Indian stock markets are near to its peak, be it Sensex or Nifty as per market experts in next one month market will create new highs and will continue to rise for next few months. Stock market movement is impossible to predict, so how come so called market experts are so sure about stock market upward movement? Are they relying on charts, software report or is there something else of which they are so sure about? These days experts apart from charts and software use Volatility Index (VIX) to measure the upcoming risk. So what exactly Volatility Index is and how investors can use it to make money in the market.
The volatility index (VIX) is the indicator of market risk or investors expectation in the near term. Volatility simply means the amount of variation in the script over a period of time. A higher volatility in a script or index means that the risk is high as the price can change dramatically in any direction. Vice-versa lower volatility indicates steady movement in a script in either direction and risk is low. And due to such volatility VIX is also knows fear index.
The first such kind of index was launched way back in 1993 in U.S. to measure volatility of S&P 100 index options prices. (Put and call option). In India Volatility Index was launched by NSE in 2008. Today Volatility Index is widely used to measure the market risk.
How VIX value is calculated?
VIX index is not derived based on the stock prices instead; VIX is based on the option prices of NIFTY. It is computed using the best bid and ask quotes of OTM (Out of the Money) and mid months option contract which are traded on F&O segment. In short it estimates the volatility between present date and expiry date. And because it is based on F&O data there are few parameters like Expiry date, interest rate, No. of orders, weightage of active orders etc. which are factored in while computation. Once the variance is computed, the square root of variance is multiplied by 100 to arrive at India VIX. To compute India VIX, the same method is used which is used to derive VIX of S&P 500 in U.S.
The VIX value is in percentage which indicates the market movement in next 30 days. So suppose if VIX is at 20 then it is expected that market will move by 20% in near term. One of the best and famous examples to understand VIX is to look at the great fall of market in 2008. Nifty fell by 500 points in span of 3-4 days; investors were in fear and were buying more put option which increases its price and thus VIX went up from 45% to 70%. This also shows that VIX goes up when investors are fearful and vice versa.
In the current scenario when market is near to its peak, India VIX is trading near to 13% which clearly indicates that investors are confident about its future direction and expect market to be in range bound. As per market experts when VIX value is less than 20 it indicates that people are less fearful in market and when it is more than 30 then it indicates the panic situation among investors as volatility will be high.
Live feed of India Volatility Index (VIX) can be checked here.
How much useful VIX index is for investors?
Volatility Index is generally used by Foreign Institutional Investors, Mutual Fund companies, Insurance companies or Ultra HNI investors which invests huge amount and are affected by a slight volatility in the market. They use India VIX Futures and options for trading purpose and to hedge the portfolio. When they see that VIX is trading above 20 they buy put options to hedge the portfolio as above 20 score means that chances of market reversal is very high in near term.
For an individual VIX is only useful when one is looking to trade in the market. In case of goal based investment it is of no use.
Word of caution: Being a Financial Planning firm, primarily we encourage our clients and other investors for goal based investments. If in case someone wants to trade then using VIX can be a good strategy. However, we would still recommend to take the expert help as it can reduce the chances of loss.