A closer look at market volatility :: Business Line

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With the September deadline for the tapering of monetary stimulus by US Fed nearing, heightened fears of an exodus of foreign investor money have been rattling the Indian market.

During the past one month, even as the benchmark indices plummeted sharply, the National Stock Exchange’s India VIX skyrocketed. So, what is the India VIX and what does it indicate?

Launched in 2008, it is a volatility index which gives a one figure snapshot (annualised) of the market’s expectation of volatility in the short-term. It measures by how much an underlying index — the Nifty — is expected to fluctuate over the next 30 calendar days.

It reflects the expectations of traders and investors about market movement as captured by prices of options contracts. The higher the India VIX, the higher is the expected market volatility and vice versa. The index generally moves higher when stock prices are falling and moves lower when they are rallying. That is, the Nifty and the VIX are negatively correlated. This is because generally volatility tends to decline as the stock market rises and increase as the stock market falls.

From about 19 on August 14, the India VIX shot up to 28 on August 21. The Nifty shed 8 per cent in this period. Earlier too, between July 23 to August 7, as the Nifty went down, the volatility index went up.

The Chicago Board of Options Exchange (CBOE) was the first to introduce a volatility index, VIX for the US markets in 1993. The VIX which is based on S&P 500 Index options captures the expected volatility in its underlying index.

CALCULATION

The India VIX is calculated based on the Nifty index option prices. CNX Nifty options are the most actively traded contracts in the derivatives segment of NSE and the significant trading volume in these enables determination of the value of India VIX.

Of the several things that drive the price of options, volatility is one. In fact, greater the expectation of volatility, greater will be the demand for options. This is because, it is in times like these that hedging and speculative demand spurts. This, in turn, pushes up the options prices (premium).

Conversely, when investors are more confident about markets being relatively stable, the demand for options both for hedging and speculation will be less. This will bring down the options prices. Thus, a rise in India VIX points to greater volatility in future and vice versa.