The National Stock Exchange (NSE) has launched India's first ever Volatility Index or the India VIX, based on prices of options on the benchmark Nifty 50 Options prices.
A volatility index captures the implied volatility embedded in prices of options and reflects markets expectations of volatility over the near term. In this regard, India VIX, which will be calculated using the prices of 50 stock options of Nifty, will indicate by how much the Nifty could fluctuate over the next 30 days.
Over the last decade or so, there has been a paradigm shift in the Indian capital markets. The Indian markets are no longer isolated from the global economic events. We have witnessed bouts of volatility in our markets, some of which may have their origin in global events. The recent sub prime crisis and news of probable recession emerging from the US, are examples of how events which are international, can cause volatility in our markets. Inflation rates, global energy prices, exchange rate fluctuations etc. are witnessing constant changes in the recent years. These are affecting the volatility of the markets, NSE said on its website.
In this regard, the India VIX is a simple but useful tool in determining the overall volatility of the market. The index captures the implied volatility embedded in option prices. Not only is the volatility index used as an indicator of implied volatility of the market, various tradable products, such as futures and options contracts are available on the volatility index internationally, it said.
A Volatility Index reflects the market's expectation of volatility over the near term. The index captures the implied volatility embedded in option prices. Volatility is often described as the 'rate and magnitude of changes in prices' and, in, finance often referred to as risk. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualized volatility, denoted in percentage e.g. 20 percent) based on the order book of the underlying index options. Market volatility keeps changing as new information flows into the market. It would be imperative for market participants to have an index designed to track market volatility, it explained.
The Volatility Index is a good indicator of the investors' perception on how volatile Markets are expected to be in the near term. We have done our homework before finally launching this product and it will help determine the overall volatility in the market, Ravi Narain, managing director and CEO, NSE, said, following the launch of the index on April 8.
Different people can use a VIX for different purposes, Narain said. Some people may take it into their books and trade on it. Others may hedge, and some may make changes in their asset class, he said.
Greater the liquidity in the options segment, better the index. There are also plans to introduce an intra-day volatility index once this one finds acceptance among market participants, a senior NSE official added.
Welcoming the launch of India VIX, a market analyst said, The India VIX value provides the expected volatility perceived by the market over the next thirty calendar days. Based on the India VIX value an investor can perceive the expected change in his portfolio of investments and thereby take necessary risk management action to safeguard against the uncertainty.
Globally such volatility indices are used by those investors who use stock and index options frequently. For India, it would be very useful for hedge funds and foreign institutional investors (FIIs) who invest through the options route, the analyst said.
In a related development, stock market regulator Securities and Exchange Board of India's (SEBI) chairman C.B. Bhave said it might soon allow launching products based on a volatility index.
The advantage of measuring things is to first define them. The volatility index will increase the understanding among people. Once that happens, we will be ready to launch products based on it, Bhave said.
On the foreign bourses there are various tradable products available, based on the volatility index, however NSE does not intend to introduce any such products in immediate future but chances of this in the long term cannot be ruled out, Narian added.
ABOUT VOLATILITY INDEX
Volatility index or VIX, also called the fear index or risk index, is an indicator that captures the level of fear in the capital markets and help investors understand market risks better and take decisions accordingly. When investors turn fearful, the VIX index moves higher. The Chicago Board Options Exchange (CBOE) was the first to develop volatility index in 1993. There is also the VXN which tracks the Nasdaq and VXD that tracks the Dow Jones Industrial Average.
The implied volatility, as captured by the volatility index, is not about the size of the price swings, but rather the implied risks associated with the stock markets.
Implied volatility increases when the market is bearish and decreases when the market is bullish. This is due to the common belief that bearish markets are more risky than bullish markets.
Market volatility keeps changing as new information flows into the market. High readings indicate a higher risk in the market place. For instance, the reading of VIX reached almost 45 in 1998 as the LTCM (Long-term Capital Management) crisis exploded. It took a few months for the investor's fears to abate and the VIX to return to below 20. The World Trade Center attack in 2001 also made the VIX climb above 45, as the investors' fear level reached the zenith.
India VIX is a volatility index based on the Nifty 50 Index Option prices. It uses the same methodology that CBOE uses to compute its VIX, which is based on the prices of options of the S&P 500 index. From the best bid/ask prices of Nifty 50 options contracts (which are traded on the F&O segment of the NSE), a volatility figure percentage is calculated, which indicates the expected market volatility over the next 30 calendar days.
Higher the implied volatility, higher the India VIX value and vice versa. There are some differences between a price index, such as the Nifty 50 and India VIX. Nifty 50 is calculated based on the price movement of the underlying 50 stocks, which comprises the index. India VIX is calculated based on the bid-offer prices of the near- and mid-month Nifty 50 Index Options.
While Nifty 50 signifies how the markets have moved directionally, India VIX indicates the expected near-term volatility and how the volatility is changing from time to time.
It has been observed that when the market is range bound or has a mild upside bias, volatility is globally observed to be typically low. On such days, investors prefer buying call options (a position taken on the view that the market will move higher) over put options buying (a position taken on the view that the market will move lower). This kind of market may indicate lower risk.
Conversely, when the selling activity increases significantly, anxiety among investors tends to rise. Investors rush to buy puts, which in turn pushes the price of these options higher. This increased price that investors are willing to pay for put options shows up in higher readings on volatility index.
At present, NSE will publish only the index values at the end of the day. Once there is stabilization, products based on India VIX will also be launched.