Also known as the fear index, the Vix (short for Volatility index) is an important index for anyone wanting to develop an understanding of the Indian stock market for the simple reason it measures the most important and worrying characteristic of the market – its volatility. India Vix calculation is based on how volatile the stock market is. That means there is a direct relationship between the market volatility and the India Vix index. The higher the Vix index, the higher volatility can be assumed to be.
To have a better understanding of the Vix index, its calculation, and its importance, it is imperative to begin with the very basics.
First of all, what is market volatility? Market volatility simply refers to the rate of fluctuations in a security’s price or a market index’s value. The reader must please note that volatility shows the risk factor – exactly what kind of risk the investor might be taking by investing on a given day.
Market volatility is measured by what is called a volatility index. A volatility index, as its name suggests, is an index so created that it should be able to measure the market volatility in a given market. There is a direct relationship between market volatility and the volatility index – thus, high volatility will result in a higher volatility index. The first such volatility index, or simply VIX, was created by the Chicago Board Options Exchange (CBOE) in 1993.
India VIX is a volatility index for India that was first created in 2008. It is based on NIFTY 50, which means that it indicates the degree of volatility or fluctuations expected in NIFTY 50. It measures the expected fluctuations in the next 30 days by traders.
How is it calculated?
The India Vix calculation takes into account the following factors:
- Time to expiry
- Interest rate
- Forward index level
- Bid-ask quotes
These factors are used in a particular formula to reach a resultant index which is supposed to reflect the expectant and existing fluctuations in the market.
How to read and interpret the data?
The opposite of volatility is stability. Thus a low India Vix index suggests that the market prices are quite likely to stay safe in the coming month or so. However, a spike in the index suggests there can be a sudden fall in the market.
In recent times, the COVID-19 pandemic has brought a big spike in the India Vix index because of the uncertainties and risks the pandemic has represented. Thus, the index jumper is above 75 for a time.
The reader must please note that while high volatility is undesirable, incredibly low volatility may be unattractive too. The desired volatility range for India Vix is 15 to 35. Thus If India Vix crosses above 35, it may be too dangerous. On the other hand, if it is below 15, the volatility may be too low for the market to stay attractive.
Why is it important?
The importance of an index like India’s fix can’t be gainsaid. It serves as a measure of the risk factor for several stakeholders, but its primary importance is most significant to the small shareholders who may not be able to or not have to carry out such complex calculations on their own. By monitoring the India Vix index regularly, they can hope to have a chance of foreguessing future market patterns. They can use the information given by the index to plan their investments, contingencies, etc., in advance.
To put it in other words, a Vix index democratizes the market and freely avails the information which can only be had with great experience, expertise, or a lot of money. Some of the ways stakeholders can use the Vix index to their advantage:
- Stockholders may cut back their losses by divesting quickly when there is a spike in the India Vix index. This is particularly desirable if the stockholders were going to divest in the near future anyway. The long-term investors may want to hold on and take risks.
- People can also use Options (where one agrees to buy and sell a security at a pre-defined price) to secure their securities against market volatility.
- Stakeholders can also nest their investments by investing directly in India Vix. The India Vix investment is likely to increase or decrease in inverse proportion to the market.
The Bottom Line
One can easily wrap up the above discussion by concluding that India Vix is a great tool that can be monitored and used by investors to plan their investments in an informed manner. It is imperative that the reader must understand that India Vix, much like all such stock market tools, is an imperfect tool and can’t be blindly trusted and that any market investment one might make is always going to have at least some element of market risk – no matter how low India Vix is. As long as the reader understands this, they can easily benefit from this India Vix.