What is Volatility Index? - 6 Things that VIX Indicates | Espresso

India Vix Trading: Things that Volatility Index Indicates

Whether you are new to the stock market or have been around for a while, you may have come across several trading tools and indicators. And if you have been trading futures and options, then VIX or the Volatility Index is one such term that most traders and investors are familiar with.

Published on 17 March 2022

Let’s understand what VIX simply means. The Indian stock market uses the NIFTY 50 to gauge market volatility, and this tool helps traders and investors decide when to buy and sell their stocks. The VIX is used as a reference in relation to the expectations of the price volatility in the market over a term of 30 days. So, essentially, VIX helps traders and investors identify the impact of the expected volatility in the market.

What are VIX trading strategies?

Since the Volatility Index or VIX simply denotes the risks in the markets, these are some of the strategies to keep in mind if you want to know what it is that the VIX indicates.

  • The VIX helps equity traders understand the level of risk in the markets. If a short-term trader or intraday trader wants to know in which direction the volatility is moving, the VIX can help them prepare their strategy. In case the volatility is expected to increase steeply, intraday traders may have to quickly trigger their stop losses. Here, they may either choose to cut down on their leverage or widen their stop losses.
  • As an options trader, you can use the VIX indicator effectively since the decision to buy or sell options is determined by the volatility. Options tend to become more valuable, and the buyers stand a better chance of profits if the volatility rises. In the other case, when the volatility comes down, option sellers have a good chance of making profits.
  • Long-term investors are also known to rely on the VIX as a market indicator. Such investors are not concerned with the short-term market volatility, but institutional investors are much more cautious when it comes to the risks and mark-to-market (MTM) losses. While trading in futures and options, an investor can opt for a put and increase their hedge to face the market risk when the risk is indicated by the VIX.
  • In India, VIX trading strategies are also used for trading volatility. When you expect greater volatility in the markets, you can choose to buy straddles or strangles, which are options strategies. However, note that these can get quite expensive if the volatility rises. Hence, some traders tend to go for futures on the VIX index so that they don’t have to be too concerned about the direction of the market.
    Also Read: Short Straddle
  • The VIX is also a reliable indicator when it comes to index movement. During index trades, it can help to plot the Nifty and VIX movement for the past 9 years since the introduction of VIX. This shows a negative correlation on the charts and indicates that when the VIX bottoms out, markets have a tendency to peak out and when the VIX peaks out, the markets may bottom out.
  • Portfolio managers also make use of the VIX to widen their exposure to a high Beta portfolio. They can do this when the VIX peaks out and later add low beta stocks when the VIX bottoms out.

Ideal Range for India VIX

On a theoretical basis, the value of the VIX moves between 15 and 35 units and the range of the price fluctuation is between +15 and – 15 for a time duration of 30 days.
Know more about Stock Market Fluctuation.

Hence, if the value is close to or around 15, it indicates low volatility while values closer to 35 or above are indicative of higher volatility.

Importance of India VIX

India VIX and volatility move parallel to each other. If the value of India VIX is high, it indicates an expectation of a higher volatility, that is, a considerable change in Nifty. If the value of India VIX is low, it is an indication of lower volatility expectations, which means a low chance of change.

India VIX also showcases a negative correlation with Nifty. When the India VIX falls, the Nifty rises and when the India VIX increases, the Nifty typically falls.
Also Read: Things to Remember when trading in Nifty Futures

Given that the India VIX has a direct correlation with market volatility, the role of the VIX is crucial in helping market investors gauge the volatility and take their investment decisions accordingly.

Conclusion

It is important to note that in the last 9 years, since the inception of the VIX and India VIX trading strategies, a lot of traders and investors have been able to utilise it as a reliable tool to identify the volatility and risk in the market. While it may not be simple to understand how the volatility index or India VIX strategies work, with time and experience, traders learn to study the VIX.

Chandresh Khona
Team Espresso

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