Don’t read too much into the India VIX
No, a low VIX does not indicate a positive election result
With the general elections on, the Indian stock markets have paused in their bullish streak to trade sideways lately. But investors don’t seem to be happy with this breather. Instead, they are putting every possible indicator under the microscope for signs that market will resume its upward climb.
The most recent indicator to be dissected was the India VIX. In the April 23 session, the India VIX fell from 12.7 to 10.1, a near 20 per cent dip. Many interpreted this as a sign that election-related uncertainty was at an end, with the ruling NDA regime likely to return with a thumping majority. They pointed out that the India VIX fell 30 per cent on May 23, 2019, and 33 per cent on May 16, 2014 — the two previous occasions when general election results were announced. Therefore, the 20 per cent dip ahead of this election result, and the low VIX value of 10, meant that election-related uncertainty is already behind us.
But is this really a correct interpretation of VIX movements? It isn’t. To know why, it is useful to understand how the VIX works and to look at history.
HOW VIX WORKS
The India VIX (short for India Volatility Index) attempts to measure expected volatility in the Nifty50 over the next 30 days. The calculation of India VIX is modelled on the CBOE (Chicago Board of Options Exchange) VIX.
To arrive at the daily VIX value, the exchange takes the forward value of the Nifty from its futures contract and calculates the expected variance in it by using the order book for outof the-money Nifty option contracts for the immediate month, and the one after it.
To simplify, the VIX attempts to derive the expected volatility in the Nifty from trades punched in by options traders for diering Nifty levels for the current and next month. The VIX value represents the annualised percentage change expected in the index in the next 30 days.
The calculation methodology reveals three limitations of the India VIX. One, it only captures expected volatility in the Nifty50. During big market moves, broader markets and small- or mid-cap stocks may move at in a dierent direction and at a dierent pace from the Nifty50. But the India VIX captures the expected volatility only in the Nifty50.