Is Nifty's Implied Volatility Under Pricing Actual Volatility.....?

Most policy makers (particularly central bankers) strive for equilibrium/stability and those steps sow seeds of volatility.....
O Ashuji

Volatility across asset classes has widely picked up since April 2013 (coinciding with Japan's monstrous monetary experiment). Precious Metals experienced historic sell off (SPDR Gold ETF holding is down close to 400 tons or close to 30% since Jan 2013), Bond Yields across countries (First Japan and recently US and Emerging Markets) have turned hugely volatile, Emerging market currencies are behaving like penny stocks. Only, asset class whose volatility pales in comparison to such wild swings across asset class is equity markets. Will it play catch up....Very Likely....!!!

Is Nifty's Implied Volatility Under Pricing Actual Volatility.....?

Chris Cole at Artemis Vega Fund (www.artemiscm.com) does some really good work on volatility and same is shared for free on the website. Many opportunities in the market arises due its participants tendency to extrapolate recent price or volatility action. Indian Stock Market (Nifty) like many other stock markets have experienced sharp collapse in Implied Volatility since June 2012. Avg Daily VIX collapsed from 23 in June 2012 to recent Avg Daily VIX low of 13.9 in Jan 2013. Recent average has been 18-19. As, I have stated numerous times in past price compression during Oct 2012-Jan 2013 was historic and anyone extrapolating that behavior is likely get news anchor job at business channels. Recent, pick up in Implied Volatility looks slower compared to actual pick up underlying price behavior.

Let DATA talk.....

Methodology

1) Number of Daily % moves are used to understand volatility. A month is considered to be volatile if it has large number of moves greater than 1%, 2% and 3%.

2) Score is calculated assigning weights to those moves. For eg, 1% move is assigned weight of 1, 2% is assigned weight of 2 and 3% is assigned 3.

3) Weighted average score is calculated. High score would imply higher volatility.

4) Score is compared to IV's in those months to understand if actual volatility is being under priced.

Results

Number of Daily % Move, Score and Avg VIX 

Conclusion

1) Score greater than 10 is compared with Average IV. July 2012-April 2013 didn't have score greater than 10 and just shows how dead market has been in terms of movement. 

2) Score greater than 10 tends to have corresponding VIX of 20+ atleast. However, recent score of greater than 10 (May and June 2013) is having lower corresponding IVs. May and June 2013 IV at 17 and 18.7 is much lower. This indicates IVs could increase given actual increase in Volatility. Options continues to be the way to play this.