Understanding India VIX and its Impact on Options Traders

INDIAVIX closed at 11.80; it now not only stands at one of its lowest levels of the near past; any spike in the INDIAVIX can have a significant impact on traders. 

As an options trader, there are several factors that impact your trading decisions. One such factor is India VIX. India VIX, or the India Volatility Index, is a measure of the market’s expectation of volatility over the next 30 calendar days. In this comprehensive guide, we will discuss everything you need to know about India VIX and its impact on options traders.

Introduction to India VIX and Options Trading

Options trading is a popular form of trading where traders buy and sell options contracts. An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and date. The price of an options contract is influenced by several factors, including the underlying asset’s price, time to expiry, and volatility.

India VIX is a measure of the expected volatility in the Indian stock market over the next 30 days. It is calculated using the implied volatility of NIFTY 50 options. India VIX is a widely used tool by traders to gauge the market’s expectation of volatility. The higher the India VIX, the higher the expected volatility, and vice versa.

What is India VIX and how is it calculated?

India VIX is calculated using the Black-Scholes model, which is a mathematical formula used to value option contracts. The model takes into account five variables: the current stock price, the strike price of the options contract, the time to expiration, the risk-free interest rate, and the expected volatility of the underlying asset.

The expected volatility of the underlying asset is estimated by calculating the implied volatility of NIFTY 50 index options. Implied volatility is the expected volatility of the underlying asset implied by the prices of its options contracts. The implied volatility of NIFTY 50 index options is then used to calculate India VIX.

The variance for the near and mid-month expiry computed separately are interpolated to get a single variance value with a constant maturity of 30 days to expiration. The square root of the computed variance value is multiplied by 100 to arrive at the India VIX value.

The value of India VIX is expressed in percentage terms. For example, if India VIX is 20%, it means the market is expecting volatility of 20% over the next 30 days.

Understanding the Impact of India VIX on Options Trading

India VIX has a significant impact on options trading. The higher the India VIX, the higher the options premiums. This means that as an options trader, you will pay a higher premium for an options contract when India VIX is high.

India VIX also impacts the pricing of out-of-the-money (OTM) options. OTM options are options contracts where the strike price is significantly higher or lower than the underlying asset’s current market price. When India VIX is high, the pricing of OTM options increases significantly as traders expect an increase in market volatility.

How to read and interpret India VIX levels

India VIX levels are expressed in percentage terms. A low India VIX level indicates that the market is expecting low volatility over the next 30 days, while a high India VIX level indicates that the market is expecting high volatility.

India VIX is measured on a scale from 0 to 100, with higher values indicating higher expected volatility. Generally, India VIX levels between 0-20 indicate low volatility, while levels between 20-30 indicate moderate volatility and levels above 30 indicate high volatility.

As an options trader, it is essential to keep an eye on India VIX levels to make informed trading decisions. A sudden increase in India VIX levels can indicate an impending market correction or a significant news event. Similarly, a sudden decrease in India VIX levels can indicate a period of market stability.

Why India VIX is important for options traders

India VIX is an essential tool for options traders as it helps them gauge the market’s expectation of volatility. When India VIX is high, options traders can buy options contracts to hedge against potential market volatility. On the other hand, when India VIX is low, options traders can sell options contracts and collect premiums.

India VIX is also a useful tool for options traders to identify market trends. A sustained increase in India VIX levels can indicate a bearish market trend, while a sustained decrease in India VIX levels can indicate a bullish market trend.

How India VIX affects OTM Options Premiums

As mentioned earlier, India VIX has a significant impact on the pricing of OTM options. When India VIX is high, the pricing of OTM options increases significantly as traders expect an increase in market volatility. This means that as an options trader, you will pay a higher premium for an OTM options contract when India VIX is high.

On the other hand, when India VIX is low, the pricing of OTM options decreases significantly as traders expect a decrease in market volatility. This means that as an options trader, you will pay a lower premium for an OTM options contract when India VIX is low.

Strategies for Trading Options during High India VIX Periods

Trading options during high India VIX periods can be challenging, but there are strategies traders can use to manage their risks. Here are a few strategies to consider:

• Buy options contracts as a hedge against potential losses due to market volatility.
• Sell options contracts at high premiums to take advantage of market sentiment.
• Use options spreads to limit potential losses and manage risk.

It’s important to note that trading options during high India VIX periods can be risky, and traders should be prepared to manage their risks accordingly.

Impact on Options Sellers of a sudden spike in the VIX

Options sellers, also known as writers, can be negatively impacted by a sudden spike in India VIX. When India VIX spikes, options premiums tend to increase, which can lead to losses for options sellers.

To manage their risks, options sellers can consider using options spreads to limit potential losses. Options spreads involve buying and selling options contracts simultaneously to create a spread that limits potential losses.

Common Misconceptions about India VIX

There are several misconceptions about India VIX that need to be addressed. One such misconception is that India VIX is a measure of the market’s direction. India VIX is a measure of the market’s expectation of volatility and not its direction.

Another misconception is that India VIX is a leading indicator of market direction. While India VIX can indicate potential market trends, it is not a reliable indicator of market direction.

India VIX Trading Tools and Resources

There are several India VIX trading tools and resources available to options traders. One such tool is the NSE India website, which provides real-time India VIX data. Options traders can also use options pricing calculators to estimate the pricing of options contracts based on India VIX levels.

Staying Ahead of the Game with India VIX

India VIX is an essential tool for options traders to gauge the market’s expectation of volatility. As an options trader, it is essential to keep an eye on India VIX levels to make informed trading decisions. India VIX also impacts the pricing of OTM options, and options traders can use several strategies to hedge against potential market volatility. By understanding India VIX and its impact on options trading, options traders can stay ahead of the game and make informed trading decisions.

Milan Vaishnav, CMT, MSTA
Consulting Technical Analyst
Member: (CMT Association, USA | CSTA, Canada | STA, UK) | (Research Analyst, SEBI Reg. No. INH000003341)