Fear index VIX at 9-month high: What does this mean for markets?

The India Volatility Index continued to crawl higher on Thursday after closing at a 9-month high of 16 yesterday. The volatility index or VIX is commonly known as fear index in market parlance and is an indicator of how volatile the market is likely to be in the days ahead. A higher reading indicates that volatility is likely to rise going forward.

The India VIX has been steadily rising since the last week of November, when it was quoting around 11.

Also read: India VIX jumps ahead of election results, stock market braces for higher volatility amid recovery

Why has the VIX risen sharply over the last few days?

One reason being attributed is the expiry of monthly options contracts today. Dinesh Nagpal, technical analyst explains that what the markets must have been witnessing over the last two days is a spike in the short covering of option sellers. “Because the VIX is going up, the premiums are also going up very fast but they are melting very slowly. The VIX had given a breakout signal above 14.8 that this will not go to stop that it is enough. So we have to see whether we continue to see rates going up tomorrow in a new settlement or not,” he says.

Why do options premiums rise when VIX rises?

When VIX rises, it means people expect the market to be volatile. As a result, they buy options to hedge against any adverse movement. When too many people start buying options, the prices of options start rising as option sellers start asking for a higher price as a compensation for the risk they are taking on.

Does higher VIX lead to higher options prices or is it the other way round?

Usually it is higher VIX leading to higher options prices, but the effect could also be circular. Besides futures prices too have a role to play in this equation.

“If you look at the NIFTY futures to spot differential, it is right now at the highest on record at almost 200 points for the January series,” says Rohit Shrivastava Founder and Market Analyst, Indiacharts.

When people are willing to pay a higher premium to hold or rollover in the index futures, then that rollover cost is actually priced into the options premium. So the higher the futures basis, the higher the premium cost, and that higher premium cost is equal to higher VIX,” he says.

Also read: VIX dips below 10 indicating Indian market is unfazed by global risks, traders puzzled

Does high VIX a sign of a correction in the offing?

Srivastava points out that usually one can expect the markets to correct when the VIX goes up but currently both VIX and the market rising simultaneously.

“This is an indication that excessive bullishness and whenever it reverses will come with some degree of volatility which the VIX is already showing. The same kind of pattern can be observed even at the peak of October 2021, when we topped at 18,600 and then stayed below that for several months,” he says.  Srivastava expects a similar set up going into 2024 where the VIX is advancing along with the NIFTY which is a “bearish divergence” showing that the excessive bullishness of the market participants.

What should investors do?

Milan Vaishnav, Founder, Gemstone Equity Research & Advisory Services says: “What we are now seeing the market is getting vulnerable to some sharp profit taking bouts from higher levels. This means we now need to be rather mindful of the fact that markets may see some consolidation at higher levels or see some sharp profit taking bouts from the current levels,” he explains.

Given the divergence from the usual trend, how should investors view the VIX moves?

Dinesh Nagpal says that if the reason for the rise is the expiry of monthly contracts, the impact should be seen only till the end of day today. But if the Index continues to go up even tomorrow then there could be some alarm bells. “Being an election year, the market could be then calculating for some populist measures etc that could impact the market. But I will only consider that if we see continuous rise of VIX from tomorrow, then it could go as high as 18 or 19 in that case,” he adds.

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