The National Stock Exchange has launched a volatility index reflecting the market's expectation of volatility over the near term, which is the next 30 day period.
The chairman of the Securities and Exchange Board of India, C B Bhave, who launched the index called India VIX, captures the implied volatility embedded in options prices. The index is based on the Nifty 50 Index Option prices.
"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," said Bhave.
From the best bid-ask price of Nifty 50 Options contracts (traded on the F&O segment of NSE), a volatility figure (percentage) is calculated, which indicates the expected market volatility over the next 30 days. Higher the implied volatility, higher the India VIX.
Implied volatility as captured by the volatility index refers to the implied risks associated with the stock markets and not the size of the price swings. When the market is range bound or has a mild upside bias, volatility is globally observed to be typically low.
On such days, call option buying (a position taken on the view that market will move lower) generally outnumbers put options buying (a position taken on the view that market will move higher), indicating lower risk.
Conversely, when selling activity increases significantly, investors rush to buy puts, pushing the price of these options higher. This increased amount investors are willing to pay for put options shows up in higher readings on the volatility index.
High readings indicate a higher market place but the volatility index can also be used as a contrarian indicator since spikes in the volatility index are associated with a market fall.
The introduction of the index would add volatility as an asset class to the investor's portfolio," said Ravi Narain, MD and CEO, NSE.
Investors could hedge their portfolios against volatility with an offsetting position in India VIX futures or options contracts. The implied volatility information that the index gives can also be used in identifying mispriced options.
"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," said a senior NSE official.
Based on experience gained with the benchmark broad based index, sector specific volatility indices would be constructed to enable hedging by investors in those specific sectors.
In January, Sebi had given the green signal for the launch of volatility index by both the exchanges. "Based on the experience gained and awareness generated, derivatives on Volatility Index shall be considered for introduction in due course of time," the Sebi circular had said.
However, NSE is the first exchange to launch such an index in India.
