India VIX stands for the India Volatility Index. It is an index circulated by the NSE and calculates the degree of fluctuation that can be expected in the Nifty50 by active traders over the next 30 days. The term VIX was initially coined in 1993 by Chicago Board Options Exchange. With their permission, NSE started the India VIX in 2008. It is a common belief that in volatility indices like the VIX and India VIX, the mean revision of the value is replicated through the fluctuations it shows around a long term variance.
The calculation of the volatility index is done based on the Black Scholes Model. It is used for pricing options contracts. In the Black Scholes Model, five primary variables are used to derive the ‘fair price’ of the contract. The Volatility Index calculates the volatility that traders can expect in the market by working backwards from the Nifty options contracts buy-sell prices.
What is India VIX?
As stated above, the India VIX indicates the volatility of Indian markets from investors’ perspective. The method used to calculate it is similar to what the CBOE uses. Volatility and India VIX value move parallel to each other. If India VIX has a high value, one can expect higher volatility, which means that a noteworthy change in Nifty can be expected. If the India VIX has a low cost, this means that we can expect lower volatility, which translates to minimal change.
India VIX and Nifty show a massive negative correlation. Whenever India VIX drops, there is a rise in Nifty. Conversely, Nifty can be expected to fall whenever there is a rise in India VIX. If we look at historical data, India VIX reached a peak a few days before NIFTY touching a bottom during the post-Lehman crisis. Investors have to know how to interpret India VIX and the level of complacency or fear associated with it.
Why is it important?
Remember the uncomfortable jolt you feel when a roller-coaster ride just begins? Keep that in mind, since big moves in the market can be identified by a similar feeling of volatility that is gut-wrenching. If you wish to figure out whether other investors in the stock market are feeling complacent or fearful about the future, you should rely on India VIX.
India VIX meaning can be understood in one way as a representation of the annualized change that can be expected in the Nifty50 for a duration of the next 30 days. Let us take an example to understand better. Suppose the India VIX is 11.97 at a given time. This would mean that for the next 30 days, Nifty is expected to move in either direction by the investors by an annualized rate of 11.97%. A movement of around 12% in a year is not that high a number.
There is another way to read the VIX score. You can compare its current value to the high and low points reached by it in 52 weeks, or even longer. Looking at the VIX scores throughout shows us that a high score was reached in 2009 where VIX was at 55-57. It touched a low of 8.75 in 2017.
How does it affect you?
If equities make up a majority of your portfolio, it is wise to play safe. Excessive risk-taking is never a good route to take. If you notice a fearlessness amongst other investors, then you should treat that as a bad sign. It indicates that other investors, even if they may have different opinions about valuations, are not that concerned about imminent market movements. So, a relatively harmless VIX can be interpreted as an indicator to tread cautiously at that point of time.
Since the market mood can change rapidly, it does not take much time for complacency to be replaced by fear. So, whether you are an investor who is well-seasoned or just starting, it is a good idea to keep an eye on VIX since this is a good indicator of fluctuations in the market.