Understand what is the correlation between India Vix and Nifty: The Indian benchmark index, Nifty is an important pillar that comprises 50 stocks that are the highest traded among all the stocks listed on the stock exchange. This index functions as a market indicator that represents the overall health of the market.
Stock market participants use this index to determine the broader trend of the market. Adding on to this index, what if I tell you that, there is another index that can help you determine the amount of change that is expected in the Nifty 50? This index is known as the India Vix.
In this article, we will understand what India Vix is and discuss the correlation between India Vix and Nifty.
What Is VIX (Volatility Index)?
The term Vix refers to the ‘Volatility Index’. This index is a representation of the expected volatility in the market for the next 30 days. This index helps the market participants determine the level of fear, stress, or risk in the market and thus is also referred to as the ‘Fear Indiex’.
The Vix is calculated based on the bid-ask quotes of the Market Index’s option contracts and indicated in the terms of percentage.
This index was first formed by Chicago Board Options Exchange (CBOE) in 1993 which is popularly known as the CBOE VIX. This index is based on the options contract of the S&P 500 Index for the next 30 days. The NSE started its own index called the ‘Index VIX’ which is based on the nifty index.
What Is India VIX (Volatility Index)?
NSE introduced the ‘India Volatility Index’ in 2008 which represents the expected volatility of the Nifty over the next 30 days. This index helps the market participant get an idea about the general sentiment in the market.
When the India VIX is rising, it means there is an increase in the volatility in the market resulting in increased fear in the market. When the India VIX falls, it means there is a decrease in market volatility and an increase in market stability.
India VIX moves in an ideal range of 11%-25%. But that doesn’t mean that the index will always stick to this range. There are times when the index has traded beyond these levels.
One of the scenarios, when VIX had shot up beyond the levels of 25, is during the times of covid. You can see a huge spike in the chart where the VIX has reached the level of 70.
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Components For Calculating The India VIX?
The value of India VIX is calculated in the same way as the CBOE VIX, that is, by using the Black & Scholes (B&S) Model. The components of the B&S Model include strike price, the market price of the stock, time to expiry, the risk-free rate, and volatility.
Let us see, how each of these elements plays a role in the calculation of the VIX index:
- Time To Expiry: To attain a level of precision, the data used to calculate the time to expiry is in terms of minutes rather than days.
- Interest Rate: A relevant tenure rate, which is for 30 to 90 days is used while determining the risk-free interest rate.
- Forward Index Level: The computation of the India VIX is based on out-of-the-money option contracts. This contract is found out using the forward index level.
The forward index level determines the at-the-money strike which helps in selecting the options contract which shall be used for computing the VIX index
- Bid-Ask Spread: The ATM strike which is accessible at a slightly lower level than the forward index level is the strike price for the NIFTY option contract.
NIFTY call option contracts with a strike price above the ATM strike and NIFTY option Put contracts with a strike price below the ATM strike are recognized as out-of-the-money options. The best bid and ask price of such contracts are used for the computation of India VIX.
Correlation Between India Vix And Nifty?
India VIX helps us understand the is the expected annual change in the NIFTY50 index over 30 days. In simple terms, it helps us understand how much the NIFTY50 can move over the next 30 days.
A low level in the India VIX implies confidence in the market movements among the participants and there is an expectation of lower volatility and a stable range.
On the other hand, a higher level in the India VIX implies that the market participants have lower confidence which results in high volatility and one can expect a major directional move in the market.
Let us understand the Correlation between India Vix and nifty more clearly with the help of an example:
If the current level of Nifty is at 17,800 and India VIX is trading at 12. Then the expected volatility over the year for the next 30 days would be:
- The expected downside for the year = 17800 – 20% of 17800 = 14,240
- The expected upside for the year = 17800 + 20% of 17800 = 21,360
Though India VIX only shows market volatility and does not attempt to predict the direction of market movement, historical evidence suggests that India VIX and NIFTY are negatively correlated to each other. This means, when the volatility has risen, Nifty has seen a fall and vice versa.
The above chart clearly suggests the negative correlation between India Vix and Nifty. Especially during the times of Covid, you can see that, while the VIX has shot up to the level of 70, the Nifty 50 had lost nearly 40% of its value. Now you might have an idea of why the VIX index is also referred to as the Fear Index.
Also Read: What is Stock Options Trading? – Learn Options Trading With Examples!
In Closing:
In this article, we discussed what is VIX and India VIX, their components, and the Correlation between India Vix and Nifty.
India VIX provides insightful data on market volatility. Traders must notice changes in market volatility and modify their strategies as necessary. Though the short-term swings in volatility might not affect the profitability of long-term investments, they need to keep an eye out for long-term changes in volatility and reevaluate their investments.
FAQ:
1. What is the relationship between India VIX and Nifty?
India VIX is a measure of market volatility, while Nifty is an index that represents the performance of the Indian stock market. Generally, when India’s VIX is high, it indicates higher volatility, which can have an inverse relationship with Nifty, causing it to decline.
2. How to calculate a nifty weekly range using VIX?
To calculate the Nifty weekly range using VIX, subtract the value of India VIX from the highest Nifty value during the week to get the upper range, and subtract the VIX value from the lowest Nifty value during the week to get the lower range.
3. Does VIX affect Nifty?
Yes, VIX (Volatility Index) can affect Nifty. Higher VIX levels indicate increased market volatility, which can lead to a decline in Nifty. Conversely, lower VIX levels suggest lower volatility, which can be associated with a more stable or rising Nifty.
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