WHY VIX IS A FEAR FACTOR?

VIX is volatility index. Also known as Fear index of market. Let us dive deep into VIX with this article. As per definition, The…

VIX is volatility index. Also known as Fear index of market. Let us dive deep into VIX with this article.

As per definition, The variance for the near and mid month expiry computed separately are interpolated to get a single variance value with a constant maturity of 30 days to expiration. The square root of the computed variance value is multiplied by 100 to arrive at the India VIX value.

So, to put it simply, it measures how volatile a market can be.

Let’s understand market volatility.

Volatility in simple words is a sudden deviation from an expected behavior. To understand this clearly let’s take an example; You are watching mouth-watering food on tv makes you feel hungry but the next moment your mother serves you….

lauki ki sabji !!

suddenly you will lose your appetite. 😉 that is volatility of mood in this circumstances.

Another best example to understand volatility would be the ongoing turmoil of the Maharashtra political crisis, CM post decider between Uddhav Thackeray to Devendra fadnavis to finally Eknath Shinde. (too much volatility  politics)  . Too much volatility is a risk factor as prediction of future movement becomes uneasy and that’s where the FEAR FACTOR is born.

Suppose there are two stocks. Both roughly give a 25% percent return yearly. Stock A, there is a steady rise of 0.1% daily consistently While in the second stock B, sometimes Stock B goes up from 0 to 8% or at times falls back by 8%. So you can easily guess that stock B is more volatile. VIX labels a number to this phenomenon.

VIX gauges how volatile or fluctuating the Nifty50 will be over the next 30 days.

Stock and options traders use the volatility index, or VIX, to gauge the market’s anxiety level.

If the current index is trading at 16,000 and India VIX trading at 20.

Suppose VIX is 20% now. That is in coming 12 months, the market can go up by 20% or down by 20%.

Then, expected volatility over next year over 12 months will be:

Index spot: 16,000

India Vix: 20

The expected downside for next 12 months = 16000 – 3200 [20% of 16000] = 12800

The expected upside for next 12 months = 16000+ 3200 [20% of 16000] = 19200

A rise in VIX is generally reflected whenever there is uncertainty in markets, and generally occurs in situations like elections, RBI monitory policy changes, geopolitical crises, disasters, etc.

Let’s understand VIX with different scenarios

1. CRASH SCENARIO CORONAVIRUS PANDEMIC 2020:

It was one of the historical moments that our world witnessed with too much uncertainty. India VIX was at its peak during the first covid wave in May 2020. Last time we witnessed such high volatility was during global financial crisis 2008.

The above image shows how Nifty fell ( top) in 2020. At the same time the bottom VIX line shoots up

It has been observed that India’s VIX correlates negatively with NIFTY price move. Which means, when India’s VIX rises, investors might expect markets to fall.

On 20th January 2020 India VIX was lowest of 10.165 and on the same day market topped.

On 24th March 2020 India VIX was highest of 86.635 and market bottomed.

Check Below Image

At such times investors wish to exit there Mutual Fund holdings or stock holdings in fear of crash. This is the only way for investors, to avoid losses when VIX is rising (used as an indicator of upcoming fall). In simple words, You cannot make money in a falling market but, save yourself from losses only. This is similar to driving a car without reverse gear. Therefore fear is genuine.

2. RALLY SCENARIO: TIME PERIOD BETWEEN MAY 2020 TO JANUARY 2022:

Since may 2020 , market started to recover and a never ever seen before rally resumed. !

This was the time when fear in the market evaporated and thus VIX dropped in value ( check the orange line in chart).

Nifty was in continuously rally mood, making new highs every month. Market participants were doing one thing, Get up, Brush your teeth then BUY any stock to Book profit at end of the day/week.

There was less uncertainty in the market movement. This was the time of moderate volatility when investors can pull out some analysis and make the right decisions and calibrate their investments.

3. SIDEWAYS MARKET:

We call this period a bumpy market. The VIX index normally hovers between 15-24. ( considered as a normal market. For clarity, in March 2020, at its peak VIX quoted 80 ! As the market began to recover, the number fell below 20. When fear is infused, Vix could rally up to 30 levels or more. Investors get nervous. January 2021 to May 2021.

MARKET goes up but VIX may Shoot up (instead of fall) When?

After an healthy rally for few months, Market participants get anxious about some upcoming correction (fall).

This instils fear of loss in them. They worry what if this upcoming correction could wipe out my past six months’ earnings?

Fear increases when market keeps going up without taking a breather too !

These type of erratic VIX/Market move happens during events like election/finance budget etc.

While VIX is a simple reflection of risk in the market, the real question is what should be your approach towards it as a market participant.

You should not wait till VIX makes high, you should be able to anticipate it. As explained it is a very good indicator for traders and investors . It is a reliable gauge for index movement.

As we can see in this above data, when PE is high, Vix is low since Nifty will be at higher prices. When PE drops, Vix goes up. When vix is below 15, its safe to buy large caps since mid and small caps are at high PE. When VIX shoots to 50+, Consider to buy small or mid cap stocks or MF .

Conclusion

So now you know what VIX is. What happens when VIX rallies, or falls or moves sideways.

You will keep an eye on VIX. If it shoots up, you will exit your stocks, if they are in profit. Also wait for some more time before you decide to invest more into that favorite stock. There is high possibility that market may crash, since VIX is going up and up.

VIX is measured on indices & NOT on a particular stock

When VIX is falling, Avoid exiting stocks. Hold onto them since market is probably going to go up farther. When VIX is falling, avoid buying a lumpsum investment. Probably go via SIP route.

Finally if you cannot decide when to do what , Why don’t you hire a professional like us for free?

There are just handful SEBI registered Investment Advisors in India. We are on amongst them. Authority in this domain.

Sujith Salunkhe

Btech in Information Technology followed by an PG in Financial engineering & Risk Management from National Institute of Securities Markets. Certified Investment Advisor XB, FRM (USGARP) .

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