Category: Investing Insight

Investing insight to make you a better investor.

Midcap Select Index Futures, Part II

At the launch of Nifty Midcap Select Index futures, we had pointed out that strategies that work on the broader Midcap 150 index should work on it as well. Since then, MIDCPNIFTY has had a colorful journey with the exchange experimenting with different tenures and expiries. However, the experimentation phase seems to be over and volumes have steadily improved with the product finding decent traction.

Some quick thoughts on liquidity:

  • Simply don’t trade the opening and closing stubs and you are golden.
  • Also, stick to the nearest expiry – the spreads on the other two will make your eyes bleed.
  • The tightest spreads can be usually found around 15 minutes to close – great if you are taking positional trades end-of-the-day.

On the face of it, MIDCPNIFTY futures look good enough to trade. Happy hunting!

Historical vs. Implied Volatility

India VIX is a volatility index computed by NSE based on the order book of NIFTY Options. For this, the best bid-ask quotes of near and next-month NIFTY options contracts. India VIX indicates the investor’s perception of the market’s volatility in the near term i.e. it depicts the expected market volatility over the next 30 calendar days. Higher the India VIX values, higher the expected volatility and vice versa. (NSE)

Does the actual volatility come close what the VIX was implying 30 calendar days before? Not always and probably never.

What if it’s pricing something more immediate? Here’s the regression with a 10-day lag:

Regression with no lag:

The relationship between implied and historical is one of those things that are directionally true… sometimes.

Code and charts on github.

Trend-following Bonds

Does trend following work on bonds? According to alphaarchitect, it should. However, they use data going back to 1928 and we wanted to look at something more recent. Also, we wanted to check if it worked for Indian bonds?

For Indian bonds, you are better off buying and holding. Once you consider transaction costs and taxes, there is no benefit.

For US, we ran the same SMA scenarios on the TLT (20+), IEF (7-10), SHY (1-3) and AGG etfs. There is some benefit to applying a 100-day SMA filter on the first three. However, the after-cost benefits are questionable.

Code and charts on github.

VIX Seasonality

Is India VIX seasonal? Yes.

There is a huge amount of dispersion in the daily data when grouped by months. Taking averages of these may not make much sense.

However, when you decompose the series, you get some interesting monthly seasonality.

Zooming into the “season_year” chart:

If you transform the seasonality component and plot it by month, you’ll notice why everybody gets nervous in May.

Code and charts on github.

Overnight Volatility

Currently, Indian markets are open for 6.5 hours. During that time, global commodity markets are largely closed and overnight US futures markets are barely coming to life. This exposes positions carried forward to the next day to event risks. How is this risk priced?

Surprisingly, Close-Open (next-day) (CO) volatility is less than Open-Close (same-day) (OC) volatility. This doesn’t quite jive with the intuition about large overnight risks. This holds even if you include pre-pandemic data.

If you believe that overnight risks are larger than what the market perceives, then buying strangles at the close surprisingly doesn’t cost you much. A na├»ve strategy should breakeven after costs and occasionally, you might get lucky.

The unknown-unknown is scarier than the known-unknown. However, it is the known-unknown that you should be worried about more.