Volatility futures not for retail investors

Good hedging instrument, minimum contract size of Rs 10 lakh is a deterrent

Many investment advisors ask investors to prepare for an important event. Say, an impending election or Budget. While it is not advisable to change your asset allocation for such events, one could always earmark a small amount to take calls which could earn a quick buck.

But this is where the NVIX – the futures contract of the National Stock Exchange volatility or VIX index, to be launched on Wednesday – isn’t a great idea for retail investors. With a minimum contract value of Rs 10 lakh, it does not encourage participation from retail investors.

It has its uses, though. Take for instance, the national elections that are a few months from now. As the outcome is uncertain, investors can buy the NVIX as a hedge against their equities portfolio. If the market falls, the futures will gain.  If the market gains, your equities portfolio will gain because there is an inverse correlation between markets and implied volatility, explains Siddharth Bhamre, fund manager, derivatives, Angel Broking. So, if Nifty gains, India VIX can be expected to fall and vice-versa. “It is not an investment tool. It is a hedging tool,” Bhamre adds.

The India VIX gives a sense of how much of a swing trader expect in the market over the next 30 days. It does this by taking the prices of the near and middle month out of money options contracts and uses the Chicago Board Options Exchange methodology to arrive at the volatility.

Currently, the India VIX (Nifty-50) is hovering around 14 per cent, which is fairly stable. This means traders believe the Nifty could go up/down by 14 per cent (on an annualised basis). The NVIX contracts will have a weekly tenure and will be settled on Tuesdays. It is an additional tool to hedge along with existing futures and options contracts that are linked to Nifty or Sensex.  Investors can also use it to diversify their portfolios, says Kiran Kavikondala, director, WealthRays Group. “Currently, the derivative products available in India track Nifty or Sensex. The new futures contract will track India VIX, which has a negative co-relation to Nifty. So, it covers the risk of Nifty stocks. Whatever stock the investor buys, he can buy a NVIX contract as a hedge,” Kavikondala says.

In markets abroad, investors keep rolling on derivatives contracts. But in India, derivatives are not considered as investments. That is why retail investors should not enter this unless they understand it fully, Kavikondala adds. Since the underlying is volatile, it is difficult to bring down the margins. So, the only way to attract retail investors would be to bring down the high contract size, while maintaining high margins. “If the contract size is Rs 1-2 lakh, then investors will not mind paying the high margin. Today retail investors can trade in existing derivative products with small amounts ranging between Rs 25,000 and Rs 1 lakh. In comparison, in VIX futures the margin requirement is too high,” Bhamre says.

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