What is volatility index (VIX)?

It’s a measure of the traders’ expectation of the rate of change in stock prices in the near-term (Current month & a portion of the next month). It is also known as the fear index as it indicates the uncertainty amongst market participants. In India, the Volatility Index is calculated based on the calculation mechanism adopted by the Chicago Board Options Exchange (CBOE) by using the bid/offer prices of NIFTY ATM Options Prices.

What to make sense of the VIX levels?

  1. When Vix goes up → It means that traders are willing to pay more to get the right to buy the underlying. In essence, they foresee the risks increase in the near future. Try looking at it from an insurance buyer’s mindset. When the perceived risk is high, the buyer is willing to pay more to cover that risk.
  2. When Vix goes down → It means that traders are willing to pay less to acquire the right to buy the underlying. In essence, they foresee the risks to reduce or remain low in the near future. In insurance analogy, when the perceived risk is low and there is complacency, the willingness to pay for insurance reduces, the prices reduce.
  3. Sudden Spikes → Historically, India Vix has not spiked above 40 despite many sudden uncertainties in the market. However, when there is a fear of epic proportions, the levels have gone above and beyond 40. Such times are considered the riskiest and unpredictable when compared to other uncertainties that are part and parcel in the marketplace.

Can VIX is useful to make position in options?

It is very logical question, VIX is useful to me to create my option position. The answer is YES, by studying VIX we can ascertain the risk involved in stock market. In last 3 days as on 25 Feb the VIX was at high because of air strike done by Indian air force.

In a week period I.e. 1st March today VIX fall almost 20% from pick. So, market is showing some strength and almost every stock option fall drastically due to fall in VIX. Take any name reliance volatility was 29 and during day it reach to 26, so vix is common parameter to study overall market fear.

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