India VIX slumps as market players wind off volatility trades after Lok Sabha election results

Jun 03 2014, 09:36 IST
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India VIX dropped from a four-year high to 16.5 after the election outcome. India VIX dropped from a four-year high to 16.5 after the election outcome.
SummaryTo make the most of the momentum build-up around the election outcome, investors traded market volatility with higher enthusiasm

To make the most of the momentum build-up around the election outcome, investors traded market volatility with higher enthusiasm 2-3 weeks ahead of the results. However, as the ‘event risk’ subsided since May 16, the expected market volatility, as depicted by options premiums and India VIX, a gauge representing implied volatility, have come off drastically.

After witnessing a two-fold jump to 37.7, between the start of April and mid-May, India VIX dropped from a four-year high to 16.5 after the election outcome.

According to experts, as the date of exit polls and election results approached, all classes of investors, including retail, high networth and institutional, increased bets on volatility through options.

“As they realised that market momentum may keep the indices on elevated levels, we saw several HNI clients approaching us with even R20-50 lakh of funds, requesting us to execute volatility trades with quantifiable risk,” said a derivatives trader with a domestic broking house.

Depending on their view of the likely outcome of the election, these investors entered into either long or short volatility trade that requires minimum investment of R25,000 to R50,000.

While futures on India VIX are available as a trading product, most of the trades are believed to have taken place through the combination of dealing in call and put options.

“Due to the contract size of VIX futures, which increased further with a higher underlying value, the initial investment requirement further rose. So limited volumes contained trading in VIX futures,” said a derivatives strategist.

At the time of their introduction, India VIX futures had a minimum contract size of R10 lakh and a lot size of 600.

Investors who have a view that the realised or actual volatility would be higher than the implied volatility represented by the option premium entered into long-volatility trade while those who opined that realised volatility will be lower executed short-volatility trade. The increased option premiums were reflected by the jump in value.

After the poll outcome, however, most traders unwound their positions as implied volatility crashed. Market observers now see these trades gaining interest again in mid-June, when the street starts focussing on the likely budget announcements from the Narendra Modi-led BJP government.

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