Topic 2: DECODING INDIA VIX : RISK CALCULATOR

India Volatility Index, India VIX, a measure of risk for the investors, has rosed 91% in May 2024, which is second highest monthly jump since March 2020. India VIX what actually calculates and why it is important for investors is still a enigmatic. If the current India VIX is at 25, that indictaes the NIFTY 50 is expected to fluctuate within a range of 25% either way up or down over a period of one year from the today’s mark. So lets understand the India VIX in detail as it has proven to be a good measure for risk averse investors over past few years.
The India VIX, is calculated by the National Stock Exchange (NSE) using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY option contracts traded in the F&O segment of the NSE. The India VIX is a numerical representation of market expectations regarding short-term volatility, typically over the next 30 days. The India VIX is derived from the option prices of the NIFTY 50 index, using the Black & Scholes model, which considers variables like strike price, market price of the stock, time to expiry, risk-free rate, and volatility. The strike price (K) represents the pre-determined price at which options on the Nifty 50 index are exercisable. For the India VIX calculation, this value is determined based on the out-of-the-money call and put options of the Nifty 50 index. The market price of the stock (S), this variable denotes the current market price of the Nifty 50 index, and it is usually the latest available price. Time to expiry (T) refers to the remaining time until the options on the Nifty 50 index expire. For the India VIX, this period is generally set to 30 days, as the index aims to measure short-term volatility. The risk-free rate (R) is the interest rate offered on risk-free investments, typically represented by government bonds. It serves as a benchmark for comparison, and in the context of the India VIX calculation, it is often the yield on the government bonds with a corresponding time to maturity (30 days). And lastly the Volatility (σ), this is the most critical variable in the India VIX calculation. The calculation methodology for India VIX is a combination of option quotes and variance, where option quotes are the best bid and ask quates of out-of-the-money near and mid-month NIFTY option contracts traded in F&O segment of Nifty. 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. Then this 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. Finally, the square root of the computed variance value is multiplied by 100 which gives the valye of India VIX. Hence the India VIX is a numerical representation of market expectations regarding short-term volatility. A higher India VIX indicates greater anticipated volatility, reflecting the market's expectation of sharp movements. Conversely, a lower VIX level suggests lower volatility and a more stable market environment. It represents the expected degree of price fluctuations in the Nifty 50 index over the next 30 days. Historically, India VIX and NIFTY have exhibited a strong negative correlation. When India VIX rises, NIFTY falls, and vice versa. This means that a higher VIX often corresponds to a bearish market sentiment, while a lower VIX indicates increasing confidence among traders. How the traders and investors benefits from India VIX? In past few years it has become an important tool to measure the risk for the portfolio and fund managers to determine the beta exposure and deciding factor for the option traders. India VIX futures contracts are available for trading, allowing investors to hedge against short-term volatility. The India VIX index is also used to price derivative contracts and premium. The range in which the India VIX moves is between 15-35 but it can also breach lows and high values under certain circumstances. The India VIX affects stock prices by influencing investor confidence and expectations of market volatility. A higher VIX can lead to increased uncertainty and potentially lower stock prices, while a lower VIX can indicate greater stability and potentially higher stock prices. Historically, India VIX and NIFTY have exhibited a strong negative correlation. When India VIX rises, NIFTY falls, and vice versa. This means that a higher VIX often corresponds to a bearish market sentiment, while a lower VIX indicates increasing confidence among traders. The India VIX has been closely watched by the fund managers and traders to guage the volatility ahead of Lok Sabha election results. As in the month of May 2024 India VIX has been very volatile phase toucjhing all time high of 91%. There are various factors which contribute to the volatility of the Index. Firstly, the economic numbers like GDP, Inflation rate and employment affects the market volatilty and hence the India VIX index, strong numbers increases confidence and lower down the volatility, while weak data causes uncertainty and high volatilty. Secondly, geopolitical events like wars, international conflicts or election season affects the India VIX as it effects the uncertainity and thus increases the volatility. These events lead to major shift of investors to the safer investments thereby affecting the market volatility. Third factor which affects the India VIX is corporate announcements like mergers and acquisitiion, earnings, regulatory changes and other news which effects the profits of the company. Positive news lead to lower volatility and increased investor confidence, while negative news causes uncertainity and high volatility. Fourth one is interest rate movements which affects the cost of borrowing and hence the market sentiments. Higher interest rate high volatility and lower interest rate contributes to stable market. Fifth factor which influence the India VIX is retail investor behaviour, markets are driven by buying and selling decisions of the retail investors. Retail investors' preferences for out-of-the-money options can lead to fluctuations in the VIX, particularly during times of high market uncertainty. Lastly, futures and options trading, forward index levels determines the strike option of the options contract, which is the current market price of NIFTY 50. This forward index level is used to measure volatility for next 30 days. Also the Bid-Ask prices are used to calculate the India VIX. Options market dynamics like trading volume, open interest and the patterns of buying and selling, has an impact on India VIX and hence the market volatility. So as a result all volatilty factors collectively contribute to the India VIX movements, and thereby providing the traders and investors a valuable information to traders and investors to make informed investment decisions. India VIX has been volatile in May due to various factors, primarily related to the ongoing Lok Sabha elections. The index has risen by around 53% so far in May, with the current price at 24.6. This surge in volatility is attributed to the concerns over the election results, which are expected to be declared on June 4. The market participants are cautious due to the potential impact of the election outcome on the BJP's seat count, and foreign portfolio investors have been selling Indian equities, leading to a decline in the domestic market. Lok Sabha elections tend to increase India VIX volatility due to uncertainty around results, with the index often spiking around result days. The market's reaction depends on whether the outcome was anticipated, and global factors can also influence the India VIX during election periods.