Uses of Volatility Index
Volatility Index offers great advantages in terms of trading, hedging and introducingderivative products on this index. Investors can use volatility index for various purposes asmentioned below:
Investors’ portfolios are exposed to volatility of the market. Investors could hedgetheir portfolios against volatility with an off-setting position in India VIX futures oroptions contracts.
Volatility index depicts the collective consensus of the market on the expectedvolatility and being contrarian in nature helps in predicting the direction. Investorstherefore could appropriately use this information for taking trading positions.
Investors could also use the implied volatility information given by the index, inidentifying mis-priced options.
Short sale positions could expose investors to directional risk. Derivatives onvolatility index could help investors in safeguarding their positions and thus avoidsystemic risk for the market.
Based on the experience gained with the benchmark broad based index, sectorspecific volatility indices could be constructed to enable hedging by investors in thosespecific sectors.
India VIX calculation methodology
India VIX is calculated using the methodology adopted by CBOE currently for computingVIX on S&P 500 options. This method does not use any option pricing model such as Black and Scholes to calculate the VIX. Simply put, it derives the implied or expected volatilityfrom the near and mid month options bid and offer prices of the Nifty 50 index options. Fromthe options bid and offer prices an indicator can be derived as to what is the volatility theinvestors are expecting in the market. This volatility figure, denoted in percentage, is theIndia VIX value. The actual computation methodology is given below.