India VIX
VIX in trading terminology is short for Volatility Index. It is a measure of expected market’s volatility in the near term. India VIX is index by NSE (National Stock Exchange) to denote volatility in the Indian Stock Market.
India VIX is a volatility index based on the NIFTY Index Option prices. From the best bid-ask prices of NIFTY Options contracts, a volatility figure (%) is calculated which indicates the expected market volatility over the next 30 calendar days. India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to the NIFTY options order book using cubic splines, etc.
Note: “VIX” is a trademark of Chicago Board Options Exchange, Incorporated (“CBOE”) and Standard & Poor’s has granted a license to NSE, with permission from CBOE, to use such mark in the name of the India VIX and for purposes relating to the India VIX.
To know about Indian VIX in detail, you can read this whitepaper by NSE in India VIX – Whitepaper
Here is a quick version:
The India VIX, also known as the volatility index, is a key measure of the expected volatility in the Indian stock market over the near term. It indicates how much movement or fluctuation market participants expect in the Nifty 50 index over the next 30 days.
It is calculated based on the prices of Nifty 50 options contracts, which are financial derivatives that give the holder the right but not the obligation to buy or sell the Nifty 50 at a predetermined price on or before a specific expiration date.
How is India VIX Calculated
Specifically, the India VIX uses the implied volatility values of different Nifty 50 put and call options across a wide range of strike prices. Implied volatility is a measure of the expected future volatility of the underlying Nifty 50 index based on current option prices.
A complex mathematical formula is used that considers both call and put implied volatilities across all available strike prices. The formula places greater weight on at-the-money options with strike prices closest to the current Nifty 50 level compared to out-of-the-money options.
The output is expressed as an annualized percentage number – so a VIX level of 20 indicates the Nifty 50 is expected to move up or down by 20% over the coming year. The higher the VIX level, the more volatility the market is expecting in the near term.
The factors considered in the computation of India VIX are mentioned below:
1) Time to expiry:
The time to expiry is computed in minutes instead of days in order to arrive at a level
of precision expected by professional traders.
2) Interest Rate:
The relevant tenure NSE MIBOR rate (i.e 30 days or 90 days) is being considered as
risk-free interest rate for the respective expiry months of the NIFTY option contracts
3) The forward index level:
India VIX is computed using out-of-the-money option contracts. Out-of-the-money
option contracts are identified using forward index level. The forward index level
helps in determining the at-the-money (ATM) strike which in turn helps in selecting
the option contracts which shall be used for computing India VIX. The forward index
level is taken as the latest available price of NIFTY future contract for the respective
expiry month.
4) Bid-Ask Quotes
The strike price of NIFTY option contract available just below the forward index
level is taken as the ATM strike. NIFTY option Call contracts with strike price above
the ATM strike and NIFTY option Put contracts with strike price below the ATM
strike are identified as out-of-the-money options and best bid and ask quotes of such
option contracts are used for computation of India VIX. In respect of strikes for
which appropriate quotes are not available, values are arrived through interpolation
using a statistical method namely “Natural Cubic Spline”
After identification of the quotes, the variance (volatility squared) is computed
separately for near and mid month expiry. The variance is computed by providing
weightages to each of the NIFTY option contracts identified for the computation, as
per the CBOE method. The weightage of a single option contract is directly
proportional to the average of best bid-ask quotes of the option contract and inversely
proportional to the option contract’s strike price
Computation of India VIX
The variance for the near and mid-month expiry computed separately are interpolated to
get a single variance value with a constant maturity of 30 days to expiration. The square
root of the computed variance value is multiplied by 100 to arrive at the India VIX value.
What do these extreme VIX levels mean for options writers?
The Indian VIX also plays a very important role in option pricing. Higher levels typically indicate greater option price volatility, while a stable range means that option prices are relatively cheap.
In other words, high VIX levels expose option writers to unlimited risk for limited reward (premium). A put/call option that is deeply out of the money can become an in the money or even an out of the money option in a few trading sessions.
For example, the price of XYZ stock is Rs 300 and the trader has sold 280 put option contracts (2,000 shares) for a premium of Rs 10 and there are 7 days left before expiry. So with the current volatility, the share price can reach 240 rs in 2 trading sessions. The seller’s loss on the option with 5 days to go is therefore
- Exercise price : Rs. 280
- Cash price: Rs. 240
- Deserved bonus: Rs. 10
Here is the loss for the option writer: Rs. (240+10-280), i.e. a loss of Rs. 30 per party, which amounts to a loss of Rs. 60,000 (2000*30) per party. Therefore, the option’s writer should ideally avoid selling contacts, and even if he does, the premium charged should also be higher.
Summary
In summary, the Indian Vix is a volatility index that measures market expectations for volatility in the near future. We can say that the Indian Vix is a discrete but very effective indicator for assessing the range of an index, which in turn gives us a clear idea of the expected movement of the share price.
Historically, high Vix values have always been followed by large movements in indices and stock prices. Similarly, when options are priced, the premiums charged increase or decrease with changes in the Vix level.
India VIX provides a single numerical estimate of future market volatility derived from the implied volatilities of a wide range of Nifty 50 options. It acts as an investor sentiment and market risk indicator.
Frequently Asked Questions
What does India VIX mean?
India VIX is the volatility of the Indian stock market.
What does a VIX of 15 mean?
In summary, a VIX level of 15 indicates quite low expected stock market volatility and fear, which often occurs when markets are rising steadily or at cyclical peaks. It suggests smooth short-term conditions are priced into options by market participants.