With a sudden reversal of sentiments leading to a sustained downtrend in the equity market worldwide, the implied volatility (IV) of Nifty options have shot up drastically in the past couple of trading sessions. The IV is the measure of markets? expectation of volatility in the near term, and in general, it increases when the market is bearish and decreases when the market is bullish .
The measure of implied volatility in the NSE India volatility index (VIX) touched 31.90 on Tuesday; its highest in 2010 from the level of 23 registered during the beginning of the year, pointing towards increased cautiousness among the market players. Similarly, the Chicago Board Options Exchange (CBOE) Volatility Index or CBOE Volatility Index, which is tracked closely by global investors, closed at 26.40 on Monday, its highest in 2010 from 20.04 registered during the start of the year.
Going forward, experts feel that the movement of implied volatility will have to be closely monitored in order to understand the direction of the market. ?IV will have to be critically watched in coming days,? said TS Harihar, head of institutional derivative, ICICI Securities. He pointed out that an implied volatility in the range of 30? 35 in the current environment would signal a bottoming of domestic equities from where it would bounce back. But, if it crosses beyond those levels, then the markets would be heading for fresh selling.
The BSE Sensex is now 10% down from its 52?week high of 17,790.33 points touched on January 6, 2010, while the NSE Nifty is down by over 9% from its yearly high of 5,281.80.
On Saturday, the NSE VIX touched a high of 30.21 in the intra-day trade before closing at 29.22, down 2.83% from the previous day?s close of 30.07. On Friday, when the domestic equity indices tanked heavily with the BSE Sensex down 2.68% and NSE Nifty losing 2.61% following a global equity sell-off, the NSE VIX touched an intra-day high of 31.23 before closing at 30.07.
?Implied volatility generally shoots up when there is high amount of uncertainty about future. For the last few days, the markets have been highly volatile primarily because of global factors. The events unfolding in Europe have created a fresh round of uncertainty among the equity investors leading to a spike in the implied volatility,? said Yogesh Radke, head of quantitative research, Edelweiss Capital.
During the month of January, when the Indian markets traded in a very range bound manner, experts pointed out lack of any major movement on India VIX. However, the trend started changing following reports of China tightening its credit disbursals, US administration?s proposal to curb banks? investment in riskier assets and the latest news showing a few European economies facing severe sovereign crisis resulting in a sustained downtrend in the global equity market.
?Once this range got broken, investors started taking aggressive directional bet with heavy build up of positions in index options,? added Harihar. But he pointed that FIIs who sold index futures last week when the market tanked on Friday were long only investors and were merely hedging their cash market portfolio.