The Bombay Stock Exchange (BSE) has launched a realised volatility index on its benchmark Sensex and plans to introduce futures and options contracts on the same after an approval from the stock market regulator.
Realised volatility is the standard deviation of daily log returns of the price of an asset over a fixed time period. It is used to quantify the risk of a financial instrument over a period of time, as actually observed in the market.
The Sensex Realized Volatility (REALVOL) index aims to provide market participants with an accurate measure of the historic volatility of the 30-stock index over one, two and three-months time horizons.
“The Sensex REALVOL will be a useful tool for option writers attempting to manage their risk, as their profit and loss is driven by the difference between realised volatility and implied volatility over the life of options written,” BSE said on its website. “Products based on the REALVOL family of indices will allow Indian traders to hedge against sudden price movements and to take directional bets on the realised volatility of the Sensex,” the exchange added.
At present, BSE’s rival National Stock Exchange (NSE) offers volatility index based on the Nifty index option prices. This index, called India VIX, measures market’s implied volatility over the near term.
The difference between realized volatility and implied volatility is that the former measures the historical volatility of the price of an asset, whereas the latter measures the market’s expectation of future volatility. Realised volatility is calculated using actual price movements of the underlying asset, whereas implied volatility is derived from option prices, using an option pricing formula such as Black-Scholes.
On April 27, the Securities and Exchange Board of India allowed stock exchanges to introduce derivative contracts on volatility index provided the index has a track record of at least one year.