LIMITATIONS
Two, the bid-ask quotes that go into the VIX calculation can be impacted by volumes and build-up or unwinding of positions in the options contracts that it uses. For instance, some say that the April 23 slump in the VIX occurred because of traders significantly unwinding positions in Nifty options ahead of contract expiry on April 25 and elections thereafter. The VIX also transitions from currentmonth data to next-month data three days ahead of the monthly expiry, which could have contributed to this move.
Three, and most important, globally volatility indices such as the VIX are seen as good predictors of market moves because derivative markets are dominated by sophisticated investors. In theory, options contracts are supposed to be bought and sold by knowledgeable institutional investors and money managers who like to hedge their portfolios or take directional calls on the market. But in India, the options market is a playground for retail investors and the majority of punters in this market are looking to make
India VIX methodology of calculation only captures expected volatility in Nifty50
Bid-ask quotes can be impacted by build-up or unwinding in options contracts
Sophisticated investors don’t call the shots in Indian derivatives market a quick buck. Retail investors also like to dabble in out-of-themoney options because they are inexpensive. Whether these investors are really taking a considered or knowledgeable view on the Nifty when punching in trades is open to question. This significantly undermines the predictive power of the India VIX.
WHAT IT SIGNALS
Historical trends in the India VIX suggest that it hasn’t been all that great at predicting incoming market turbulence. One of the biggest market declines in recent years occurred in the initial months of Covid, when the Nifty tumbled 38 per cent from 12201 points on February 12, 2020, to 7610 points by March 23, 2020.
The India VIX showed no signs of this impending volatility in the days before this crash. After trading in the range of 14 to 17 from January 1, 2020, to February 19, 2020, it climbed to 25 levels by March 3 — well after the correction began. As the correction continued, it soared to 60-70 levels and further to 83 on the day after the Nifty50 hit rock bottom. Though the next bull phase had begun by July 2020, the VIX remained elevated and did not subside below 15 until June 2021.
Nor did the VIX transmit SOS before the 2008 market crash sparked by the global financial crisis. The VIX actually dipped from about 40 in November 2007 to 28 on January 8, 2008 — the day when the Nifty50 began its 60 per cent descent from its peak.
The VIX hasn’t been a reliable indicator of positive triggers for the market either. In the month running up to May 23, 2019, when election results showed the NDA returning with a substantially improved vote tally, the VIX traded at an elevated level of 21-29, indicating nervousness about the upcoming results. It subsided to 15-16 levels once the results were out.
All this tells you that you cannot use the India VIX to crystalgaze future events or market moves. However, the one thing it is really useful for is to gauge the current mood of the market. With the benefit of hindsight, it is clear that extreme fear in the market saw the India VIX shooting up to levels of 70-80. Levels over 80 coincided with market bottoms and were great times to buy stocks. Readings below 20 show the market in a sanguine mood. The recent reading of 10 shows that the prevailing mood is one of complacency, perhaps excessive optimism. Any adverse election result, even one showing the NDA winning with a modest majority, can thus significantly disappoint markets and set o a correction.