SEBI permits derivative contracts on volatility index

SEBI vide circular CIR/DNPD/ 1 /2010 dated April 27, 2010 has permitted stock exchanges to introduce derivative contracts on volatility index like the Volatility Index (“VIX India”) of National Stock Exchange (“NSE’). The derivative contracts introduced on volatility index are subject to the following conditions:

(a) The underlying volatility index has a track record of at least one year.
(b) The exchange has in place the appropriate risk management framework for such derivative contracts.

SEBI also has asked stock exchanges to file details like contract specifications, position and exercise limits, margins, the economic purpose it is intended to serve, likely contribution to market development etc. to SEBI before introduction of such derivative contracts.

Earlier in January 2008, SEBI has permitted stock exchanges to adopt any of the volatility index computation models available globally or develop their own model for computation of volatility index. Last month SEBI has permitted in principle the introduction of derivative contracts on volatility indexes.

Volatility Index is a measure of market’s expectation of volatility over the near term. Volatility is often described as the “rate and magnitude of changes in prices” and in finance often referred to as risk. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage e.g. 20%) based on the order book of the underlying index options. Currently, only the NSE has the Volatility Index, called India VIX. NSE has introduced this index in April 2008.

A copy of the circular is available here.