VIX at a historic low: Is it an investment opportunity?

Long-term investors are better off investing their money in the stock market through SIPs

- Akshat Rohatgi & Saumitra Khanolkar

To be sure, not all investors consider it a negative influence. Some investment gurus have even labelled it as an opportunity to buy undervalued companies. That is perhaps why Warren Buffett said “the true investor welcomes volatility".

For the benefit of investors, stock markets have a dedicated index to measure volatility. The VIX, or volatility index, is used by investors to measure market risk, fear and stress, before they make investment decisions. For instance, the India VIX is a measure of how much the Nifty 50 index is expected to change in the next 30 days. It tells us how unpredictable the market is likely to be. If the India VIX is high, it means there is a lot of uncertainty and fear in the market. If it is low, it means the market is more stable and predictable. However, the VIX also tends to mean revert and its current level is unusually low.

VIX and options

The VIX is related to options pricing, and so here’s a quick guide to what options mean. Options are financial contracts that give the holder the right to buy or sell an underlying asset at a predetermined price within a specified time frame.

There are two types of options: Call options give the holder the right to buy the asset at a certain price, while put options give the holder the right to sell the asset at a certain price. Call option buyers take the view that the market will rise while put option buyers take the opposite view. A third view is that volatility will happen, without specifying the direction of the swing. This means investors take a considered view on the VIX rather than the stock market movement.

The India VIX is a metric that is calculated using the Black Scholes Options pricing model. It takes into account five variables for option contracts for the months ahead. These include the strike price, market price of the stock, time to expiry, risk-free rate, and volatility.