Market experts have been watching the Chicago Board Options Exchange’s volatility index (VIX) for some time now to gauge the extent of panic on the street. Also called the fear index, the VIX now has a reading of about 70, indicating that fear levels are rather high. Three months ago, the index was at the 20 mark. Still, the level of panic has receded a bit from its peak of 89.5 on 24 October.
The National Stock Exchange’s (NSE) domestic counterpart, the India VIX, on the other hand, has been hitting new highs lately. Last Friday, it hit an intra-day high of 92.5 but closed at a lower level of 70.1. This Monday, the intra-day high was 91.8, and the close, too, was at a high 85.1. These are the highest readings for the India VIX since NSE started computing the index earlier this year. VIX closed at a much lower level of 65 on Tuesday, but derivatives traders say that the implied volatility for the most liquid options continues to be very high.
What’s the reason for the high implied volatility? In the past one month, the average difference between the intra-day high and low for the Nifty has been as high as 7%. The least volatile day saw a difference of 4.4% between the intra-day high and low, while the most volatile day witnessed a difference of as high as 16.3%.
Also See: Fear Factor (graphic)
Most trading sessions open with what is called a “gap”, where the first traded prices are at a significant premium/discount to the previous day’s close. It’s because of this high overnight price risk traders carry that options are now being priced at exorbitant levels.
Option writers are in effect pricing in the possibility of a large gap at the opening in the option premiums they charge.
Options buyers, on the other hand, are also not averse to paying these high premiums since the high intra-day volatility provides opportunities to reverse their positions.
It’s interesting to note that despite the high premiums, there are more index options contracts changing hands in markets than those of index futures.
On Tuesday, 45% of all trading in the equity derivatives segment was in the index options segment, with index futures accounting for another 35%. A large section of the market is betting that volatility will remain high.
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