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8.27.2012

What does low volatility mean?


The NSE Volatility Index has been in a tranquil mode for last few months and plummeted to lowest levels in two years 

While market fluctuations are part and parcel of the investment cycles, the changes in the degree of fluctuations offer useful clues for gauging the underlying sentiments. Volatility is one of the most popular measures. In major world markets, the Volatility index has developed overtime one of the key ingredients of modern day financial markets. The CBOE VIX has become a key fear gauge for equity investors across the world. In India as well, the NSE has launched an index to measure the degree of changes in direction in the broad market.

Volatility Index is a measure of market’s expectation of volatility over the near term. Volatility is often described as the “rate and magnitude of changes in prices” and in could be simply referred to as a measure of degree of risk involved in the market while investing at the present valuations. The index, thus is a measure, of the amount by which an underlying equity market is expected to fluctuate, in the near term, calculated as annualised volatility, denoted in percentage terms based on the order book of the underlying index options.

India VIX is a volatility index based on the Nifty 50 index option prices. From the best bid-ask prices of Nifty 50 Options contracts, a volatility figure (%) is calculated which provides an indication of the expected market volatility over the next 30 calendar days. In simple terms, when markets expect an increase of volatility, prices of options move higher. This same logic could be helped to reduce or add to the holdings to protect or increase profit.

Since its launch about three and a half years ago, the NSE VIX has been in a peculiar mode. The index witnessed a massive upshot in early 2009 when the Indian markets were mired in turmoil in line with their global peers in the aftermath of the global credit crisis. The local markets bottomed out from the lowest levels in years in March 2009 and trended mostly up. The benchmark NSE NIFTY hit its all time high last year before slipping and has been rising yet again in last few weeks after a troubled period during mid 2012. The VIX has been mostly trending lower over the last few months, unscathed by the gyrations in the broad markets. Apart from a quick burst of upside movement during August-September last year, the index has been mostly in a steady downward hill and plummeted to lowest level in two years on August 23, 2012.

A high VIX appears just before a market rally, and a low VIX usually augurs a slide, the historical trends in CBOE VIX reveal. The India VIX has been locked in a lackluster, almost tranquil stretch over the last few months leading to its current drop to two year low. Volatility suddenly seems to be a thing of the past even as the equity markets around the world gyrate around monetary stimulus hopes and the world economic outlook remains clouded. 


Much of the logic is imbued in investor psychology. In the current context, for the local investors, the ever-increasing connectedness with the global cues clubbed with a flagging interest from the cash market participation, could well mean that the trends and patterns in volatility could act as a useful indicator to predict market behavior. The NIFTY has rallied by around 12% since hitting its six-month lows of 4835 in early June and has been mostly aided by an influx of foreign institutional buying even as the broad set of domestic cues remained either unaltered or deteriorated. The earnings growth of the local companies has been weakest in nearly two and half years while broad macros remain unsupportive too. 

While the index can’t be used as the primary decision tool and rightly so, it’s ultra silent movement is too much for comfort.  What’s bothering me is whether the market is ready to support a low-volatility environment when inflation stays elevated, political scenario is a mess and global markets, particularly in the US, look ready to witness a retreat after hitting four-year highs.