India VIX stands for Volatility Index it measures the
volatility expectation of the Nifty 50 index over the next 30 trading sessions.
VIX is also called as the "fear gauge" it’s because VIX tends to rise
when there is rise in uncertainty in the market and it tends to fall when there
is calm environment.
VIX doesn't tell us about the direction of market movement
but the magnitude of the expected market movement. One more thing to note that
the VIX is represented as an annual movement percentage of Nifty 50 Index. For example,
India VIX is 16 then it’s expected that within the next 1-year Nifty can move
in the range of -16% to +16% of its current SPOT price.
How Is INDIA VIX Calculated?
The methodology used by the National Stock Exchange (NSE) is
derived from the Chicago Board Options Exchange (CBOE) VIX calculation formula.
The NSE employs a mathematical model in which they employ the best Bids and
Asks of the Near Month expiry and Next Month expiry OTM options. The OTM
contracts are selected because they are very much sensitive to movement
expectations. We will not go deeper with the calculations because it’s not
necessary.
As we have discussed above India VIX represented as an
annualised percentage so in order to find the monthly movement expectation of
Nifty 50 we have to employ some calculation.
Expected Monthly Movement Formula:
Expected Monthly Movement = India VIX ÷ √12
We are dividing it by 12 since there are 12 months in a
year.
Example:
If India VIX is 16:
then, 16 ÷ √12 = approximately 4.61%
This means the market is roughly pricing in a possible
monthly movement of around 4.61% on either side, not a guaranteed move and not
a direction forecast. Suppose Nifty is trading at 24,000 then the expected
movement is 1,106 points either side within the next 30 days.
Expected Daily Movement Formula:
Expected Daily Movement = India VIX ÷ √252. We are dividing
by 252 because approximately there are 252 trading sessions in a year.
Example:
If India VIX is 16:
16 ÷ √252 = approximately 1%
If Nifty is at 24,000, then 1% is about 240 points. This
means the market may be pricing in a daily movement of roughly 240 points on
either side. These are estimates based on volatility assumptions. Actual market
movement can be higher or lower.
The figures shown are for illustrative purpose only.
Impact Of VIX On Options Pricing:
VIX measures the volatility of the underlying Index. Let me
tell you in a straight forward way when the VIX his higher the options premiums
become expensive and when the VIX is low the options become cheaper. This is
because higher VIX represents a higher volatility condition. To make you
understand this let me give you an example suppose there are two identical
homes of nearly identical size and value but different part of the cities. One
house is located in a neighbourhood that fire prone area and another house is
located in a less fire prone area the house in the higher fire prone area will
have higher insurance premium and the house in the less fire prone area will
have lower insurance premium. Similarly, the Options contracts are type of
insurance premium.
VIX effect on Options Prices Rise and Fall; Options
contracts are a type of insurance contracts, when the VIX rises it means the
market expect elevated movement so the option prices rises similarly when the
VIX falls it signals towards a muted movement so the Options premiums decreases
As you know that VIX represents the volatility Lets explain IV impacts options
prices.
(A) VIX Rise Impact On Option Price:
#1 When the India VIX rises above the historical data
for example 14%-15% or it remains near 14%-15% the options prices behave very
much nicely on both CALL and PUT side. It’s because the movement in Delta is
quite nice for example if there is 1 point movement in the index the moment in
Delta is about 0.7-0.8 in new contracts. Along with this Theta is in the range
of 0.4-0.5 in the new contracts along with these options IV tries to align
itself with India VIX in ATM and OTM options due to which it helps in price
discovery. When the India VIX trades near the historical average, here we can
see a good movement in both sides and support and resistance works wonderfully
in these types of conditions. If your direction is right, you get good profits
in both option buying and option selling.
#2 When the India VIX trades above the historical
average for example 16-17% or even more then we see extreme volatility with
spikes and there is formation of 100-200 points candle in either way and high
possibility of unidirectional move and market easily show 300/400-point
volatility. In this type of market options IV tries to align itself with India
VIX and options premiums become very expensive and they can even trade 2X/3X/5X
from its fair value. When market trades with a very high VIX, we need to select
the strike price if you execute Option Buying/Option Selling then you need to
see the options IV which has for example 14-15%. It’s because it will protect
you from extreme volatility. If you are a contra trader or an aggressive trader
who can absorb the volatility then you can select high IV strike prices in that
case the volatility of the underlying asset will be reflected the options
positions.
#3 When the India VIX is extremely high than its
historical, which also represents high risk/extreme volatility. In these situations,
one should not trade in aggressive positions if you are an Option Trading you
can get a big profit or a big loss and it’s seen historically that PUT side IV
is on the higher side.
(B) VIX Fall Impact On Option Price:
#1 When VIX falls below the historical levels and day
to day basis it makes lower low this doesn't mean that upside or downside move
can't come because many people co-relate low VIX with the start of bullish
market, technically its wrong. Low VIX also indicates low volatility and low
buying selling interest. Whenever this situation happens it shows the less
interest in the market-by-market makers such as Institutional Players/Prop
Desk/HNI clients. In this situation and low India VIX condition the moves that
are generated that are slow and fragile and they try to trade in narrow 30–40-point
volatility. In a narrow range there is 60–70-point move.
#2 When VIX falls below the historical level and
starts to trade lower for example there is a support and up move is generated
then the up move is very much slow, which lacks both volume and momentum then
there is suddenly formation of spike and in this spike candle there is
adjustment of the option premium suddenly in the spike candle. This type of
price action will be seen in the PUT side when there is a down move near that
resistance.
#3 Due to historically low VIX options prices become
quite cheap this is why if you are an Option Buyer this type of condition is favourable
because the options prices don’t decay and if the trade moves in your direction
and spike is generated then it gives you a good profit due to adjustment of
premium. But this condition is bane for the Option Seller, because due to low
VIX there is very much less Theta in the ATM and OTM options and Delta is
stable and options decay very slowly.
VIX Impact On Gap Up/Gap Down:
We will discuss about the VIX impact on option pricing when
market opens with Gap Up/ Gap Down.
(A) Gap Up Condition:
When market opens Gap Up most of the time India VIX shrinks
and if the Gap Up is not large for example 100-150 points, then options prices
opens flat or opens negative, in case the market opens Gap Up and the VIX rises
the option prices rises with accordance to the Gap Up in the index for example
for a 50 point Gap Up ITM options rises by 60-65 points, ATM options rises by
30-40 points and the OTM options rises by 15-20 points.
(B) Gap Down Condition:
When market opens Gap down the VIX and IV increases from the
previous day closing, and VIX increases by 2-3% from the last trading session,
in this condition the PUT side ITM option opens with a massive gain. This
happens because when the VIX increases, the options become expensive and
options IV tries to align it. Let’s day if the VIX is 16% in gap down condition
and then the ITM option IV becomes 16-17% and we see almost equal gain the ITM
options. Along with this if the IV is higher than we will see higher gain on
that strike price and if the IV is lower on a strike price, then we will see
lower gain on that strike price in OTM and ATM options.
Futures Impact On Options Prices:
This is the most important thing moving options prices. As
you know Futures contract is a type of derivative, since it’s a forward-looking
contract it trades in premium with respect to the underlying asset. The Future
contracts have monthly expiry in the Indian market. For example, hypothetically
Nifty spot on 13rd DEC 2025 was 24,000 then the Futures contract of the DEC
month expiry would be trading more than 24,010 or more if everything is normal.
#1 The Future Prices is directly responsible for
moment of options, if the future contracts have less volume and less activity
the option prices movement will be slow and fragile. When the Future traded in
discount with respect to the spot, in that condition the CALL options prices
doesn't move much and when the Future tries to align itself with the SPOT or
tries to trade in premium with respect to spot, we can see sudden adjustment in
options premium. This is why when there is less activity in Future contracts
then there is very less movement in the options prices despite the SPOT being
in trending movement.
Vega And IV Crush Effect On Options Prices:
Vega is the Greek option that explains the relationship
between the price of an option and the volatility changes of the underlying. In
theory, Vega indicates the value by which the price of an option changes for
each one percentage point change in implied volatility (IV).
In other words, Vega is typically described as how much the
value of an option increases or falls when volatility changes direction by 1%.
A higher Vega number indicates that the option price will be
more sensitive to volatility changes, whilst a lower Vega value indicates that
the option price will be less sensitive to volatility changes.
Options IV is directly proportional to the option pricing,
the higher the option IV the higher will be its pricing. Similarly, the lower
IV of an option, then the option contracts will be cheaper.
Options IV increases rapidly when there is a big event in
the market, because traders take positions expecting the event to turn out in
their favour, so when a lot of traders take position options IV increases so
the options prices increases drastically and when the even has occurred the IV
cools off the options prices suddenly crash even if there is low or no movement
in the SPOT. This phenomenon is called IV crush. Options sellers benefit a lot
from this IV crush and it’s a nightmare for the options buyers.
What Caution Should We Take In Those Conditions?
When VIX trades below its historical average, in these
condition if you buy and hold the option and the direction of the trend is in
your direction then you can get good profits, but the disadvantage in this
condition that you can’t find perfect Stop Loss in options, you will have to
keep the option buying positions hold without any emotions, and sometimes you
will have to keep the Stop Loss on spot basis which can be a bit larger too. In
low VIX conditions, one should avoid option selling positions. Even if you are
selling options then you should keep at least 200-point difference from the
SPOT in OTM direction and even then, the profit will be quite slow since the
options will be cheaper the Theta of the options will be low. In this condition
one should not trade with aggressive lots because if the trade goes opposite to
your direction and VIX rises then you can face a massive loss.
Final Thoughts:
The derivatives trading Options and Futures trading is very
much risky and before trading such instruments you should know the implications
of this instrument and you should know the volatility of these. You cannot do
options trading every day, you need to wait for the perfect conditions for
options trading and control the positions sizing according to the market
conditions.
Thanks for reading, for more such educational and important
articles you can join our Channel Dicey Trade.
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