India VIX

About India VIX

Market volatility is a key component for stock market investors. In finance, volatility represents the risk and is defined as the extent of price variation. The volatility index (VIX) is the expected level of fluctuation in the short term.

VIX is a trademark owned by the Chicago Board Options Exchange (CBOE) and Standard & Poor's (S&P) has authorised NSE to use this mark in India.

The India Volatility Index, also known as India VIX, is an indicator of the anticipated level of volatility in the National Stock Exchange (NSE) index for the upcoming 30 days. It is calculated to see the potential price fluctuations in the market.

History of Indian VIX

The India VIX was introduced by the NSE in 2008. It is computed based on the current index option prices of the NIFTY and is generally expressed as a percentage rather than an absolute value. India VIX is a volatility index derived from the prices of NIFTY Index Options. Computing a volatility percentage from the optimal bid-ask prices of NIFTY Options contracts represents the anticipated market volatility.

India VIX and Volatility

India VIX includes five variables in its calculation. These are strike price, market price of the stock, expiry date, risk-free returns and volatility. It looks at the expected volatility by investors, considering the best bid and ask quotes of out-of-the-money, present and near-month NIFTY options contracts.

VIX and volatility are inversely proportional. A higher VIX suggests increased market volatility, while a lower VIX indicates reduced volatility in NIFTY. A VIX value of 15 means that investors anticipate price fluctuations within the range of +15 and -15 over the next 30 days. Theoretically, VIX fluctuates between 15 and 35. A value near or below 15 signifies low volatility, whereas values exceeding 35 indicate high market fluctuations. Historically, NIFTY and VIX have demonstrated a negative correlation which means that NIFTY tended to rise when VIX was below 15.

There also exists a positive correlation between volatility and India VIX. This means that when volatility is increased, the value of the India VIX index is also high. Before the COVID-19 pandemic, the India VIX remained low, below 30 since 2014, indicating a stable market. With the onset of the pandemic, the India VIX value surged to 50. So, the equity index experienced a fall, losing nearly 40% of its value and trading at the 8000 level. As a general rule of thumb, a higher India VIX value corresponds to increased volatility and more market risk.

The India VIX reached its all-time high reading of 92.5 in November 2008 during the global financial crisis. More than a decade later, it was recorded at 87 in March 2020 due to COVID-19.

How is India VIX Value Calculated

India VIX uses the computation methodology of CBOE and makes adjustments to align with the NIFTY options order book. The calculation involves gathering data for the following four factors:

• Time to expiry: Computed in minutes instead of days for a more precise value.

• Interest Rate: The model relies on a risk-free interest rate, typically linked to the NSE Mumbai Interbank Offered Rate (MIBOR) rate for a specific tenure corresponding to the expiry months of the NIFTY option contracts.

• Forward index level: The most recent price of the NIFTY Futures contract for the respective expiry month is taken as the forward index level. This level is crucial for identifying out-of-the-money options, beginning with determining the at-the-money strike price. The strike price is then used to select OTM option contracts.

• Bid-Ask Quotes: The bid-ask quotes of the OTM option contracts, identified after determining the ATM strike price and located just below the forward index level, are used in the calculation of India VIX. In cases where there are strike prices with unavailable quotes, values are determined through interpolation using the statistical method of computation called Natural Cubic Spline.

Following the identification of the quotes, variance is computed for both near and mid-month expiries. This calculation involves assigning weightage to each of the identified NIFTY option contracts. The variances calculated for the near and mid-month expiries are subsequently interpolated to determine a unified variance value corresponding to a 30-day expiration period. The final India VIX value is calculated by taking the square root of this computed variance and then multiplying it by 100.