Traders frown as listless market, historically low VIX turning into bane for them

The drop in VIX does not impact everyone evenly. Manual traders are at the shorter end of the stick.

For many market participants, the India VIX may not be of much importance but there is a growing section of market players – the option writers, or sellers — for whom this is perhaps one of the most important metrics. Traders selling options are finding it hard to make money because of a steady fall in the India VIX index.

India VIX, or simply VIX, is a measure of the market’s expectation of volatility over the near term. India VIX is based on Nifty index options prices. Without going deeper into the exact calculation, suffice it to say it is rendered from the best bid-ask prices of Nifty options contracts, which indicates the expected market volatility over the next 30 days.

On April 21, India VIX continued its downward journey and hit an intraday low of 11.62, which is the lowest level for the index since January 2020. This simply means that market participants are now expecting lower volatility in the near term compared to a week ago.

But why are option sellers worried? Because VIX is highly linked to options premiums. Since VIX indicates the implied risk in the market, and options premiums tend to increase with higher volatility, reflecting the higher risk involved. Thus they are not able to pocket the premium that they used to, leading to lower profitability, if any.

The reason behind the current low level of the VIX is unclear. Some attribute it to lack of market participation while others see in it the changing behaviour of traders.

Surge in activity

Retail participation in the stock market has surged manifold in the last three years. There are more traders and trading accounts in India now. In March 2023, the index option turnover was Rs 12,794 billion on NSE, nearly double of Rs 6,636 billion in April 2022.

In FY22-23, individual traders contributed 35 percent to all index option trading (in terms of premium turnover). This compares to 22 percent in FY21-22 and 31.5 percent as in FY20-21, the year just before the pandemic boom, which brought an influx of traders. Interestingly, foreign traders that used to dominate trading are now just bystanders with a contribution at meagre 9.5 percent in FY22-23.

Two-fold problem

What is worrying is that most options traders are turning into option sellers, whether influenced by other traders or instinctively. This has created a two-fold problem: one, the market movement has grown narrower, and, two, risks have increased.

“If everyone starts selling options, who will buy them?” asks Raghavendra Singh, a Pune-based trader, adding that this leads to artificial supply and demand, which is dangerous.

“Most options sellers have not made money in recent months, the reason being the abrupt behaviour of options prices. Often, we have seen the price jump manifold within a few minutes, and vice versa,” Singh told Moneycontrol.

Kirubakaran Rajendran, an algo trader, expressed his concerns in his blog. He pointed out that due to the rise of options sellers, trend-following traders have not been able to make money.

“A big, trending intraday move occurs often, but now the frequency has gone down,” Rajendran says. “Intraday trend followers must have suffered and would have not made good returns in recent years due to the rise in option sellers, who arrested such big trending moves.”

And when the market makes no big moves, the VIX will fall to historic lows. No wonder, when asked why he thinks that the VIX is so low, Ashish Gupta, a Singapore-based options trader who plays the volatility in the market, quipped, “because (there is) no fear.”

Who is most affected?

The drop in VIX does not impact everyone evenly.

Manual traders, that is, those who process their buy or sell orders manually, get the short end of the stick. Algo traders, who deploy software to make their trades, fare a little better.

Ankush Bajaj, an algo trader, confirmed that while his trades are profitable, his friends who make manual trades are facing problems. “When manual traders see a low VIX, they decide not to trade. However, for algo traders no emotion is involved, hence we trade,” he added.

Moreover, algo traders have an efficient system designed to trade in a low VIX environment as well, thus they are able to adjust swiftly to any abrupt changes.

Other than such algo and manual options traders, traders who depend on volatility to make money are also impacted.

"Since the volatility risk premium is not there, it is a difficult time right now," Gupta said.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.