The VIX can be interpreted as a market fear indicator as in periods of uncertainty and pessimism the VIX can go up as more people start opting for options primarily puts due to fear of large market meltdown.
Given, the nature of the Index and the fact that a high volatility could mean a strong negative indicator, I wanted to test if using VIX, one could trade on the overall market index.
The experiment was carried out for the Indian market. NSE has had released an India VIX Index way back in February 2014. The VIX ever since it’s release has a fairly good negative correlation with the NIFTY50 Index.
While the NIFTY50 have an incredibly smooth slope, VIX has had a fairly sketchy trend downwards. A couple of peaks are surprisingly high but had a negligible impact on the NIFTY50’s movement.
The correlation between the price of NIFTY50 and India VIX is -0.55 which is a pretty decent number, to begin with. The goal though is to understand if we can predict the change in NIFTY50 as a function of India VIX’s change.
Interestingly, though we see some correlation between the prices, the strategy comes a cropper when trying to predict the change in NIFTY50 as a function of India VIX. Also, the trend has a slight tilt as we increase the delay from 1 to 180 days.
So, VIX on its own has very little explainability as far as movement of NIFTY50 is concerned, so even though based on the definition, we might expect a to predict a drop, we are probably missing a very crucial part of the process.
- VIX is more of a perceived risk indicator but not all preassumed risks result in negative results.
- Both indicators move hand in hand with any negative perception probably getting factored into the price.
- VIX might be more of a risk management tool than a feature for a predictive model. It might be useful while setting the stop limits for your trading system.