correlation between India VIX and Nifty: VIX tends to drop when Nifty goes up, and vice versa.
2. India VIX at high levels implies a market expectation of large movement in Nifty and vice versa.
3. Looking at the past data, one can infer that VIX is considered frighteningly high if it is above 20 and low if it is below 15..
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.
Here are some of the ways of using the India VIX futures
1. You have a stock portfolio and are worried about markets going down, or volatility increasing : buy India VIX futures.
2. You see that India VIX is at the top end of the multi year range, and you speculate that it is going to go lower , you can short India VIX futures.
3. A major event is around the corner and you find the India VIX very low and expect the volatility in the market to pick up, you can buy India VIX futures.
Technical Analysis and India VIX
If you look at the India VIX historical data, it is an easy observation that it is not a trending data series but rather an oscillating data series (range has stayed between 11 and 35). Since the India VIX doesn’t trend after a certain point, but rather oscillates in a range, we shouldn’t use trending indicators like moving averages, but rather use oscillators. Using these, one can make views on the expected behavior of the Nifty especially after sharp rises or corrections – example, reducing Vix after a sharp correction may imply a reversal is visible soon and vice versa and allow you to enter a trade faster than conventional technical tools.
Not only does the VIX tell you a lot about what’s happening right now, it also lets you look at the past. You can compare the current value to the 52 week high and low of the values and then make your trading decision. If it is closer to the lower band then you can expect a huge rally coming up in Nifty soon and similarly you can exit your positions if the value is touching the upper band. You can form numerous trading strategies based on the India VIX.