Abnormal Volatility Index is an aberration

 

The volatility in the stock market is expected to rise significantly in the coming days as we move closer to the counting of votes on 16 May for the ongoing Lok Sabha elections. The Volatility Index, or India VIX, which shows the expected volatility in next 30 days, has risen significantly. The index touched a high of 34.39 on 21 April compared with the level of 16.19 on 21 March.

The Volatility Index is defined by National Stock Exchange (NSE) as “a measure of the amount by which an underlying index is expected to fluctuate, in the near term, (calculated as annualized volatility, denoted in percentage, for example 20%) based on the order book of the underlying index options.”

Normally, the correlation between CNX Nifty and VIX is negative. Put differently, when the market is falling, the expected volatility is higher and when the market is on its way up, the expected volatility is lower. However, the correlation has turned positive in recent months, indicating that expected volatility has gone up along with the underlying index (Nifty). So what brought about the change in the normal behaviour of VIX?

Clearly, the ongoing election is a big event for the market and depending on the outcome on 16 May, stocks can move in either direction in a big way, at least in the short run.

The consensus view is that market will go up if the opinion polls are proved correct and the Bharatiya Janata Party-led National Democratic Alliance comes to power. However, the outcome is not certain and if it is not in line with the opinion polls, the market can fall significantly in the short run.

Talk of the Congress party’s willingness to support a coalition of regional parties after the results are declared is also adding to the fear. Therefore, the rise in the expected volatility indicates that investors and traders are hedging their portfolios. Siddharth Bhamre, head (derivatives and technical research), Angel Broking Pvt. Ltd, said, “There are more speculative positions than hedge positions. People use events such as this (elections) to speculate.”

Should you be worried?

Markets are moving towards a big event and the outcome of the general election will play a significant role in deciding the direction of the market in the short- to medium-term. So, as we move closer to the counting day, the volatility is expected to rise as investors and traders will position themselves in different ways depending on their view of the outcome.

However, as an investor holding stocks with a long-term view, you need not worry. Prasanth Prabhakaran, president (retail broking), India Infoline Ltd, said, “People with leveraged positions should be cautious, but normal stock investors should not be worried.”

As a long-term stock investor, you would have bought stocks that you are holding on the basis of the fundamentals of the company and not necessarily with a view on election outcome in mind. Therefore, you don’t need to do anything different at this stage. If stock markets fall in the short run after the results are announced, depending on the stocks you are holding, it can, in fact, be treated as a buying opportunity.

 

                   md.aquil alam 

                  pgdm   1st year 

source.live mint