On Thursday, the India volatility index (VIX) — an index which measures market risk perception — closed at 13.52. This is the lowest since the index inception in November 2007. VIX is calculated based on the order book of Nifty Options contracts. It is considered a ‘fear gauge’ — one which gives pointers about the expected volatility in the market over the next 30 days.

indicator

A high reading means that market participants expect the market to be very volatile while a low reading means expectations of muted volatility.

But traders usually use the VIX as a contrarian indicator. They interpret high VIX as unjustified market pessimism and low VIX as irrational optimism among market participants. So, a VIX close below 20 is treated by traders as indicative of a bearish market while a close above 30 is considered bullish.

For example, during the financial crisis in late 2008, VIX was quoting at around 85. At that time, the Nifty had touched a 5-year low of 2,500 and gained thereafter. Also, when the Nifty peaked at 6,312 in November 2010, the VIX quoted at around 19. But within a span of 20 days, the Nifty declined to 5,750. Similarly, in July 2011, the VIX was trading at just 17.

But by August 2011, the Nifty had declined almost 19 per cent. If past is an indicator, then one can expect a decline in Nifty in near term.

Though the SEBI gave a go-ahead a couple of years back, stock exchanges are yet to introduce derivative contracts based on volatility index

> Shaurya.mishra@thehindu.co.in

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