Rise in volatility index makes traders jittery. A sharp directional move in Nifty may be coming

In the last five sessions, Nifty has fallen 3.4 percent and Sensex 3.5 percent.

Bears exerted their dominance on Dalal Street as the Indian share market extended its losses on October 26. The BSE Sensex plummeted by 500 points, representing a nearly 1 percent decline, while the NSE Nifty 50 dipped below the 19,000 mark, primarily due to mounting concerns about inflation and a looming recession.

Persistent Foreign Institutional Investor (FII) selling, coupled with weaker-than-expected Q2 FY24 earnings, further added to the downward pressure on Indian equities. Notably, even the decline in oil prices failed to divert attention away from the increasing US bond yields and the escalating geopolitical crisis in the Middle East.

Interesting there is also a huge rise in India VIX index in the last two sessions which is making the lives of traders tough especially as the monthly futures and options (F&O) contracts are set to expire on October 26. Option premiums are directly influenced by India VIX.

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The index closed at 11.31 on October 25, before shooting as high as 12.17 from the low of 8.82 in the previous session – traversing a range of 38 percent.

India VIX is a volatility index based on the index option prices of Nifty. India VIX is computed using the best bid and ask quotes of the out-of-the-money near and mid-month Nifty option contracts which are traded on the F&O segment of NSE.

“VIX moves when traders take positions in far out-of-the-money (OTM) strikes. In the last two days, some traders have taken a large position in far OTM strikes, which is leading to higher VIX,” said Rajesh Sriwastava, a proprietary derivatives trader based in Bengaluru. “This indicates a large move may be coming in either direction.”

The market has already seen sharp moves in the last one week. In the last five sessions, Nifty has fallen 3.4 percent and Sensex 3.5 percent. Open interest data as of October 25 suggests bears are more dominant and there is huge supply pressure in the market.

India VIX indicates the investor’s perception of the market’s volatility in the near term. The index depicts the expected market volatility over the next 30 calendar days, that is, higher the India VIX values, higher the expected volatility and vice-versa. Thus, when India VIX is higher, option writers who are theoretically exposed to unlimited risks and limited gains (equal to the option premium), charge higher premiums to compensate for the associated risks.

India VIX has been consistently low for a long time now, even as a war in the Middle East is brewing. There is genuine fear that the war between Israel and Hamas may escalate into a wider conflict among more regional players such as Lebanon, Syria and possibly Iran. Such a scenario will be catastrophic for the world economy and markets.

Also read: Israel-Hamas war already affecting regional economies: IMF's Kristalina Georgieva

It is no wonder that VIX based on S&P 500 has shot to above 20 level from 12 in September, signaling that the US market has been quick in recognising global risks to the economy. However, back home, consistently low VIX has baffled traders. Therefore derivatives traders, especially those writing options, have been complaining that low India VIX means less bangs for their bucks thus limiting their profit per trade.

Though some see a beginning of change in trend.

“The volatility in India VIX indicates that the index is bottoming out. It is possible that we can see India VIX rising above 15-16 now,” said Raghvendra Singh, a Pune-based derivatives trader. “My reading is that selling pressure will be heavy on expiry. The Nifty may close below 19,000 (on October 26).”

Such a change will be a welcome one, believe Srivastava.