Earlier I read a piece of writing on VIX trading in the December 2012 issue of the Traders Magazine. Can the volatility index (INDIAVIX) be used to predict the Nifty future? New concepts on the volatility index trading have arisen in technical analysis that recommends that combining technical analysis with the India VIX chart may end up in a trading system. This system can beat the buy & hold method of the Nifty index. James Kozyra and Camillo Lento examined 9 trading ideas in S&P 500 and located that eight of the 9 produced sure gains.
FAQ
The INDIAVIX is also known as the benchmark index for the volatility of the National Stock Exchange. It represents the implied volatility within the stock market for the next 30 days. The INDIAVIX is calculated in actual time by NSE and is a weighted mix of the buy-sell price for the Nifty options. The formula that calculates the index takes present market prices for all out-of-the-money options for the current and the nearest months. In a second theory, the volatility index is calculated by the annualized change in the Nifty index in the next 30 days. The volatility index tells us 3 things: (1) Market behaviour, (2) Greed and fear and (3) Market sentiments.
We can watch the India VIX chart, but we can not trade the volatility index directly. But we can definitely trade the Indian stock market using the India VIX chart. INDIAVIX at a historical low denotes that the market is also at its low and a high value of the index denotes the top is near. The medium value of the index denotes the market is in a stagnant state.
Where Can We Check India VIX Chart and Rate?
You can check the INDIAVIX live rate and basic chart on the NSE website. But that is a very basic chart. So, nowadays in any broker’s terminal, we will get the quotes for the volatility index. Suppose we can see the charts and quotes for this index in the Zerodha Kite platform. We need to add the symbol on the market watch of the terminal and from there we can open the chart.
In the image above I have opened a daily chart for the volatility index. Just like any other chart, we can apply any technical indicator on this chart too.
How to Trade the India VIX Chart?
The India VIX chart can tell us the market condition. Whether the market is cool or volatile. Suppose we open a 1-year chart of the instrument.
From the image above we can see the high during this 1-year period is 30.18 and the low is 9.16. Currently, it is quoted at 15.22. So we are close to the low. That means we are still not in a very volatile market. Still, our market now is in a cold state.
Simple Trading Rule for the Volatility Index
The simple trading rule with the volatility index is a 50-day simple moving average crossover of the INDIAVIX. Although I have not yet examined this in the Indian situation completely, it once produced 12.7% annual returns from January 1999 to July 2009 in the S&P 500. These performances exceed the buy & hold method with a margin of 12.49%. To conclude we can say that the VIX can predict the S&P 500. At the same time, buy & hold yielded a return of 2.28% or an annualized yield of simply 0.21%.
Designing a Trading System from Volatility Index
In the same way, we can design a trading system on the AmiBroker charting software and do some backtesting of the same too. We can simply buy the market when the India VIX chart goes below the 50-day simple moving average. On the other hand, we can sell the market when the same goes above the 50-day simple moving average. We have not included the brokerage in the testing phase. After checking the figures through a backtesting process, we concluded that the moving average whipsaws should be minimized and brokerage be added for the profit calculations. Check the image below for the trading system designed on AmiBroker.
On the top, you can see the end-of-day chart of the Nifty index and on the bottom, you can see the India VIX chart with buy and sell signals. You can see the buy signals are coming when the VIX has bottomed out and sell signals are coming when it tops.
Download the Amibroker AFL Code for VIX Trading:
Comparing the Volatility Index and PE Ratio
We can also compare the INDIAVIX with the PE Ratio. Suppose now the INDIAVIX is quoting at 15.23 and the PE Ratio for the Nifty index now is 27.31. We saw that INDIAVIX is on the lower side indicating that still, the market can go up. But the PE ratio is also on the higher side. This denotes that the market can take a halt. So, here we need to move with a cautious buying approach for the medium term.
India VIX Chart and Options Trading
You can also trade options on the basis of INDIAVIX. When INDIAVIX rises it denotes that people are buying options. On the other hand, when the INDIAVIX falls it denotes that traders are selling options. Accordingly, options traders can set their call and put trading strategies.
If you see that the volatility index is increasing by 3%-4% you can trade that day buying options. Do not short-sell options that day. You will have an idea of INDIAVIX by 9:30 AM to 10:00 AM on any trading day. On the other hand, if you see VIX falling on any day, do not be on the buy-side for that day in the options market. Rather your strategy can be selling options for the day.
Suggested Reading
The following book is typically a good book on this subject. Trading VIX Derivatives: Trading and Hedging Strategies Using VIX Futures, Options, and Exchange–Traded Notes (Wiley Trading).
Conclusion
INDIAVIX is an index to measure the volatility of the Indian stock market. If it rises we can say the market is volatile. And if the index falls we can say that the market is cool or stagnant. We can create both intraday as well as delivery trading strategies using this volatility index rate of change and India VIX chart.
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Thanks for this article, I would like to know the relation between VIX and IV, as well as how can we use IV for Options trading
Venu, actually the India VIX is calculated using the IV of all the options on Nifty. Regarding how to use IV for options, let me check if we can write something on that in the future.