Sometimes, the way your mom serves the meal is sufficient to gauge her mood and temper on that day. Similarly, wouldn’t it be better if you had something to gauge the mood of the market for any particular period of time?
Well, there is something that can help you do that, and it’s known as “VIX”.
VIX, which is otherwise known as the ‘Volatility Index’, is used by investors as a measure to find out the volatility in the market. In other words, it will help you in finding out how fearful or confident the market is under any given conditions.
So, let’s spend a few minutes to decode the term and identify as to how it will be benefiting your investing activity.
VIX – Volatility Index
VIX is an Index that has been circulated in India since 2008. It assists the traders, investors and speculators by measuring the amount of volatility that will persist in the top 50 stocks of the Nifty in the next one month period. Note that this has an expiry period of 1 month.
It has its roots in Chicago, which was initially brought to existence by the Chicago Board of Options exchange. The NSE uses the VIX index and allows it for circulation by acquiring legal licensing from the CBOE.
The Volatility Index uses the Black Scholes Model, which has 5 key elements to it. They are as follows:
- The strike price of the contract.
- The market price of the stock.
- Time to expire.
- Risk-free rate.
The above factors act as a key influencer of the result, which will be stating the market performance in the next 30 days. VIX uses both the standard deviation and the Beta to generate the results.
While Beta estimates the movement of stocks with respect to the market, standard deviation plays a key role in measuring the variation from the expected outcome.
How to read VIX?
The correct reading of the index is essential to make informed decisions. While knowing its importance, it is also crucial you understand how to interpret and understand the same. An investor can use the VIX in two ways:
- First, to simply understand the amount of volatility in the market and base your judgment and actions accordingly. Say the VIX for a particular day is 25.63. That means the markets will be moving by or be volatile by 25.63% in either of the ways.
- The next way is by way of comparison. You will have to find out the week high and the week low. Let us take an example. So the 52 High is 86, which happened in March, and the corresponding low is somewhere around 9. However, the current VIX prevailing in the market is approximately 23. This shows that the market is still nervous about its investment options, and a lot of investors are still fearful about making an investment.
So how will it assist you?
Say the economy is performing badly. You are fearful and have a feeling that the markets are going to fall. If you intend to decode as to how your counterparts in the market feel about the same, one of your options is to rely upon the Volatility index. It helps you to understand whether the market is confident or fearful, and thus you can tailor your investment decisions accordingly.
Nothing helps better than a good example. For instance, in March 2020, the VIX went to an all-time high of 86, hinting at a market fall and the market, in no time, saw a crash. Also, on November 14, 2008, which was the year of a major financial crisis, the India VIX stood at a high of 92.53, hinting at something disastrous. And what happened next was something that no investor would dare to forget. Such is the instance as to how one can use the VIX index to forecast the future movement and proceeding which you can increase or decrease your holding on shares and other securities.
Also, there might be circumstances when the market will be highly confident. Irrespective of the various opinions, they are hopeful of the various changes in the market and expect it to be optimistic. In such a case, you might want to act cautiously regarding the same.
The above are some instances where the VIX was used to make the best of the given market conditions. You can use it in a similar way and be assisted in making the right choice as to buy, sell or hedge the securities basing on the situation prevailing in the markets.
5 ways to utilize VIX
VIX can be used in 5 effective ways as follows:
- VIX can be useful when you want to trade in volatility. Say you expect the market to fall. Then you can take the assistance of the India VIX and make decisions accordingly. Further, you can buy futures on the VIX volatility to acquire a profit on your decision.
- Mutual funds and other equity managers can derive enormous benefits from the tool as such. In the long term, they might be exposed to a number of volatility based situations. VIX might help them to make informed decisions and hedge the securities according as they cannot surpass a certain threshold of risk exposure.
- Investors and traders who trade on options and futures can decide their side and make investments depending on the movement of VIX.
- Also, intraday traders and speculators are the most to benefit from it. They can easily find out the volatility in the market and plan their strategies accordingly. They can also alter their ‘stop losses’ with adherence to that.
- People who are trading on a long term basis can also extract enormous benefits from the same. For instance, if you sense the market is going to have high volatility, then you can simply play safe and reallocate your funds accordingly. Exposure to high-risk stocks can also be assessed and modified, therefore.
The VIX indicator is like an alarm that could wake you up at the right time and offer you an idea of the market. Thus, it prevents you from any probable loss in the near term or at least helps you to minimize it. Having said that, make it a point to check it whenever you are planning to make some changes to your portfolio, to play wisely.