National Stock Exchange (NSE) has decided to float futures contracts based on its volatility index (VIX) with effect from February 26th 2014.
"India VIX Futures will enable the participants to hedge and express views on the expected volatility," NSE said in a statement.The India VIX futures can be used to hedge equity portfolios and held investors to take directional views on volatility, among others. According to NSE, all market participants currently permitted in the F&O segment are permitted to participate.
About India VIX
India VIX is a volatility index based on the index options prices of NIFTY. India VIX is computed using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY options contracts which are traded on the F&O segment of NSE. 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 computation methodology
India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to the NIFTY options order book using cubic splines, etc.
The factors considered in the computation of India VIX are mentioned below:
1) Time to expiry:
The time to expiry is computed in minutes instead of days in order to arrive at a level of precision expected by professional traders.
India VIX is a volatility index based on the index options prices of NIFTY. India VIX is computed using the best bid and ask quotes of the out-of-the-money near and mid-month NIFTY options contracts which are traded on the F&O segment of NSE. 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 computation methodology
India VIX uses the computation methodology of CBOE, with suitable amendments to adapt to the NIFTY options order book using cubic splines, etc.
The factors considered in the computation of India VIX are mentioned below:
1) Time to expiry:
The time to expiry is computed in minutes instead of days in order to arrive at a level of precision expected by professional traders.
2) Interest Rate:
The relevant tenure NSE MIBOR rate (i.e 30 days or 90 days) is being considered as risk-free interest rate for the respective expiry months of the NIFTY option contracts
The relevant tenure NSE MIBOR rate (i.e 30 days or 90 days) is being considered as risk-free interest rate for the respective expiry months of the NIFTY option contracts
3) The forward index level:
India VIX is computed using out-of-the-money option contracts. Out-of-the-money option contracts are identified using forward index level. The forward index level helps in determining the at-the-money (ATM) strike which in turn helps in selecting the option contracts which shall be used for computing India VIX. The forward index level is taken as the latest available price of NIFTY future contract for the respective expiry month.
India VIX is computed using out-of-the-money option contracts. Out-of-the-money option contracts are identified using forward index level. The forward index level helps in determining the at-the-money (ATM) strike which in turn helps in selecting the option contracts which shall be used for computing India VIX. The forward index level is taken as the latest available price of NIFTY future contract for the respective expiry month.
4) Bid-Ask Quotes
The strike price of NIFTY option contract available just below the forward index level is taken as the ATM strike. NIFTY option Call contracts with strike price above the ATM strike and NIFTY option Put contracts with strike price below the ATM strike are identified as out-of-the-money options and best bid and ask quotes of such option contracts are used for computation of India VIX.In respect of strikes for which appropriate quotes are not available, values are arrived through interpolation using a statistical method namely “Natural Cubic Spline”
After identification of the quotes, the variance (volatility squared) is computed separately for near and mid month expiry. The variance is computed by providing weightages to each of the NIFTY option contracts identified for the computation, as per the CBOE method. The weightage of a single option contract is directly proportional to the average of best bid-ask quotes of the option contract and inversely proportional to the option contract's strike price.
Computation of 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 India VIX values will be computed up to 4 decimals with a tick value of 0.0025.
For further details please refer to the white paper with the detailed methodology on computation of India VIX at www.nseindia.com
VIX is a trademark of Chicago Board Options Exchange (CBOE) and Standard
& Poor's has granted a licence to NSE to use such mark in the name
of the India VIX and for purposes relating to the India VIX.
Three thoughts on VIX for markets
The VIX has a small history in India so far. Three broad takeaways for markets:
The VIX has a small history in India so far. Three broad takeaways for markets:
- VIX and Nifty have a negative co-relation: In general India VIX starts to increase at the time of stress in the markets and falls as investors become calm. It is perceived to be one of the best tools to predict near-term market volatility. The correlation between Nifty and VIX over last 5 years is negative 0.84, a significantly high number, making it a strong indicator for prediction of stress in markets.
- Markets rise once VIX peaks: Once the VIX has peaked, markets usually give a positive return over 1 week and 1 month. Of the 4 instances when India VIX has crossed 30% mark, Nifty has always given a positive return with average return of 6.5% in a month.
- VIX rises ahead of election result; falls post result announcement: Market is usually jittery prior to the declaration of election results as it is uncertain about the outcome. India VIX had jumped sharply prior to the declaration of results showing the underlying fear of investors on the uncertainty of the results. India VIX increased from 36% on 1st April'09 to 55% a few days before results. However, it fell sharply to 43% once results were announced. it is expected that VIX will rise as we near May this year too.
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