Eighteen months after introducing India’s volatility index, or VIX, market regulator Sebi has begun its groundwork to introduce derivatives contracts, with the index as the underlying. VIX is a measure of traders’ near-term expectations of implied volatility, or IV, based on the 50 stock options prices on the Nifty index. The regulator is believed to be talking to market participants about the possibility of introducing futures and options that traders can use to bet on the direction of the VIX.
“The preliminary work has begun as we are in the process of understanding the investor appetite for such products. We are seeking an informal feedback from market participants,” said a senior Sebi official.
To start with, Sebi is likely to introduce just futures contracts on the IX and then options in the next phase. The move to explore the feasibility of introducing derivatives products on VIX comes in the wake of a rise in activity in India’s options segment over the past couple of years. The pick-up in action in options contracts, which has been partly driven by volatility traders, has helped better ‘price-discovery’ of options, encouraging officials to look at the possibility of introducing VIX derivatives.
“It will mostly be used by savvy traders, as derivatives on VIX means futures on options or options on options, which is not easy to understand for a retail investor,” said the derivatives head of a foreign broking firm.
IV is a key parameter in pricing of options’ premium. Market participants usually track IVs (or VIX) to gauge the sentiment in the market, as traders are known to purchase more options for a premium — similar to a person buying a general insurance — when they sense higher risks. As demand for options rises, there is a corresponding rise in IV (or VIX) too. In the past, options premiums, or IVs, have shot up, when there had been expectations of sharp market movements either side. Similarly, IVs remain low, when the market doesn’t sense any major risks or the undertone is still optimistic.
What the proposed VIX product aims is to help traders bet on IVs (or VIX) with a single derivatives contract at lower costs. Currently, traders use a combination of options contracts to construct volatility trading strategies such as straddles and strangles, which are costlier than single contracts.
“It is a good move, but a wider section of institutional investors should be allowed to trade in such products,” said Ashish Maheshwari, head-derivatives, Antique Stockbroking. “Also, given that the liquidity is mostly in near-month options, VIX derivatives should also be for the near-month with the same expiry,” he said.
Some brokers fear that this move could negatively impact volumes in options segment, as specialised volatility traders could shift to such products, because of lower costs. The share of index options’ turnover in total turnover of NSE’s futures and options segment has risen to 34% in 2009-10 compared to 11% in 2006-07.
