Personal Finance

Now, you can make money from fear

Rajalakshmi Nirmal | Updated on February 16, 2014



Hedge the volatility in stock prices via futures contracts on the NSE’s Volatility Index

The National Stock Exchange (NSE) is set to roll out futures contracts on its volatility index, the India VIX. The contract will be launched on February 26. This opens up a way for traders to hedge volatility risk on equity investments.

The volatility index — VIX — was first introduced by the Chicago Board of Options Exchange in 1993 to measure volatility in the US market. It was based on S&P 100 Index option prices. Ten years later, VIX based on S&P 500 options was also introduced. India VIX was launched in 2008 by the NSE and is an indicator of investors’ perception of volatility — or how much the index can fluctuate — in the near term.

The index’s value is computed from the best bid-ask quotes of the near and next month Nifty option contracts. The index usually moves higher when stock prices drop and declines when stock prices rise.

So, one should turn cautious when the volatility index rises. A sharp spike in the VIX is generally noticed in a market crash when panic levels are high. India VIX hit a high of 92 in the bear market of 2008.

How traders benefit

Traders can use India VIX futures to hedge volatility. The Nifty and the India VIX are negatively correlated. So, a trader who expects prices of his stocks to fall can go long on India VIX futures contract and cover his risk. Take, for instance, Nifty’s drop between July and August last year when it slipped from 6,093 to 5,118. In this period, India VIX leaped from a low of 37.9 to a high of 83.17. India VIX futures will also serve as a good portfolio diversifier.

Contract specifications

At any point in time, three contracts will be available for trade. Each week’s contract will expire on the Tuesday of that week. India VIX futures shall be marked-to-market (MTM) on a daily basis. The MTM shall be netted along with other equity derivatives contract at the clearing member level.

On the expiry day, all open contracts will be cash settled. The tick size is 0.25. The minimum contract value at the time of introduction will be ₹10 lakh. The daily settlement price will be the weighted average price for the last 30 minutes of the respective futures contract. The final settlement price will be the closing value of the India VIX index on the expiry day.

The closing value of the India VIX index itself will be the average of the index values for the last 30 minutes of trading.

Price computation

Values of India VIX futures will be computed up to four decimals.

The contract’s price will be quoted as the expected India VIX index value multiplied by 100. Suppose, one wants to buy a VIX futures contract at 18.1321, the price will be quoted as 1813.21.

The value of one contract will work out to 1* 1813.21* lot size. All traders with a demat account and a broking account can trade on India VIX futures.

This product is a simpler tool for traders to cover the portfolio from price volatility, according to Bhavin Desai, Equity Derivatives Analyst at Motilal Oswal Securities. “Futures on India VIX will let traders hedge volatility without having to resort to sophisticated software or complicated option strategies. India VIX has been around for a long time now and is not completely unknown to market participants. NSE has suggested that the minimum margin requirement would be at least 14 per cent (9 per cent initial margin + 5 per cent exposure margin).”

Published on February 16, 2014

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