I am writing this blog to familiarise you with perceived values of VIX around election time, Also I will try to bust some myths on VIX , Highlight Some characteristics in India VIX and I will try to also highlight some distortion in VIX calculations by NSE.
This will be a long write up and Hence I will break it in 3 Parts.
VIX refers to perceived Volatility for next 30 days. But In recent days to the Run up of Election results we discovered that VIX futures has jumped from around 1300/- to 4000/- and now quoting at around 3300/-.
There is huge volatility in this futures and also there lies lack of idea about pricing of VIX to common public.
If we look at VIX futures, Near week and 2nd Week VIX futures are quoting at premium and far week futures is quoting at a steep Discount.
Please read my previous blog (Here) on VIX for basics.
We can see 13, May Futures quoting at 3440/- and 20th May Futures quoting at 2323.75/-, which is at a steep discount ? I am sure we all know that Election results in India are on 16th May, So The volatility will be high before the election and than It should fall after the election results
VIX is calculated using 2 months Out-of-Money Options Implied Volatility (IV) and as days pass, Next month IV starts getting higher weightage in VIX and Near Month IV. So if you may think that VIX will go up before election, but the Question is " How up VIX can go before Election ?"
I don't have that answer, But what I can help you with is scenario analysis for valuation of VIX. The value of VIX on or after 16 may will be based on election results, But 13th May contract is also important because There will be buildup of expectation of Election outcome which will be priced in the IV. Also the Exit Polls will be out on 12, May evening.
As Discussed VIX is calculate using 2 months IV, Calculating composite IV of all OTM calls and Puts is tedious process and not easy to compute, so for simplicity you can take approx IV of 3 strikes of OTM calls and Puts of Nifty. (Beware There are pitfalls in doing this, and we can be easily wrong, but It can still be used in current scenario as it would be the simples for common traders. Caution expected.
We also know that IV will go up to go down based on perception of outcome, but How VIX move? IF u can calculate approx IV of May and June Options, I will put in the scenario of valuation based of Expected IV.
Please note that June IV is lesser that May IV because of election results and June IV will tend to fall further after results. But Before results May IV will tend to go up and June IV will follow, but It will be far lower than May IV.
Please find the price of VIX on 13th May based on Scenarios of IV of May and June.
|May IV||June IV||VIX||Weightage of June IV|
Please see the expected value of VIX on 13th May, 3014 based on Expected Volatility Scenarios. Though May IV can go up, but VIX may not go up in same ratio. because of weightage of June IV will be higher.
I am giving this value based on perception that IV of June will be significantly lower than May, Which is also vindicated because 20th May VIX is Quoting at a significant discount.
To Sum it, Though IV of May may go high but VIX may not follow. This is based on my perception which I have discussed and valuation based on that perception.
In Next Part I will discuss the Scenarios for Settlement of VIX on 20th May, 2014.
This is not a recommendation to anybody whatsoever to buy OR sell this share, but it is my thought process and views on this topic.
I welcome your critical comments and suggestions.
PS : I intend taking position in VIX.