The volatility index called the India VIX, indicates the investor’s perception of the market’s volatility in the near term. The index depicts the expected market volatility over the next 30 calendar days. i.e. higher the India VIX values, higher the expected volatility and vice-versa. India VIX indicates the market’s perception of the expected near term volatility

A higher volatility means that a security’s value can potentially vary over a larger range of values. This means that the price of the security can change dramatically. A lower volatility means that a security’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time

The volatility index is expressed in percentage terms and was available at end of the day basis. However, from July 19th, 2010 it s being displayed on a real time basis available on NSE website

How is VIX calculated

India VIX is a volatility index based on the index option prices of NSE’s benchmark index NIFTY. India VIX is computed using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY option contracts, which are traded on the F&O segment of NSE.

What factors are taken into account to calculate VIX

Time to expiry of the options contracts of Nifty that are selected to calculate the index

The NSE Mibor rate is being considered as risk-free interest rate for the respective expiry months of the NIFTY option contracts

A methodology called the forward index level is being used to select the contracts which will be used to calculate the index

Weightage is given to each of the options contracts that are chosen, as per the method adopted by the Chicago Board of options exchange (CBOE). The weightage of a single options contract is directly proportional to the average of best bid-ask spread of that option contract and inversely proportional to the option contract’s strike price

Where did VIX originate?

VIX is a trademark of CBOE Incorporated and Standard and Poor’s has given a license to NSE, with permission from CBOE, to use this trademark in the name of India VIX and for purposes relating to India VIX

What is the relation between Nifty and VIX

Nifty and VIX are negatively correlated. Based on the data for 2010, it can be observed that when Nifty is on an uptrend, volatility is relatively lower and vice versa.

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Yesterday the European Central Bank (ECB) announced the key rates and as the streets expected, they were unchanged.

There was no positive out of the press conference from Trichet, the only thing he did was subtly pleading to the world that “EURO is a stable currency’ and reiterated again the same things that the ECB would leave no stone unturned to save the real economy. This lead to over 200 points rally in Dow Jones and more than an 1.5% gain in Euro. I believe that it is more of a short covering bounce back and the only direction the Euro is headed is southwards.

I expected July to be a calm month for the markets, and the biggest reason is that the China AG Bank is coming up with the world’s biggest IPO of all time. On July 16th it is coming up with an IPO of $30 billion and this could really suck huge liquidity from the markets even if it is just fully subscribed. One should wonder what if, the issue gets oversubscribed by two times and three times. It could evaporate the liquidity of the size of two times Reliance Industries total market capitalization which is around Rs 3 lakh crores.

In history too IPOs of high magnitude from good companies have lead to a dearth of liquidity in the Secondary Markets and this time also I expect the same Ag Bank, whose 350 million customer base is bigger than the population of the United States, had $US7.1 trillion in assets as of 2008, its last public financial filing, is a bank which even the institution would love to own and hence the liquidity could dry up.

Hence a good trading strategy for Traders could be to establish position in put options in Nifty expiring in the month of July, as the VIX has also come down significantly. For Investors the best is to stay out of any extravagant short term positions and continue their SIP.

Happy Investing…!!

Author:Rahul Sonthalia, Research Head, Kredent

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