Betting on volatility easier from this month

NSE to launch VIX derivatives from February 26, measuring swing expectations; investors can take weekly positions

The National Stock Exchange has announced it would be starting a product which allows investors to bet on market volatility by the end of the current month.

“Futures contracts on India VIX shall be made available for trading in the futures & options segment from February 26,” said an announcement on the exchange website.

The product would be a derivative based on the NSE’s India VIX, a volatility index, the so-called ‘fear gauge’ which measures traders’ expectations of how wildly the market might swing in the days ahead, on the basis of index options prices.

Investors will be able to take weekly positions on market volatility, with three contracts each with a tenure of one week. The minimum value of each contract will be Rs 10 lakh.  

The margin requirement globally for such instruments is four to five per cent. Meaning, investors can trade on volatility for as little as Rs 50,000, according to an expert. The exchange would need to issue a separate circular on this, he said. An exchange spokesperson said a separate circular was likely but declined to comment on details.

The exchange applied to start trading on a volatility-based derivative in 2010. The stock market regulator did not allow the product, with sources indicating it had some initial discomfort with the speculative nature of the product. Meanwhile, the exchange continued to provide live values of the Volatility Index since July 2010, after launching it in 2009 based on end-of-day prices.

The index value is arrived at on changes in the price of Nifty options and acts as an indicator of expected volatility over the next 30 days. Higher the value, the greater the expected volatility.  Traders currently use a combination of existing index derivatives to take a position on the expected market volatility, say experts. The introduction of a direct derivative for volatility will make such trades less complicated and also more cost-effective, they added.

U K Sinha, chairman of the Securities and Exchange Board of India, announced the regulator’s approval of the product last month. Institutions and wealthy individuals are expected to be the first users but retail investors, too, are likely.

Yogesh Radke, head of quantitative research, Edelweiss Securities, said the VIX derivative provides an instrument for hedging volatility especially with elections due in a few months, traditionally seen as a period of large market swings.

“The options volume had begun to pick up with the elections. This provides an easier tool to take a position on expected volatility and provides an avenue to hedge risk, and can possibly be used even by retail investors,” he said.

Amit Gupta, head (derivatives), ICICI Direct, also said there might be a spike in volatility on account of a new government.

“In 2009, we had seen a large move after a new government came into power...Any large move is likely to happen after the elections,” he said.

BETTING ON VOLATILITY

* Volatility-based derivatives to begin trading from February 26 on NSE

* Contracts to be worth Rs 10 lakh

* Contract cycle would be weekly, with expiry on Tuesday

* Earlier, traders bet on volatility through complex structures

* Experts say trading on volatility would be easier, more cost-effective through the new product