Traders looking to bet on volatility may move from options to Vix Futures

MUMBAI: Traders love volatility and will soon get a product to directly bet on instead of doing so indirectly through the options segment of capital markets. So, rather than retail investors, who confine themselves to familiar environs of the cash market, brokers believe it's probably this market segment which stands to benefit most from introduction of Vix futures from February 26.

The biggest risk that a hedger or holder of physical shares faces is adverse price movements which can reduce the value of his or her portfolio. His bet typically would be to sell either index futures or buy put options. Such a participant transfers his price risk to a trader or speculator who, without holding a physical asset, takes an opposite bet that markets will rise.

Then there's a class of trader who is agnostic about the direction of the market so long as it moves - up or down. "These guys are the vols traders and it's them that will like Vix futures most," said Siddharth Bhamre, derivatives head at Angel Broking.

Till now, these traders took the options route to bet on volatility. That's because an option's price or premium - the amount paid to take exposure to an underlier by paying just a fraction of its cost - changes with volatility, among other factors. Higher the volatility, more the change in an option's price and vice versa. Loosely speaking, this refers to an option's vega.

So, typically a trader who expects the market to turn choppy - in other words, vols to rise - will buy call (gives the holder a right to buy an underlier) and put (giving holder right to sell an underlier) options. If he believes vols will fall, he will sell or write calls and puts and receive premium from the buyers.



But, there's a catch here. The price of an option is dependent not only on volatility. Factors like time decay (theta in options lingo) and delta (change in the price of an underlier) also influence options price. The closer an option heads into expiry, time value eats into the premium. So, even if volatility rises steadily to expiry, a trader may not see a concomitant rise in an option's premium. Again despite a rise in volatility, an underlier's price might not move, which will limit the rise in option price.

"With Vix futures, a trader will bet on volatility without the fear of theta and delta eating into the premium," added Bhamre. Agrees Chetan Jain, derivatives analyst, Anand Rathi Securities, who expects institutional participants, arbitrageurs and a few HNI clients to benefit from the new product.

"Understanding the new product demands some knowledge of options, a universe that's alien to many a retail investor....this new product may not cater to this investor category," said Aadil Sethna, derivatives head, Dolat Capital, who reasoned why the small investor will most likely stay away. Volatility is uncertainty about the size of change in a security's value. Higher vols implies price will be spread over larger values and vice versa. Vix futures will be based on the underlying implied volatility index Vix, which normally gyrates between a 13-14% and 22-23% range.