The Hindu Business Line : Tech School

The launching of India VIX (volatility index), India’s very own fear gauge is a timely move by the Indian regulator. Now, instead of shaking the head gloomily and making a general statement such as ‘the market is very volatile these days’, investors can instead quip that the India VIX rose 10 per cent yesterday. The inference would be that investors were rattled by some event that resulted in a sharp decline in stock prices.

The volatility index moves higher when the stock prices are declining and it moves lower when the stock prices are rallying. Since the volatility index is derived from the prices of index options with 30 days to expiry, it reflects the near term expectations of the investors. When markets decline sharply, the perception of risk increases and this is reflected in the higher price of index options. Conversely, when the markets are coasting steadily higher, investors are complacent and the prices of these instruments too is lower.

The original VIX, that the world watches, is the volatility index based on the S&P 500 index options traded on the Chicago Board of Options Exchange (CBOE). This index was moving in a very self-content fashion between 10 and 20 between 2003 and mid-2007. With the eruption of the sub-prime crisis, the index moved beyond the band in August 2007 to record a five-year high at 37.5. CBOE VIX is moving in a wide band between 23 and 35 since then, implying that investors’ nerves are far from assuaged.

The India VIX that is based on the price of index options with Nifty as underlying has come in to existence at a turbulent phase in the market’s history. It may be recalled that the Nifty plunged more than 30 per cent from its peak in the first quarter of 2008.

The historical data on India VIX available on the NSE Web site shows how the indicator has captured the investor sentiment in this period. The indicator was at a reading of 25 in late December 2007. It zoomed up to 54.4 in the third week of January. There has been a steady decline from those levels as investors’ panic abated and it is now moving between 31 and 38 since March indicating an uneasy truce since it has not fallen below 25 nor has it moved past 40.

As the investors’ comfort level with this index increases, they would begin to recognise the band within which it should move while the market is in a bull phase and the extent to which it can spike during market crashes. This would be an additional indicator that they can track to gauge the mood among the stock market fraternity. Traders who would like to trade against the herd can buy when the VIX is zooming up and vice versa.

Once tradable products based on India VIX are introduced, traders can take positions based on their projection of the market volatility in the ensuing period. Volatility indices based on various sectoral indices is also promised at a later date. As with all new products, doubts remain about the functioning of this indicator given the relatively low trading interest in options on the Indian bourses. While Nifty-based VIX could reflect the trading sentiment to some extent, sectoral VIX might not see the light of the day yet given the low trading interest in the options on these indices.

—Lokeshwarri S.K.

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