Hello Friends,

I am discussing some finer points which comes in play for valuing India VIX. I should have spoken about finer points in my first part, But what I believe, At this juncture all of us are more interested to play around election results So at the onset, But the points I will discuss now should help you for longer time.

**Some characteristics which goes in to making of India VIX are**

a) VIX consist of 2 Implied Volatility (IV), They are for near month and next month. The IV are interpolated to arrive at VIX.

b) As Time Passes the weightage of Next month goes on increasing, and Near month goes on decreasing.

c) All out of money calls and puts are taken into consideration.

d) The calculation of VIX is not done on traded prices but only on Bid - Ask Quotes.It is an average of Bid- Ask Quote. No matter if the trade does not take place. The only caveat is that the spread between bid and ask should not be more than 30%. (It is just to avoid distortion in prices due to high bid - ask spread.) Suck condition is not there on CBOE VIX as the market is more mature over there.

e) If a Bid - Ask spread of a strike is below 30 %, All OTM strikes above that strike in case of Put and All strikes below that identified call are taken into calculation for VIX.

So if today 5000 P has a bid-ask spread of less than 30 %, then all strikes from 5000 and above upto 6700 will be considered for calculation, similarly IF less than 30 % spread is true for 8000 call, then all call from 8000 call to below 6700 call will be considered for VIX (Current Nifty is around 6700).

Also It does not matter is in above example 5150 P may not have Bid - Ask spread of 30 %, Than also it will be considered as the strike below it is already considered.

f) Once all strikes are identified, The price of each OTM call and put is taken. But if some strikes which are identified for calculation have bid - ask spread of more that 30 %, then a fair value for that strike is arrived using statical tools.

Hence all OTM strikes will have a fair value or a value generated using bid - ask.

g) Using all these data point, Volatility for each moth is generated and , the Final VIX is arrived.

**Some Specific Insight for VIX**

a) Higher the number of strikes and the distance from the current Price of Nifty, Higher will be the VIX, Because VIX takes into consideration all OTM calls / Puts and Every value of strikes are taken. No matter its impact goes on reducing as strikes becomes deep out of money, but there are marginal effect and with VIX trading upto 2 digits of VIX value, It can be huge.

b) Puts and also Deep Out of the money puts contribute more in calculation of VIX, compared to calls.

c) Typically, 80 % of the value is contributed by 3 -4 strikes, which are near the money, the rest is by other OTM calls and Puts.

d) In cases of higher IV for At the money Strikes (ATM Strikes) Eg: IV of more than 30 % , The VIX tend to be comparatively lower than ATM IV and vice- Versa.

e) IV of Near month is not considered, for last 3 days of expiry and the VIX is calculated using 2nd and 3rd month Nifty IV.

**Some Statistical loophole which I could identify in India VIX :**

a) I can rig VIX by few points by only giving bids and ask at the lowest Strike of Put of Nifty.

For Example Yesterday, 2700 P of Nifty June got active in VIX calculation and the price of VIX shot upto 0.50 points, which is 50Rs of VIX (Huge)

b) There will be calculation error in VIX for first 5 days of the starting of new Expiry, if The Expiry is of 35 days. Beware of that, Try to look for prices for 5th day only.

I will take an example here, For month ending 29th May, 2014 which is of 35 day, The first day for calculation of VIX will be from 23rd April as near month, (3 days before expiry ie Tru, Wed AND Tue.)

Again if on Thu or Wed or Tue happens to be a holiday as per above example the Prices on Tuesday will be distorted heavily, as it happened on 22april. Beware of such prices.

I will end here by saying that value of VIX can be arrived at using underlying IV, But It cannot be replicated. and There is also some ingredient of expectation inbuilt in VIX, which cannot be valued

I have tried to use simple words and no statistical jargon for readers.

This is not a recommendation to
anybody whatsoever to buy OR sell this share, but it is my thought
process and views on this topic.

I welcome your critical comments and suggestions.

PS : I intend taking position in VIX.