Now, fear index set to become a reality on Dalal Street

Investors will soon be able to trade in volatility index — popularly known as fear index on Wall Street

Investors will soon be able to trade in volatility index — popularly known as fear index on Wall Street. The Securities and Exchange Board of India (Sebi) has asked exchanges to develop a volatility index and options on this index.

According to the Sebi, the exchanges are free to decide whether they want to adopt any of the volatility index computation models available globally or develop their own model for computation of the index. “The detailed methodology for computing the volatility index should be disseminated by the exchange for the benefit of the market participants and investors,” it said.

Earlier, the Sebi appointed Derivatives Market Review Committee (DMRC), headed by Prof M Rammohan Rao, recommended the introduction of volatility index and futures and options on this index. “Based on experience gained and awareness generated, derivatives on volatility index should be considered for introduction in due course of time,” Sebi said in a circular.

Story continues below this ad

In US, Chicago Board Options Exchange Volatility Index (VIX) is a popular measure of the implied volatility of S&P 500 index options. This represents one measure of the market’s expectation of volatility over the next 30-day period. “The index is considered as measurement of market sentiment… to indicate the level of anxiety or complacency of the market,” said BSE dealer Pawan Dharnidharka.

VIX of the Chicago exchange is considered as a contrarian indicator. A high VIX value such as 41 (when the stock market is way down) can represent irrational fear and can indicate that the market may be getting ready to move up. On the other hand, a low VIX value such as 15 (reached when the market is in a bull phase) means complacency or ‘irrational exuberance’ and can indicate the market is at the risk of topping out and due for a correction.

According to an analyst, the volatility index need not be an indicator of market action as different sectors can show different volatility levels. “The Sebi move is laudable and it shows Indian markets are developing and maturing fast,” he said.

Sebi had recently decided to launch long-term options on Sensex and Nifty with tenures of up to 3 years. Besides, from February, all types of investors — including FIs and FIIs — will be allowed to make short sales in the market. Sebi is working on guidelines for SROs and insider trading.

WHAT’S FEAR GAUGE

Story continues below this ad

Volatility index represents the measure of the market’s expectation of volatility over the next 30-day period. The index is considered as a measurement of the market sentiment… to indicate the level of anxiety or complacency of the market