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
Option traders often refer 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?
Continuous Time & Option Premiums
Imagine on the 13th of March, you had bought the 10400 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 10400 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 59 on March 13th based on the best buyer and seller for the OTM options.
Combining Terminal Volatility & Vix
In our last article “How To Trade Nifty Options If VIX Is High” we had discussed that the 19th March 10400 Call option was sold @ 99 and the 26th March 10400 Call option was bought @154 on the same day. To the naked eye, it appeared like a regular calendar spread executed at 55 and booked at 89. If you look deeply, this Call spread performed well even when Nifty opened 400 points gap down on Monday and the volatility rose. The advantage of trading option using Terminal Volatility is about the precise entry and the stop loss.
Option Trade When Vix At 63
On Monday morning, the Terminal Volatility gauge identified another opportunity in a diagonal calendar spread. In this case the 9100 Put in the 19th March contract was sold and the 8900 Put in the 26th March contract was bought. We must keep in mind that we did not know that India Vix would spike up to 63 today. The spread was executed around 70 as per the Terminal Volatility and was carried overnight. The spread value zoomed to 140 when Nifty plunged to 8851 and closed at Rs.136. Hence the idea is to identify strikes that will generate returns by drifting alongside the market irrespective of the shift in direction or volatility.