INDIA VIX

India VIX is one of the most important tools to gauge the movement of the markets. The
entire concept of India VIX has been explained very well in the NSE white paper. However,
I have not been able to find any good source where the nature of movements of India VIX
has been explained. By “nature of movement” I mean implications of Increasing or
Decreasing VIX in bullish and bearish markets.

Questions that specifically come to my mind are

(i) Does VIX changes the options premiums or is it otherwise?

(ii) What does an Increasing /Decreasing VIX imply?

(iii) Does an Increasing/Decreasing VIX has same implications in bearish and bullish
markets or are they different?

(iv) What strategies should we adopt according to movements in India VIX?

So to get the answers I looked at the NSE White paper.

So the NSE definition of India VIX is that it indicates investor’s perception of market
volatility over the next 30 calendar days.

The mathematical formula looks complex at first but it is very well explained in white
paper. So I will try to find answers to my questions based only on this mathematical
model.

So the mathematical formula looks like this

India VIX= σ x 100

For its computation it takes into consideration various variables whose simple explanation
is as below

(i) F: Forward Index: It helps in determining the ATM strike price for computation of India
VIX. It is last traded price of Nifty futures in Near and Next Months. So F1 will be the
Nifty future price of near month and F2 will be Nifty Future price of next month. The
nearest strike price on the lower side of F1 & F2 shall become the ATM strike price
“K0”

(ii) Ki : These are OTM strike prices of both CALL & PUT with respect to “K0” the ATM
strike price. So all Strike prices lower than “K0” would be used as OTM PUT strikes
and all strike prices above “K0” shall be used as OTM CALL strikes. These would
change as nifty move up or down.

(iii) Q: These are the option premiums of various OTM options. These are taken as
average of Best Bid and Best Ask for various strikes.

(iv) R: This is real time interest rate.(Remains more or less stationary).

(v) T: Time remaining till the expiry. This is expressed in years. This keeps on decreasing
continuously.

I would not go into deep mathematical details but would like to draw some inferences
from this formula which would answer my questions

INFERENCE NO 1

“The Option Premiums of weekly series (excluding the last week of month) are
dependent on India VIX and India VIX is independent of all the option premiums of
all the weekly(excluding last week) series.”

India VIX is computed on the basis of option premium of OTM strike prices .

But what needs to be paid attention is that the option premiums of monthly series is
taken into consideration. By Monthly series I mean last week of present month as near
term and last week series of next month as Next Month series.

Let’s take an example, today is 04 April 2020 so VIX shall be based on OTM option
premiums of series ending 30 April 2020 and 28 May 2020.

Thus it shall be safe to assume that option premiums for OTM/ATM/ITM calls and puts of
the weekly series ending 09 April 2020 would depend India VIX and not the other way
round.

This answers my first question

Question No 1 Does VIX changes the options premiums or is it otherwise?

Doubts related to last week series

I have serious doubts related to last week series. As per NSE white paper the rollover of
month for computation of VIX happens only 3 days prior to expiry in India unlike one week
in CBOE.

So lets us say the present date is 24 April 2020 and this is near term monthly series. India
VIX shall be computed taking into consideration OTM option premiums of present series
itself. So mathematically India VIX does not influences the premium of OTM options of
both CALL & PUT till 28 April 2020 when rollover happens rather it is other way round i.e.
OTM option premiums determine VIX.

FOR ITM strikes VIX may or may not determine the option premium.

Im strictly speaking mathematically here. I may be missing some other information.

INFERENCE NO 2
“PUT Options contribute relatively more than CALL options in determination of
India VIX”

Let us have a relook at the mathematical formula of VIX. It is

We shall focus only on Option Premium Q (which is average of Best Bid & Ask) and Strike
Price of the Options.

We see that VIX is directly proportional to Option Premium and inversely proportional to
the strike price. So while computing contribution of one strike to overall VIX we know that
an option with high premium and low strike price would contribute more to VIX than an
option with low premium and high strike price.

In an option chain we know that strike price of an OTM PUT option is always lower than
strike price of an OTM call option.

Regarding Q i.e. Option Premium I shall make a bold assumption that Option premium of
an OTM Put option is more than equidistant OTM Call Option generally and definitely in
bearish markets.

So on basis of strike price and option premium it is safe to assume that PUT OTM options
contribute more to VIX than CALL OTM options that are equidistant from ATM strike Price.

I shall represent table from NSE white paper showing this Inference.

Just compare 5000 PUT option’s contribution with 5200 Call option and similarly other
equidistant strikes. This proves my Inference no 2.

If this inference is correct then it has some important implications which form basis of
other inferences.

For simplification we can assume INDIA VIX=Call VIX +PUT VIX where PUT VIX>CALL
VIX. Here CALL VIX refers to contribution by CALL Options and PUT VIX refers to
contribution by PUT Options and because of high premium and lower strike price of PUT
options PUT VIX>CALL VIX.

INFERENCE NO 3
“Nature of VIX Movement in different market scenarios”

For this part we shall assume 3 different market phases

(i) Bearish Markets

(ii) Sideways/Bracketed Markets

(iii) Bullish Markets

We will try to see what does is implication of different VIX Movements in Different Market
phases. We shall analyse following scenarios

(i) Bearish Markets-Increasing VIX

(ii) Bearish Markets-Decreasing VIX

(iii) Bearish Markets-Steady VIX

(iv) Bullish Markets-Increasing VIX

(v) Bullish Markets-Decreasing VIX

(vi) Bullish Markets-Steady VIX

(vii) Sideways/Bracketed Markets-Increasing VIX

(viii)Sideways/Bracketed Markets-Decreasing VIX

Scenario 1: Bearish Markets-Increasing VIX

In bearish markets the premium of PUT options is very high. This high premium is on
account of more demand for PUT options as a hedging tool and more riskiness
associated with option that necessitates high premium. So if VIX tends to rise then it is on
account of increase in premium “Q” of PUT options of Near & Far month expiry series
which signals that investors are of the opinion that markets are likely to fall more in
coming 30 calendar days.Thus on account of very high premium “Q” of PUT Options that
keeps on increasing we can say

“In Bearish markets if VIX increases then it signals high expectation of fall in
market.”

Scenario 2: Bearish Markets-Decreasing VIX

There can be two scenarios which are likely to happen either markets stops falling or it
rises. Let us analyse what happens in both situations.

If the markets are just stabilising after a fall then Put option premiums would come down
significantly and contribution of PUT options to VIX would also decrease. Regarding CALL
options, the premium would more or less remain same and so would be their contribution
to VIX. So overall VIX would reduce.

If Markets are moving upwards in bearish phase then we would have two outcomes. The
premium of PUT options shall decrease drastically and that of CALL would increase. So
overall PUT VIX would decrease and CALL VIX would increase. But the decrease of PUT
VIX would be much greater than increase in CALL VIX so overall VIX would decrease.
Thus on basis of above arguments we can say

“In Bearish markets if VIX falls then it signals no further expectation of fall in the
markets. It may mean either stability/consolidation or rise in markets. Attention
needs to be paid to CALL option premiums in near and far month expiry series.
If CALL option premiums are increasing then it is a signal of increase otherwise
markets may just consolidate.”

Scenario 3: Bearish Markets-Steady VIX

In bearish markets VIX is on the higher side and if it remains constant then it means that
PUT option premiums are not increasing. Thus it is a moment where investors should be
cautious as after this phase the market may continue its falling spree or may just
consolidate.

Thus on basis of above arguments we can say

“In Bearish markets if VIX remains steady then it signals either stability/
consolidation or short term break on further fall in markets.Investors should remain
cautious of any development.”

Scenario 4: Bullish Markets-Increasing VIX

As we have described earlier India VIX=PUT VIX+CALL VIX , where PUT VIX>CALL VIX

An increase in India VIX may happen because of relative increase of one option with
respect to other. So in Bullish markets if VIX is increasing then we need to pay attention to
premiums of near and far month options. If PUT Option prices are increasing then VIX
shall increase and market may be preparing for a downswing in bullish trend, however if
CALL options prices are increasing then markets may continue the trend in upward
direction.

Thus on basis of above arguments we can say

“In Bullish markets if VIX increases then it can be a mixed signal and we need to pay
attention to option premiums of near and far expiry months. If PUT option premiums
are increasing then it means VIX is increasing with expectation of fall in the market
and if CALL option premiums are increasing significantly then VIX is increasing with
expectation of rise in the market.”

However I think that chances of PUT Option premiums rising are more than significant
rise in CALL option premiums, so probability of fall in markets is high as compared to
further rise in markets though everything has to be confirmed by analysing the option
prices of monthly series.

Scenario 5: Bullish Markets-Decreasing VIX

It clearly means that PUT VIX is decreasing and market doesn’t anticipates any fall in
market in near future, so markets may continue to rise. Thus we can say

“In Bullish markets if VIX decreases then it signals no expectation of fall in near
future and markets may continue to rise.”
Scenario 6: Bullish Markets-Steady VIX
It means no expectation of fall in the market or rise in the market. Thus we can say

“In Bullish markets if VIX remains steady then it signals that markets no longer
tends to rise and may consolidate.”

Scenario 6: Sideways/Bracketed Markets-Increasing VIX

In bracketed markets with markets trading with a range if VIX increases then it may be on
account of increasing PUT VIX which means expectation of fall in near future or
Significant increase in CALL VIX accompanied with decrease in PUT VIX that signals rise
in markets. However the probability of markets rising is less. Thus we may say

“In Bracketed markets if VIX increases then it can be a mixed signal and we need to
pay attention to option premiums of near and far expiry months. If PUT option
premiums are increasing then it means VIX is increasing with expectation of fall in
the market and if CALL option premiums are increasing significantly then VIX is
increasing with expectation of rise in the market.”

Scenario 7: Sideways/Bracketed Markets-Decreasing VIX

In bracketed markets with markets trading with a range if VIX decreases then it may be on
account of decreasing PUT VIX which means no expectation of fall in near future so
markets may rise or just consolidate. Thus we may say

“In Bracketed markets if VIX decreases then it means decreasing PUT VIX which
means no expectation of fall in near future and thus markets may rise or just
consolidate.If CALL option premiums are increasing then it is a signal of increase”

INFERENCE NO 4
“Theta or time decay has no impact on VIX”
This has been taken care in the formula where time factor comes out to be eRT/T.

These are just mathematical inferences and need to be validated by an expert and back
tested.