Stocks quoted in this article:
I was out for a couple days, and wouldn't you know it, everyone's now fighting to pay up for options. The CBOE Volatility Index (VIX) is surging!
India's national election is causing a breakdown in the six-year relationship between prices of the nation's equities and options.
While the CNX Nifty Index (NIFTY) and the India VIX index have almost always traded in opposite directions since Bloomberg began compiling the data in 2007, they're now moving together more than ever before. The gauges' 20-day correlation reached a record 0.53 on April 2, up from a historical average of minus 0.48, as prices for both stocks and options increased.
Traders are paying up to protect against swings before the May 16 election results. Polls show the opposition Bharatiya Janata Party will win a majority in a government whose mandate is to revive economic growth. The Nifty moved an average 14 percent in the two days following the results of the last three elections, as the outcomes defied polls' predictions.
… Demand for protection against swings in shares is rising as some investors weigh prospects for an election outcome going against predictions. The India VIX, which measures the cost of Nifty options, surged 11.5 percent to 34.38, the highest level since Oct. 5, 2011. The gauge rose 5.7 percent to 30.85 last week for a fourth weekly increase.
Okay, wrong VIX. Why isn't Nate Silver running numbers for the India Electoral College? Oh wait, he switched back to (mostly) sports. Or what about Intrade India odds? That's "Wisdom of the Crowds" at its finest, right? I mean, no way someone could invest a relatively small amount of money to influence the press into some pretend "insights."
Never mind, Intrade doesn't exist anymore.
I guess the masses will have to handicap the Indian elections by good old fashioned poll analysis. And that, apparently, has caused expanded fear of a surprise.
It's a good lesson in the true meaning of implied volatility. It's less directional than most let on. Options prices are based on the market's best estimate of the future volatility of the underlying asset. Since options are commonly used as de facto insurance policies against stock or sector or overall market declines, we tend to directly associate them with fear of implosions. But, we fear volatile market rises, too. It's just in a different way. Yes, there are always dedicated shorts, but the fear is more about underperformance. Upside moves aren't generally as violent as downside moves, so the volatility associated with them is lower -- but it's still there.
Our own VIX tends to average a correlation of negative 0.65 or so. I'm not at all familiar with India VIX behavior, but I'm guessing there's a similar dynamic there (and anywhere, really), so that 0.5 correlation is definitely odd and unusual. I'm also guessing volatility in India in general will overprice risk based on the action Bloomberg notes after previous elections. But, that's just a guess against extreme sentiment, and not something I'm going to try to figure out how to actually play.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.