Let us talk about the Volatility Index or the VIX in this video.

Let us talk about the Volatility Index or the VIX in this video. It’s been a highly discussed topic and an important indicator to be tracked. VIX is basically a measure of volatility. The VIX is the volatility index of the CBOE, i.e., the Chicago Board of Option Exchange. It measures the implied volatility of the S&P 500 index for a 30-day period, and it is expressed as an annualized percentage. For example, if the VIX is trading at 32, it represents an implied move of 32% in the S&P 500 over the next year. In fact, India has its own VIX, which calculates its value in the same way that the CBOE does.

It includes the best bid-ask quotes and the expected volatility for the next 30 calendar days, with some tweaks to suit the options order book of the NIFTY from an Indian context. VIX plays a role in the psychology mindset of investors, because it has a tendency to rise when the market drops and to decline when the market goes up. Historically, it has been seen that there exists an inverse relationship between the VIX and the stock market broadly.

VIX is commonly known as the fear index, and it is a very important tool for option traders because option traders are always in favour of volatility. Let us discuss the implications of the VIX on volatility for options traders. Trading options is often dependent on the projection of volatility in the market. Buying and selling of options is impacted by the increase and decrease of volatility of the underlying asset or the implied volatility (IV). Implied volatility depicts the expected volatility of the underlying stock of an options contract over its time to expiry.

Change in implied volatility is directly proportional to change in options price. An increase in the implied volatility of an options contract increases the price of the contract and vice versa. To conclude, the higher the value of the VIX, the greater is the expected volatility in the markets.

Therefore, for options traders, higher volatility translates into higher options prices, all other things being equal. However, high volatility may not always give a positive outlook. Traders tend to interpret high VIX levels as danger points, and analysts have been using the VIX as an early warning system. They further start to look out for confirmation triggers on fundamental and technical parameters. VIX has been always a very important sentiment indicator. As investors or traders, we should definitely track the VIX to know the overall pulse of the market.