What is India VIX (Volatility Index)? | How VIX works?

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The India VIX (Volatility Index in short), is an indicator or measure of the expected volatility in the stock markets. It is also seen as an index that reflects the level of fear among market participants, serves as the proxy for overall market's riskiness.

5 Ways to Use India VIX (Volatility Index)

Introduction

The India VIX (Volatility Index in short), is an indicator or measure of the expected volatility in the stock markets. It is also seen as an index that reflects the level of fear among market participants, serves as the proxy for overall market’s riskiness.

Detailed Stock Analysis by Invest Yadnya
Stock Analysis by Invest Yadnya

What is India VIX (Volatility Index)?

  • Do you know that behavioural economics researchers who study our emotional connection with money say that losing money feels twice as bad as making money feels good?
  • So, the negative feelings with decreasing portfolios values are much more powerful than positive emotions of portfolio growth.
  • That is why there is a negative connotation generally attached to the term volatility.
  • Lets discuss in detail what is volatility and what is a volatility Index?

What is Volatility?

  • Theoretically Volatility means rate of magnitude of price changes in a given period of time. Thus, in simple words it is fluctuations in the stock price or market index in a specific period of time.
  • In stock market, it determines the change of prices of stocks, indices and other market related instruments.
  • If the price stays relatively stable, the security has low volatility.
  • A highly volatile security hits new highs and lows quickly, moves erratically, and has rapid increases and dramatic falls.

How to Measure volatility?

  • The indicators – Beta and Standard Deviation measure the stock volatility, whereas VIX (Volatility Index) measures the Market volatility.
  • A Beta tells us the movement in a stock’s or a portfolio’s returns in relation to that of the market returns.
  • Standard Deviation is a statistical tool, which measures the variability of returns from the expected value, or volatility.  To put it simply If the data points are further from the mean, there is a higher deviation within the data set; thus, the more spread out the data, the higher the standard deviation.
  • As far as high volatile stocks are concerned, lets discuss about Axis Bank stock. Last 1 month’s mean is around 406 /407. However, the stock has touched 478, 380. Thus, the difference between the data points from this avg gives you an idea of how volatile the Axis Bank stock is!
How Do You Measure Stock Volatility?
Axis Bank – How Do You Measure Stock Volatility?

In our Model Portfolios, we look at stock betas and their standard deviations while constructing our model portfolios too.

What is VIX?

  • Beta and Standard Deviation are the measures for Stocks, Mutual Funds and Portfolios. But what about market volatility?
  • VIX Index tells us in the near term what are the volatility expectations from the market. 
  • It was launched by the National Stock Exchange (NSE) in 2008 and is also knows as Fear Index.
  • This volatility index measures the expected volatility in a given market over a 30-day period (in general).
  • VIX measures the expected fluctuations in the market index and hence serves as the proxy for overall market’s riskiness.
    1. A higher (lower) value for the volatility index indicates that market expects greater (lesser) fluctuations in either direction over the next 30 days
    2. While, a lower value for the volatility index indicates that market expects lesser fluctuations in either direction over the next 30 days

How Is VIX (Volatility Index) Calculated?

  • Have you ever analysed the NIFY50 options order book?
  • There is model for option pricing which is called Black Scholes Model where in 5 inputs are there :
    1. Strike Price of Contract
    2. Current Market Price of the Stock
    3. Time to Expire
    4. Risk-free Rate
    5. Volatility
  • The VIX arrives at the volatility expected by the traders in the market by back-working from buy-sell prices of Nifty50 options contracts
  • The resultant index measures the degree of volatility or fluctuation that active traders expect in the Nifty50 over the next 30 days.
How Do You Measure Market Volatility – Volatility Index (VIX)
How Do You Measure Market Volatility – Volatility Index (VIX)

How to Decipher the VIX Number?

  1. VIX represents the expected annualized change in the Nifty50 over the next 30 days.
    • To simplify, a VIX of say 10 means that, for the next one month, market participants expect the Nifty 50 to move by an annualized rate of 10% in either direction.
    • A 10% move in one year, as you can well gauge, is not a high number.
  2. Another way is you look at is to compare the number with 52 weeks high and low, as of 15th May India VIX is at 38.01.
    • 52 weeks high is 86.63 around which is reached around 24th March 2020 and low is 9.16 sometime in Jan 2020.
    • The current VIX of 38.01 is clearly somewhere in between the lower and upper range. That indicates that the market is still fearful but not as much as it was in March.

How VIX Can be Useful for a Retail Investor?

  1. Long term investors can tweak their sector exposure and hedges based on shifts in VIX.
    • For example, if VIX is moving up sharply, then investors can shift to defensive sectors or increase their hedge ratio.
  2. VIX adds a lot of value for traders. It is possible to trade VIX futures on the NSE.
    • For example, if you expect volatility in the market to go up, then the VIX would go up. In such a case you can buy VIX futures.
    • Here the trader is only taking a view on volatility, not the market direction. These types of trades are very useful in times of key events or key announcements and policies.
  3. Inverse correlation with NIFTY50
    • India VIX also has a strong negative correlation with Nifty :
      1. Every time when India VIX falls, Nifty rises and
      2. When India VIX rises, Nifty is bound to fall
    • Considering historical data, India VIX soared to peak a few days before Nifty touched a bottom post-Lehman crisis.
How VIX Can be Useful for a Retail Investor – Applications of VIX
How VIX Can be Useful for a Retail Investor – Applications of VIX

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