The Fear Factor of Markets

Day traders and investors should track multiple parameters alongside

the main charts and instruments that they are trading. While many have

a direct correlation to the underlying asset, some of the indicators could

also have a negative correlation to the item that is being traded. It is

important to understand such tools and find an edge in the market.

The Volatility index is one such tool that can give you an extra

layer of confirmation for trade on both the long and the short side.

But, VIX as a standalone indicator can be confusing and misleading

as well. It is better to use it along with other parameters and setup rules

VIX or the Fear factor of Stock Market

The volatility index actually determines the expected volatility

of an index over the next few weeks. The VIX is derived

from a mathematical equation of the puts and the calls.

Thereby the VIX can help determine whether a market is

having bullish sentiment or bearish foresight. If the market

is full of greed the VIX value is considered to be in lower

ranges. If the volatility (in the case of India VIX above 20)

rises sharply, the market is fearful of a crash or a correction.

The reaction to the VIX is often immediate or within a

few weeks. If you track past charts, you may see that

the markets have reacted within a time horizon of a

maximum of 30 days. 

For option sellers/writers a High volatility factor is always

risky. It is better to stick to situations that have lower

volatility factors and can give more probab9ility of winning.

Profitability depends on a lot of factors when the VIX is high.

The oscillating prices of the option can be difficult to predict

and that may lead to significant drawdown. However, when

the VIX is lower, it becomes a nightmare for option buyers.

The prices of the options can barely move in the desired

direction. So even though the option had been chosen as

per the direction of the trend, the reward might be significantly

lower. In some cases, the double attack of time decay and

the low volatility in the markets can lead to significantly

higher losses for an option buyer.

One can see that the market has a tendency to top out

when VIX hits the lowest lows and the market falls down

when VIX makes newer highs. This negative correlation is

often tracked by hedge funds and big institutions to predict

and use the market forces to their benefit.

One should also keep in mind the important  “timings”

of the market. Keep alerts for the opening, closing, and

rollover time frames. The volatility index gets very choppy

during such timeframes and it becomes difficult to trade in

either direction. On occasions where there is a pre-determined

event or an important announcement, the VIX might abnormally

shoot up and hurt the portfolio of the option sellers.

However, there are ways and strategies to hedge certain

volatility moves. One can work with strict risk management

and an understanding of the core concepts of the asset that

is being traded. The chart has all the answers, it's about

the interpretation. Many employ the strategies like straddles or

strangles, as per their interpretation of the volatility

factors in the near term.

Books like this might help you in this process.

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The volatility index is derived from the order book of

the underlying index. The VIX is not the same as the

value of an index and it often depends on other factors

along with the market sentiments. In the case of India

VIX, the method of measurement is through a technique

that is known as the CBOE method. 

The first important parameter that is considered is the

time to expiry. This is measured in minutes and is very

crucial for determining the latent volatile on an immediate

basis. Next, a risk-free interest rate is

attributed to the month of expiry in the options.

The forwarded levels of the index are considered for

determining the at-the-money strike prices and this

determines which option will be used for the calculations.

The at-the-money strike level will be just below the forward

tenure future levels. The best bid and ask quotes of the

option at at-the-money option is then used for

calculating the VIX.

There is another statistical choice that is made in case there

is not enough to bid and ask prices in the relevant strikes.

This method is through the “natural cubic spline” in this process

separate volatility calculations are done for near and far

months expiries. In simple words, the best bid and ask

prices of the near and next month contracts are used

for the calculation of the volatility index. One can also

take the relation of VIX oscillation to be related to the

call and put prices of the underlying options.  A higher

VIX means that traders are increasing the bid on the

price of puts as compared to calls. More traders are

expecting the market to fall in the near future. On the

other hand, a falling VIX usually means that more traders

are of the opinion that the market will increase in the near

term and then they6 are willing to pay the higher premium

prices for the calls. the idea is to hold the calls for a longer

period of time and make money.

Simple errors in the market can be improved upon and eliminated by following a trading journal. 

Another important factor to keep in mind while

tracking the volatility of the market is that the

markets have some specific coping


Markets hate uncertainty and special events

and uncertain stress points lead the VIX to

significantly higher. The sudden spikes in

VIX give the idea to make money in debit strategies.

Traders and investors can benefit from this indicator

which is derived from a lot of back-end calculations.

It is not a typical indicator that gives you buy

sell recommendation by itself. However, it clearly

helps you in gauging where the market wants to be at.

Read more market-related topics here

Options Strategy for both Buyers & Sellers

How to Put Stop Loss Correctly


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