Insights On Vix From Bank of America Merrill Lynch

Volatility derivatives to trade from Feb 26

Derivatives based on trader’s expectations of how wildly the markets will swing are set to go live this month. Bank of America Merrill Lynch has identified three things to bear in mind about the new derivative product in its report entitled ‘Launch of VIX futures – Three takeaways for markets.’

 

The National Stock Exchange’s India VIX, a volatility index on whose movements the derivative will be based, has a negative co-relation with the Nifty, the index which measures how the largest companies on the exchange are doing.  In other words, if VIX rises, the Nifty can be expected to fall, according to research analysts Jyotivardhan Jaipuria and Anand Kumar.

 

“In general India VIX starts to increase at the time of stress in the markets and falls as investors become calm….The correlation between Nifty and VIX over last 5 years is negative 0.84, a significantly high number, making it a strong indicator for prediction of stress in markets,” said the report dated February 12.

 

Also markets tend to rise ahead of election results, and fall afterward. “India VIX increased from 36% on 1st April’09 to 55% a few days before results. However, it fell sharply to 43% once results were announced. We would expect VIX to rise as we near May this year too,” it said. 

 

If the VIX has touched a peak, then one can expect some upside. “Once the VIX has peaked, markets usually give a positive return over 1 week and 1 month. Of the 4 instances when India VIX has crossed 30% mark, Nifty has always given a positive return with average return of 6.5% in a month,” it added.

 

The NSE had announced earlier that it be starting futures contracts based on India VIX starting from February 26, 2014.