What is happening with India Vix?
India VIX is an index that reflects the volatility in the Indian markets. In today’s article, we shall discuss how volatility can be used to understand the behaviour of option premiums. First, let us understand how VIX functions.
How India Vix Works
Options traders often refer to India Vix as the fear indicator. However, this tool can be used intelligently because it incorporates the continuous-time stochastic value of option premiums to determine the market volatility. What does this mean? In simple language, vix rises when aggressive buying in options happen and decreases when demand for options comes down.
Put premiums are usually priced higher as people always buy puts to hedge their portfolio. So market maker always buys puts if he anticipates big volatility in markets leading to sharp rise in vix.
Continuous-Time & Option Premiums
Imagine on the 16th of January 2023, you had bought the 18,200 OTM Call option at 11:30 am. We all know that someone had to sell the option at the same time. When this transaction is underway, India VIX meticulously filters the buyer and the seller in the 18,200 OTM Call option. The same process is applied to all the OTM options in the near contract and the next contract to derive the market volatility. India Vix was at 15 on January 16th, 2023 based on the best buyer and seller for the OTM options.
Combining Terminal Volatility and Vix
Our terminal volatility calculations gave us a trade by creating a calendar spread. Bank nifty option strike 42,100 Put of 19th January 2023 Expiry was sold at 328 as it triggered terminal volatility extreme on Tuesday (17/01/2023) at 13.20 PM and we hedged this position by buying 41,900 PE of 25th January 2023 Expiry. The spread was initiated at a debit of INR 35. We covered this spread today at INR 133.
To the naked eye, it appeared like a regular calendar spread executed at 35 and booked at 133. If you look deeply, this Put spread performed well even when Bank nifty made a new low on Tuesday. The advantage of the trading option using Terminal Volatility is the precise entry and the stop loss. We shall discuss more about Terminal Volatility in upcoming article.