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Does lower VIX signal correction?

Does lower VIX signal correction?
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First Published: Thu, Jan 14 2010. 12 34 AM IST

Volatility indices are based on option prices and reflect investor perceptions about the risk of sharp swings. Abhijit Bhatlekar / Mint
Volatility indices are based on option prices and reflect investor perceptions about the risk of sharp swings. Abhijit Bhatlekar / Mint
Updated: Thu, Jan 14 2010. 12 34 AM IST
Mumbai: Investor fears have receded to their lowest level in at least 21 months going by the India VIX, the volatility index of the National Stock Exchange (NSE) that was launched in April 2008. Is this a sign of stability after the storm or a fresh bout of investor complacency ahead of a decline in equity prices?
Volatility indices are based on option prices and reflect investor perceptions about the risk of sharp swings. Abhijit Bhatlekar / Mint
The India VIX fell to 21.99 on Wednesday, its lowest level ever.
Volatility indices are based on option prices and reflect investor perceptions about the risk of dramatic price swings.
Typically, volatility indices such as VIX and the prices of underlying financial assets move in opposite directions. The lower prices that investors pay to buy protection against volatility using NSE’s Nifty index options gets reflected in lower VIX levels, which at times could suggest that investors are getting complacent and the markets might be set for a correction.
However, experts said that it’s a bit premature to jump to that conclusion because of the relatively short history of the India VIX. Besides, the fundamentals are good, being reflected in a surge in quarterly earnings and robust factory output growth.
“Sure, it means that people are pricing in very low risk,” said Apurva Shah, vice-president of research at Prabhudas Lilladher Pvt. Ltd, a local brokerage. “But what is that point (of markets correcting), it’s very difficult to say. The VIX started at a time when volatility was high.”
VIX was officially launched by India’s largest stock exchange by trading turnover in April 2008, when the markets had come off the peak of the bull run in January. It was a time of high volatility with the forced takeover of Bear Stearns Companies Inc. by JPMorgan Chase and Co., the subprime crisis, high inflation and high interest rates in India.
Graphic: Ahmed Raza Khan ./ Mint
The financial crisis that followed only worsened volatility and the India VIX closed at a high of 85.13 on 17 November 2008.
Since the beginning of 2010, it has been hovering between 22-23 levels.
“Very rarely have we seen the markets trade in such a narrow range for such a long time,” said Siddharth Bhamre, head of derivatives at Angel Broking Ltd. “People are getting complacent, but are not carrying their positions for a long time.”
The Nifty index of 50 stocks has traded between 5,083.40 and 5,233.95 since October after gaining 103.41% since the lows of March 2009. It closed at 5,233.95, up 0.45%, on Wednesday.
Some analysts such as Yogesh Radke, the quant analyst at Edelweiss Securities Ltd, are a bit puzzled at the consistent low levels of the index.
“There are upcoming events such as the Reserve Bank of India’s quarterly review of monetary policy in January and (Union) budget in February, and the VIX is not reacting to them,” said Radke. The earnings season has also started and this usually drives up volatility.
To be sure, India’s VIX is not the only volatility index to be trading at such low levels. The more famous Chicago Board Option Exchange’s VIX (CBOE VIX), which measures the implied volatility of S&P 500 options, fell to 16.93 on Monday, a 19-month low.
Closer home, China’s volatility index fell to a 31-month low in December, but inched up this week after that country’s monetary authority tightened money supply.
However, unlike the CBOE VIX, the Indian VIX is not as correlated to the Nifty index that it’s linked to.
Vinod Sharma, head of private broking and wealth management at HDFC Securities Ltd, reckons that the negative correlation between the Indian volatility index and the Nifty is 0.17, compared with 0.70 for CBOE. He is not willing to buy into the theory of investor complacency and an incipient market correction.
Moreover, economic and company-level fundamentals indicate that growth is on track, which is a large positive for market and will bring in more investor money. For instance, the Index of Industrial Production rose 11.7% in November, the fastest pace in 25 months. At least nine brokerages Mint spoke to predicted double-digit revenue and profit growth for the three months ended December.
Bajaj Auto Ltd, India’s second largest bike maker, posted a 189% growth in third quarter profits. IT bellwether Infosys Technologies Ltd’s December quarter earnings signalled a strong revival in the Indian IT services business and the company has also raised its forecast for this fiscal.
Ashwin Ramarathinam and Reuters contributed to this story.
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First Published: Thu, Jan 14 2010. 12 34 AM IST