Game of Volatility and Option Pricing – How India Vix affects Options prices
What is India Vix?
According to Google VIX a concept specific to options and is a prediction made by market participants (Calculated mathematically) of the degree to which underlying securities may move in the future. Read more about India Vix here
Now if you have a basic understanding of what India Vix actually is, look at the chart below. See how Vix behaves at market Tops & Bottoms.
The chart above is a comparison between Nifty and Volatility index / VIX (the Orange line chart being VIX)
Looking at the figure we can see, when the price of NIFTY (top chart) is moving lower, VIX (orange chart) is moving higher, and vice versa. Reversal points are marked with arrows. So we can assume that when the market bottoms out, VIX starts falling i.e volatility decreases, and when the market Tops Vix rises.
HOW VIX AFFECT BUYERS
Let us zoom into Friday’s session. (Dt. 30-09-22’)
In the above figure, The chart to the right is NIFTY and to the left is VIX. For the whole day, Nifty was in continuous uptrend while the volatility was declining. Options prices are inversely proportional with volatility. So, when index is rising and VIX is falling PUT Premiums will decline much rapidly compared to the gain of CALL Premiums. Lets understand it better from the example below.
Now look at the above chart.
At 9:25 Nifty was trading at 16800. We have chosen CE & PE both 200 points OTM from LTP. To the Top right we have 17000 CE and to the bottom right we have 16600 PE.
From 9:25 to 10:30 Nifty moved up by around 130 points.
I have marked the price at 9:25 and 10:30 on chart of both the strikes. Lets do some math.
17000 CE (at 9:25) : 95 Rs
17000 CE (at 10:30) : 122 Rs
122 – 95 = 27 Rs | If you bought 17000 CE on 9:25 at Rs 95 and sold at 10:30 at Rs 122 you will make profit of
27×50 (considering you bought 1 lot) 1350 Rs
16800 PE (9:25) : 116 Rs
16800 PE (10:30) : 66 Rs
116 – 66 = 50 Rs | If you sold 16600 PE on 9:25 at Rs 116 and bought it back on 10:30 at Rs 66 you will make profit of 50×50 (considering you sold 1 lot) 2500 Rs
This means when index is rising and VIX is falling its wiser to SHORT PUTS than BUYING CALLS (More details later on)
FROM SELLERS PERSPECTIVE
Vix is also called a fear indicator. The higher the Vix higher is the fear.
High VIX = More Volatility = More Fear. Options sellers will demand more premiums since the risk is high. So the premiums are high. In the same way, when Vix is low there is less fear in the market.
Impact of Price and Volatility Changes on Long and Short Option Positions
The chart below shows what’s best to do in mentioned conditions. “+” and “-” sign means positive and negative effects. Eg. : +/+ means Buying calls in a falling market will give the best results. This great article from Investopedia will further help you understand the below chart.
Have a profitable trading session!
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