Tuesday, May 13, 2014

Revision in PriceBands on NSE Cash Markets and Derivatives Markets

NSE came out with a revised guidelines for Revision in Price bands on Stocks Where there are no Price bands. The Circulars are (Here) for Cash Market and (Here) for Derivatives Market.


As per new guidelines 

a) Circuit will be opened only after there are at least 10 trades at Circuit Price.

b) The trades should also be from multiple Unique Client codes (UCC) on both sides.

With this guidelines the dynamics of Price bands would change, There will be many more Market Micro-structure issues which will come in to play which can be detrimental to smooth price discovery process.

The various scenarios where Price Discovery would be impacted are

a) What happen If multiple trade takes place in cash and price moves up in cash segment and 10 trades does not take place in FO market because of higher price in cash.

b) If I put to buy /  Sell  100000 shares of XYZ at circuit, then as per the circular, The Circuit would not open the circuit till I get 100000 shares and then another trade takes place (Multiple trades on both sides with different UCC )

c) If there is an upper circuit in pre-open session, the cash price would go up at the open of market, what about FO market ?

d) When a new future contract is opened, It calculates fair price using Base Price, If there is a big difference in Base price and traded price then , would Exchange still not open the band ? (eg India VIX far week contract)

e) The circular specifically says that 10 trades at price above 9.9 % with multiple UCC, Do NSE have liberty to open the band over ruling this logic?

f) What if 10 trades takes place in BSE and Not in NSE or Vice- Versa ?

g) Also If Price in Cash Market goes up, But not in FO because of Band, Will Options Bands be opened ?

The basic intention of Exchanges for such circulars was to reduce stray / Outlier trades, and It is tough for Exchange to allow dynamic price bands and alsoreduce wrongs trades which are also detrimental to price discovery.

But NSE can opt to issue clarifications to reduce confusion and for better price discovery of prices.

I have sent a mail to NSE, highlighting this issues and this write up should be taken positively for my endeavour towards better price discovery and lesser Distortion of Prices in Market.

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.

Wednesday, February 12, 2014

Understanding the Basics for Trading VIX in India

National Stock Exchange of India Limited (NSE) is all set to launch trading on Volatility Index Futures (VIX) from 26th Feb, 2014.

Let us discuss about VIX Futures, Its trading, Advantages and  Lacunae(If any).

The Circulars pertaining to launch, Contract Specification and Settlement are (here),(here).

What is VIX ?

VIX  was launched on CBOE and it is their trademark (here). In India Volatility index(VIX) is a measure of Implied volatility on Nifty Options or we can say it the expectation of volatility for next 30 day. VIX is always calculated for next 30 day only.

VIX is calculated using Implied volatility (IV) of all out of money calls and Puts of Near month and Mid month of Nifty. To know more about computation methodology Refer (here), (here),(here).

Simply, VIX would be one number, which will help us look at the expected market volatility / Nifty volatility  for next 30 day. Eg: If there is budget / Result season next month, we can expect that number to be higher, as the market will be more volatile.

Can we trade on VIX ? Also some more details ?

Yes, We can trade in VIX futures in India. It will be available for trading on derivatives segment of NSE from 26th Feb, 2014. The Lot size of VIX will be minimum Rs 1 Million. VIX will be traded on derivatives segment of NSE. The contracts will have weekly settlement and there will be 3 weekly contracts available for trading. Effectively you can take a view of IV for 30 day after 21 days.

The final settlement of the contracts will be Tuesday's (I guess on other days, there can be impact of bias in IV, like on Friday late session, the IV tend to fall because of Theta value of weekend etc). The final settlement of VIX contract will take place on average VIX price of last 30 minutes of trading on Tuesday.

The Contracts are cash settled and the settlement will take place on T+1 basis, along with other derivatives contract. Also Spread contracts will be available for rollover.

The Margins on VIX futures would be at least 15% , But I believe it will be more (Up to 20% to 22%) because of volatile nature of VIX Futures. Also the benefit of spread margin will be available on VIX futures.

Also STT is also applicable on VIX futures, which will be same applied on Index Futures

What is the Use of VIX ?

a) VIX is used as a single number to predict the expected volatility for next 30 days.

b) It can be the tool for hedging.

c) It can be a volatile product to trade.

d) It also has predictive power on expected volatility

e) Historically It has negative co-relation with nifty futures. So If Nifty goes up, VIX tends to fall and vice versa.

f) Arbitrage is also possible both covered and Statistical.

How do we trade on VIX Futures?

a) Speculation : A Person can take a view on expected volatility and trade based on it ,Beware It will be very volatile, at least 5% a day.

b) Hedge : A Portfolio investor can hedge his portfolio by buying VIX (Inverse relationship)

c) An Investor can take position on VIX based on his Option Portfolio. He can hedge his gamma 

d) VIX futures is helpful in volatile times as you can take view on VIX, as VIX futures does not suffer decay (Theta)

e) An Arbitrageur can also indulge in spread trading on VIX futures.

What are the USP of VIX Futures?

a) There is higher volatility in VIX compared to VIX itself, Hence It is a volatile product which may lure traders.

b) Institution Investor are interested in VIX as a hedge, Thereby creating depth in market.

c) Cash Settled.

d) The computation of VIX is shown on NSE screen, every second.

Is there any Shortcomings / Lacunae in VIX Futures ?

a) It is very volatile product. On a single day, there will be moment of at least 5%, means a person can gain/ lose Rs 50,000/- in a day in 1 lot.

b) The Life of contract is very small only 21 days.

c) The expiration of VIX futures and Index Futures do not fall on same day, hence a difficult arbitrage.

d) Rollover will be very expensive as you will have to pay STT every week.

All in all , VIX is a new product to trade, but It is not meant for soft-hearted people. I feel that VIX futures will be Restructured in future to get broader participation. Also the Life of VIX futures needs to be increased. 

Also note that VIX Index or Implied volatility is always higher than realised volatility in normal times.

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.