Should retail traders trade in VIX futures

By | March 16, 2014

Many traders have asked me ” Shall we trade in VIX Futures with elections round the corner ? ”

Today retail investors can trade in existing derivative products with small amounts ranging between Rs 25,000 and Rs 1 lakh. In comparison, in VIX futures the margin requirement is too high.The minimum contract value of Rs 10 lakh,it does not sound encouraging for retail investors. “Please do remember It is not an investment tool. It is a hedging tool

The India VIX gives a sense of how much of a swing trader expect in the market over the next 30 days. It does this by taking the prices of the near and middle month out of money options contracts and uses the Chicago Board Options Exchange methodology to arrive at the volatility.VIX, which has a negative co-relation to Nifty. So, it covers the risk of Nifty stocks. Whatever stock the investor buys, he can buy a NVIX contract as a hedge.

VIX has its uses, though. Take for instance, the national elections that are a few months from now. As the outcome is uncertain, investors can buy the VIX futures  as a hedge against their equities portfolio. If the market falls, the futures will gain.  If the market gains, your equities portfolio will gain because there is an inverse correlation between markets and implied volatility So, if Nifty gains, India VIX can be expected to fall and vice-versa.

Currently, the India VIX (Nifty-50) is hovering around 16 per cent, which is fairly stable. This means traders believe the Nifty could go up/down by 14 per cent (on an annualised basis). The VIX contracts will have a weekly tenure and will be settled on Tuesdays.

In markets abroad, investors keep rolling on derivatives contracts. But in India, derivatives are not considered as investments. That is why retail investors should not enter this unless they understand it fully. Since the underlying is volatile, it is difficult to bring down the margins. So, the only way to attract retail investors would be to bring down the high contract size, while maintaining high margins. “If the contract size is Rs 1-2 lakh, then investors will not mind paying the high margin.

Leave a Reply