What does the Volatility Index (VIX) indicate you?

The volatility index (VIX) is a measure of market volatility, which is why it is called the volatility index. Since a high level of VIX represents a high level of fear in the market and a low level of VIX indicates a high level of confidence in the markets, it is referred to as the Fear Index in common parlance.

The VIX is typically used to measure the near term, and as a result, the VIX is calculated using options expiring in the current month and the following month. The VIX index is based on the assumption that the option premium on key Nifty strikes reflects the implied volatility in the broader market environment.

1. To traders in the equity markets, the VIX is a very valid and realistic indicator of market volatility. The stock traders who engage in intraday trading as well as short-term traders benefit from this information because it allows them to determine whether market volatility is increasing or decreasing. They will be able to adjust their strategy as a result. For example, when the volatility is expected to spike sharply, intraday traders run the risk of their stop losses being triggered quickly, which can be disastrous. As a result, they can either reduce their leverage or increase the size of their stop losses as necessary.

2. The VIX is also a very good indicator for long-term investors, as previously stated. Generally speaking, long-term investors aren't overly concerned with short-term fluctuations in the market. Institutional investors and proprietary desks, on the other hand, are restricted in their ability to take risks and incur MTM losses. When the VIX indicates that volatility is increasing, they can increase their hedges in the form of puts, allowing them to participate in both directions of the market.

3. The VIX index is also a useful indicator for traders who trade options. Typically, the decision to buy or sell an option is based on the volatility of the underlying asset. In situations where volatility is expected to increase, options are likely to become more valuable, and buyers are likely to benefit more from their purchases. When the VIX falls, there will be more wasting of time value, and option sellers are more likely to benefit from the decrease in the VIX.

4. It is also beneficial in the trading of volatility. If you believe that the markets will become more volatile in the near future, one strategy is to purchase straddles or strangles. However, when volatility is expected to increase, these become prohibitively expensive. A better strategy would be to purchase futures contracts on the VIX index itself, which would allow you to benefit from volatility while not having to worry about the direction of the market's movement.

5. The VIX index is a very good and reliable indicator of the movement of the stock market. If you plot the VIX against the movement of the Nifty for the last nine years, since the inception of the VIX, you will notice a clear negative correlation in the charts themselves. As a rule of thumb, markets tend to peak out when the VIX is at its lowest point, and markets tend to bottom out when the VIX is at its highest point. For index traders, this is a useful piece of information.


Now what exactly does the VIX value signify?

Assume the India VIX is 20. This means that traders anticipate 20% volatility over the next 30 days. In other words, traders anticipate that the Nifty will be worth between +20% and -20% more than it is now in the next year over the next 30 days. When market participants are fearful or complacent about the future of the market, the VIX index can be used to determine their level of confidence. The VIX index gives a more precise picture of the market's choppiness.