The Hindu Business Line : Know more about volatility index

Volatility index, more commonly called VIX, is an indicator that captures the level of fear in the capital markets. When investors turn fearful, the VIX index moves higher. The Chicago Board Options Exchange was the first to develop volatility index in 1993. The CBOE Volatility Index is a key measure of market expectations of near-term implied volatility conveyed by S&P 500 stock index option prices.

Implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets.

Implied risks

The implied volatility, as captured by the volatility index, is not about the size of the price swings, but rather the implied risks associated with the stock markets.

When the market is range-bound or has a mild upside bias, volatility is globally observed to be typically low. On such days, call option buying (a position taken on the view that the market will move higher) generally outnumbers put options buying (a position taken on the view that the market will move lower).

This kind of market may indicate lower risk. Conversely, when the selling activity increases significantly, anxiety among investors tends to rise. Investors rush to buy puts, which in turn pushes the price of these options higher. This increased number of investors are willing to pay for put options shows up in higher readings on the volatility index. High readings indicate a higher risk in the market place.

The reading of VIX reached almost 45 in 1998 as the LTCM (Long-term Capital Management) crisis exploded. It took a few months for the investor’s fears to abate and the VIX to return to below 20. The World Trade Centre bombing also made the VIX climb above 45, as the investors’ fear level reached the zenith.

India VIX

India VIX is a volatility index based on the Nifty 50 Index Option prices. From the best bid/ask prices of Nifty 50 options contracts (which are traded on the F&O segment of the NSE), a volatility figure per centage is calculated, which indicates the expected market volatility over the next 30 calendar days.

Higher the implied volatility, higher the India VIX value and vice versa. There are some differences between a price index, such as the Nifty 50 and India VIX. Nifty 50 is calculated based on the price movement of the underlying 50 stocks, which comprises the index. India VIX is calculated based on the bid-offer prices of the near- and mid-month Nifty 50 Index Options.

While Nifty 50 signifies how the markets have moved directionally, India VIX indicates the expected near-term volatility and how the volatility is changing from time to time.

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