Business Today

Make volatility work for you

A new tool—derivative trading on the volatility index—for investors to reduce their portfolio risk.

twitter-logoAnand Adhikari | Print Edition: July 11, 2010

Tradable volatility products: The NSE is planning to introduce derivatives products—futures and options—with the volatility index as the underlying asset. It's similar to taking an exposure on stock or index derivatives. Investors will be able to bet on the volatility by taking a position on the volatility index.

How volatility index works: It's an indicator of market expectation of volatility over a period of 30 days based on the options price of a stock index. The index extracts this by taking the fluctuation in the put and call options prices on a given day and expressing it as annualised volatility. The index captures the implied risks associated with the stock markets. Spikes in the volatility index are associated with an imminent market rise or fall. The thumb rule; higher the volatility index, the more will be the fear amongst the investors' community.

Benefits for investors: The NSE was the first to introduce a volatility index, the VIX, in April 2008, to make investors familiar with the concept. F&O VIX products will give another trading product for investors to buy, speculate and hedge their risk in the equity market. It's like trading on volatility. Both institutional as well as retail investors can trade this product. For example, you can directly buy a volatility index if you expect wide fluctuation in the near future or hedge your risk (investment in other equity products) by taking a reverse position in the volatility index.

Global trends: There are various indices available in the global exchanges for trading on volatility. The Chicago Board Options Exchange was the first to introduce volatility index in the United States way back in early 1930s. Today, all the popular global indices are available as volatility index products. They are liquid instruments, and are actively used by traders to both speculate and hedge their portfolio.

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