Mint Explainer: Why the national election is making the market swing wildly

The impending election outcome, to be declared on 4 June, seems to have triggered a nervousness in the stock market. (ANI)
The impending election outcome, to be declared on 4 June, seems to have triggered a nervousness in the stock market. (ANI)

Summary

The extreme swings in the benchmark Nifty and Sensex indices currently have much to do with the ongoing national election. Mint explains the market moves behind the volatility

New-age investors dabbling in the stock markets would have encountered the term “Vix" more often this week than anytime in the recent past. This is not for nothing. The Vix, known better as the fear gauge, has risen by a whopping 60% over the past six sessions—from a low of 13.44 to a high of 21.49 on Monday, amid the ongoing Lok Sabha election. Mint unpacks why events such as an election have an outsized and often volatile consequence on the equity markets.

 

Let’s begin with the Vix. What is it?

Any big event such as election outcomes, the Union Budget, or geopolitical tensions, triggers significant movement in the Vix index, but in the opposite direction. The Vix shares an inverse correlation with the market: rising when the market falls, and vice-versa. 

Ahead of India’s first pandemic lockdown, when the benchmark Nifty index plunged 3,600 points to 7,511.10 over 15 sessions through 24 March, 2020, the Vix rose 248% to 87.

Monday’s level of the Vix was the highest in 19 months, and way higher than the average of 12.44 in the 2023-24 financial year.

The Nifty, which ruled at a record high of 22,794.7 points on 3 May, fell 974 points to an intraday low of 21,821.05 points on 13 May, the fourth phase of the Lok Sabha election. Over this period, the Vix jumped 60%.

Buying by domestic institutional investors enabled the market to stage a smart recovery on Monday, and the Vix closed at a lower level of 20.6.

Why is the market so volatile now? 

The impending election outcome, to be declared on 4 June, has resulted in nervousness in the market, which had baked in a sweeping victory for the Bharatiya Janata Party-led National Democratic Alliance before polling began on 19 April.  

While the ruling BJP had claimed it would win in at least 400 of the 543 Lok Sabha seats (not counting the two seats reserved for the Anglo Indian community), market circles are now pencilling in 300-330 seats for the party. 

Also read | Investors take cover ahead of election outcome

Home minister Amit Shah has said the volatility would abate post the election results on 4 June, and the markets would rally, implying a sweeping victory for the incumbent party. 

Myriad chatter such as these emanating from various quarters makes the Street jittery, and investors run for buying cover for their stock portfolios even as some initiate bullish bets. 

What exactly happens at such times?

Investors who scurry for cover amid the uncertainty buy put options on the Nifty, while those certain of a clean sweep for the BJP buy call options. (A put option buyer typically anticipates a market decline, whereas a call option buyer expects the market to rise. Option buyers pay a premium to either buy or sell the index at a future date to the option sellers.)

As the demand for put or call options increases, its prices rise. And when prices increase, the Vix, which is computed using the bid-ask spreads of calls and puts, also rises.

Options sellers have been charging more for calls and puts ahead of the 4 June election outcome, as they are exposed to unlimited risk if the market either falls too much or rises too much. 

The maximum gain an option seller makes is the premium (price of options) they receive from the call or put buyers. For the call and put buyer, the maximum loss is limited to the premium paid to the seller, while the profits are unlimited.

Assume an option buyer wants to buy a 21,800 put expiring on 6 June (two days post the election outcome) to protect her portfolio. She has to pay 365 per share (25 shares equals one contract) to the put seller. So she would profit only if the Nifty falls below 21,435 points (21,800 minus 365) by 6 June. 

This will be accompanied by a surge in Vix as it would mean a disappointing poll outcome. But if the BJP secures a clean sweep, the volatility would plunge and the option could become worthless, enabling the put seller to pocket the premium paid by the buyer. The same logic works for calls. 

The huge demand for options amid the creeping uncertainty ahead of the election outcome is causing the market to turn more volatile as it heads toward  D-day. 

What’s the buzz on the satta bazaar?

Another theory is that those punting in the unregulated satta bazaar, or the betting market, are constantly changing their positions on the stock market, using it to hedge their positions in the satta market. This is adding to the current market fluctuations.

So if these punters are betting on a BJP victory in the satta market, they are buying puts (going long volatility) in the stock market just in case the election outcome goes the other way. If they lose money in the satta market, their loss will be offset by the rise in the put option price on the stock market. 

Conversely, if they are betting on an upset for the BJP in the satta bazaar, they are likely selling puts (shorting volatility) in the stock market so they can pocket the premium from the put buyers. They keep adjusting their options positions on the markets after each phase of the ongoing election, causing the fluctuations we are seeing.

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