VIX futures

Traders are often looking for new strategies to trade a major event, say a budget or credit
policy or even important results like Infosys. Normally a trader would have bought, what an
option trader calls a Long Straddle strategy. In entering this strategy, he would buy a long call
and a long put option of the same strike price and same expiry.

In order to earn profits from such a strategy, markets need to move sharply in either direction
such that profit from one direction would be more than the loss from the other one. However,
the strong following of such a strategy leaves very little on the table (if at all) as prices of
both the call and put option rise before the event as they all fear the extreme.

Traders will now have an instrument to earn from such an eventuality. India's premier
exchange, National Stock Exchange (NSE) is launching India Vix Futures to attract traders
who are willing to bet on volatility. India Vix is a volatility index based on prices of Nifty
options.

Volatility is known as a measure of change. A higher value of volatility indicates that prices
can change at a faster pace (either going up or down) as compared to the immediate past.

Before you start trading the India Vix futures contract, here are 10 points to consider

1. Globally known as a 'fear index', Vix is actually one of the best contrarian indicators in the
world. Chicago Board Options Exchange (CBOE) which owns the Vix trademark say that
since volatility (high) often signifies financial turmoil, Vix is often referred to as the investor
fear gauge. The index is colloquially referred to as the fear index.

2. In India, value of Vix has been computed by the NSE since November 2007 based on the
out-of-the-money (OTM) option prices of the Nifty. It has touched a high of 85.13 and a low
of 13.04. As it is mentioned in percentages, value of Vix can never be below zero or more
than 100.

3. Historical data indicates that India Vix has a strong negative correlation of negative 0.8 to
the Nifty. This means that every time Vix falls, Nifty rises and every time it rises, it means
that a fall is imminent. India Vix touched a value of 85 percent, a few days before Nifty
touched a bottom post the Lehman Crisis.

4. India Vix has a mean of 26.65 and a median of 23.83, these figures are important for option
writers and traders since Vix has a tendency to revert to the mean.

5. The India Vix futures contract will have a weekly settlement and have three running
contracts along with three spreads between the contracts (spreads are the difference in prices
between two contracts). One need not have the vision of a planning commission or a
economist to trade the contracts. A smaller vision of one week or a maximum of one month is
good enough to determine the volatility. Shorter term Vix indices are more responsive to
short term volatility which will be induced due to corporate earnings, government policy
announcements or RBI's policy changes.

6. Volatility is easier to predict than price. One will not know the price of Infosys after it
announces its results, but it is easier to know that volatility will increase immediately after
profit and guidance numbers are announced by the company's management.

7. Vix futures are also considered to be a better hedge than a index future.This is because Vix
indices are more volatile and offered three to four times more returns than an asset based
index. The recent 5.4 per cent drop in the Nifty between January 23rd 2014 and February 13,
2014 resulted in a 14.8 per cent change in the volatility index.

8. The high gains are precisely the reason why speculators are attracted towards it. NSE
however, has kept the lot size for each contract at around Rs 10 lakh which will attract a
margin of Rs 2 lakh, thus making the product more expensive for the retail investor.

9. Currently India Vix is in the lowest quartile, which partly explains the Nifty trading within
three per cent of its all time high point.

10. In order to promote the futures contract, NSE is offering rebate ranging between 10 and
40 per cent in transaction charges, depending on the overall volume.

ABENOMICS+ASSESSMENT OF THE SAME
Abenomics refers to the economic policies advocated by Shinz Abe since the December
2012 general election, which elected Abe to his second term as Prime Minister of Japan.
Abenomics is based upon "three arrows" of fiscal stimulus, monetary easing and structural
reforms.[1] The Economist characterized the program as a "mix of reflation, government
spending and a growth strategy designed to jolt the economy out of suspended animation that
has gripped it for more than two decades."[2]
The term "Abenomics" is a portmanteau of Abe and economics, and follows previous political
neologisms for economic policies linked to specific leaders, such as Reaganomics,
Clintonomics and Rogernomics.

Background[edit]
Japan's economy underwent a "Lost Decade" since the burst of the Japanese asset price
bubble in the early 1990s. GDP growth was slow and unable to absorb the resulting increase
in unemployment. The Japanese government raised consumption tax rates from 3% to 5% in
1997, which worsened the recession and deflated the economy. Concerned about the negative
effects of the tax hike, Lawrence Summers[3] had told the Japanese government not to raise
the consumption tax. Ignoring the warning, the government then raised the sales tax in 1997
for the purpose of balancing its budget, and then the government revenue decreased by 4.5
trillion yen because consumption stumbled. The country recorded a GDP growth rate of 3
percent in 1996, but after the tax hike the economy sank into recession.[4]
The nominal GDP growth rate was below zero for most of the 5 years after the tax hike.[5]
[6]
During the global economic recession, Japan suffered a 0.7% loss in real GDP in 2008
followed by a severe 5.2% loss in 2009. In contrast, the data for world real GDP growth was a
3.1% hike in 2008 followed by a 0.7% loss in 2009.[7] Exports from Japan shrunk from 746.5
billion in U.S. dollars to 545.3 billion in U.S. dollars from 2008 to 2009, a 27% reduction.[8]
By 2013, nominal GDP in Japan was at the same level as 1991 while the Nikkei 225 stock
market index was at a third of its peak.[2]
In 2012, the Diet of Japan under the government of Yoshihiko Noda passed a bill to increase
the consumption tax rate to 8% in 2014 and 10% in 2015[9] in order to balance the national
budget; this tax hike was expected to further discourage consumption.[10]
Abe's economic policy is also related to the rise of China as an economic and political power.
Abe's supporters drew explicit parallels between Abenomics and the Meiji era program of
fukoku kyohei (enrich the country, strengthen the army). In addition to providing a stronger
counterweight to China in the Asia-Pacific region, strengthening the Japanese economy is
also intended to make Japan less reliant on the United States for defense.[2]
Implementation[edit]
Abenomics consists of monetary policy, fiscal policy, and economic growth strategies to
encourage private investment. Specific policies include inflation targeting at a 2% annual rate,
correction of the excessive yen appreciation, setting negative interest rates, radical
quantitative easing, expansion of public investment, buying operations of construction bonds
by Bank of Japan (BOJ), and revision of the Bank of Japan Act.[12] Fiscal spending will
increase by 2% of GDP, likely raising the deficit to 11.5% of GDP for 2013.[13]
Two of the "three arrows" were implemented in the first weeks of Abe's government. Abe
quickly announced a 10.3 trillion stimulus bill, and appointed Haruhiko Kuroda to head the
Bank of Japan with a mandate to generate a 2 percent target inflation rate through quantitative
easing. Structural reforms have taken more time to implement, although Abe made some
early moves on this front such as pushing for Japanese participation in the Trans-Pacific
Partnership.[2]
The mid-2013 House of Councillors election gave Abe complete control over the Diet, but the
government showed some internal division over specific structural reforms. Certain cabinet
members favored lower corporate taxes, while others were wary of the potential political
backlash for cutting taxes on large firms while raising taxes on consumers. Labor laws and
rice production controls have also become contentious issues within Abe's government.[14]
Effects[edit]
Abenomics had immediate effects on various financial markets in Japan. By February 2013,
the Abenomics policy led to a dramatic weakening of the Japanese yen and a 22% rise in the
TOPIX stock market index.[1] The unemployment rate in Japan fell from 4.0% in the final
quarter of 2012 to 3.7% in the first quarter of 2013, continuing a past trend.[15]
The yen became about 25% lower against the U.S. dollar in the second quarter of 2013
compared to the same period in 2012, with a highly loose monetary policy being
followed.[16] By May 2013, the stock market had risen by 55 percent, consumer spending
had pushed first quarter economic growth up 3.5 percent annually, and Shinzo Abe's approval
rating ticked up to 70 percent.[2] A Nihon Keizai Shimbun survey found that 74% of the
respondents praised the policy in alleviating Japan from the prolonged recession.[17]
The impact on wages and consumer sentiment was more muted. A Kyodo News poll in
January 2014 found that 73% of Japanese respondents had not personally noticed the effects
of Abenomics, only 28 percent expected to see a pay raise, and nearly 70% were considering
cutting back spending following the increase in the consumption tax.[18]
Abenomics worsened Japan's trade deficit in 2013 as the weaker yen increased the cost of
imports, including food, oil and other natural resources upon which Japan is highly reliant.
However, the Abe government viewed this as a temporary setback, as the weaker yen would
eventually increase export volumes. Japan also managed to maintain an overall current
account surplus due to investment income from overseas.[19]
Analysis[edit]
Koichi Hamada, a monetary adiviser for Shinzo Abe, warned that the planned vat hike could
hurt Japan's economy which started to recover from long recession and deflation. He says that
the Japan government should defer the tax hike so that it could not discourage consumption,
adding that economists such as Jeffrey Frankel have suggested[20] the gradual increase of the
rate of the tax by one percent annually. Although Hamada is concerned about the effects of
the tax hike, he expects that monetary easing by BoJ can offset its negative effects, applying
the Mundell-Fleming model to Japan.
Depreciating a domestic currency can boost its export if the Marshall-Lerner condition is met.
If it is not, the trade balance initilly becomes worse.
See also: Marshall-Lerner condition
Since the disastrous nuclear incident in Fukushima in 2011, all nuclear power stations in
Japan have been shut down. Making up for lost electricity generation, Japan has imported[21]
extra fossil fuels, which worsened the country's trade deficit partly because of weaker yen.
The increasing cost of electricity may hurt businesses in the country, and hamper the country
from boosting its economy. But Shigeru Ishiba said that people were noticed that electrity
could be supplied without nuclear power generation. Thus, restarting the reactors is still
controversial: a nationwide poll showed that 76 percent either opposed nuclear power or
wanted Japan to reduce the reliance on nuclear energy, while in some regions[22] such as
communities close to Sendai city, where nuclear power plants create jobs and relating
subsidies are granted, restarting the reactors is widely supported. Unless nuclear reactors are
restarted, the Marshall-Lerner condition is not be met due to heavier dependence on fossil
fuels and increase of reliance on import.
Views on Abenomics[edit]
Support[edit]
The International Monetary Fund characterized the program as "a unique opportunity to end
decades-long deflation and sluggish growth and reverse the rise of public debt," but argued
that "all three arrows need to be launched for the policies to succeed. Uncertainty about the
ambition of fiscal and structural reforms is adding to underlying risks."[23]
Economist Joseph Stiglitz has explained how Shinzo Abe's programme for Japan's economic
recovery has led to a surge in domestic confidence, and questioned how far Abe's
"Abenomics" could claim credit. He referenced Momcilo Stanic, saying there is every reason
to believe that Japan's strategy to revive and boost its economy will be a success.[24]
Washington Post journalist Neil Irwin cited successful expansion by Toyota, with operating
profit rising 88% in the second quarter of 2013, as evidence that the economic program of
Japan is working. He has stated that "the fact that one of Japan's biggest and most important
companies is again finding ways to make money on the homefront is a good sign that the
nation's economic torpor may not last too much longer." He has also argued that Abenomics
could "change the economic psychology of Japan domestically" by providing export hikes
through currency devaluation.[16]
Criticism[edit]
At a meeting at the House of Representatives, the Democratic Party of Japan President Banri
Kaieda questioned several measures of Abe's economic plans and also criticised the
administration's plan of inflation targeting, concerned that it may result in a drop in real
wages if jobs and salaries only increase marginally. Abe asserted that his administration
would achieve higher wages by reinforcing competitiveness and growth potential (such as
modifying tax policies and greater investment in R&D[25]), macroeconomic policies and
sustainable fiscal structure.[26]
European Central Bank policymaker Jens Weidmann expressed concern that government
interference and pressure on the Bank of Japan endangers their independence and may lead to
currency wars. Russian Central Banker Alexei Ulyukayev considered the possibility that other
countries might follow suit and engage in destabilising devaluations.[27]
In addition, there is a rising skepticism regarding Abenomics, pointing out that the policy is
too much focused on the demand side of its economy, not on the supply side. Such as the case
of the Japanese government's push for generic medicines within its Universal Healthcare
System without actually addressing the root causes.[28] One of the fundamental problems
that Japan is facing is its aging population. As the population pyramid becomes inverted, the
labor pool shrinks from year to year. This brings about a number of problems for the Japanese
economy.[29]
First, the government commitment in spending on pensions, medical expenses and social
security will continually act as a substantial burden to the already indebted country with a
public debt of 240% its GDP.[29] This will further worsen the financial integrity of the
Japanese government leading to an erosion of international confidence in Japanese economy.
The lack of confidence can raise the risk premium (CDS).
Secondly, its dwindling workforce cannot sustain the economic output level that is
maintained in the future. The Japanese demography will drastically change so that more
young people will have to support for the older population, which implies that this change in
demography is the main culprit for the last two decades of deflation and stagnant economic
growth.[29] This has another implication to why the consumer demand might be falling
behind.[29]
One BOJ board member expressed concern over the planned tax-hike set to take effect in
2014 and 2015.[30] Paul Krugman worried about the negative impact of the tax-hike on its
economy, pointing out that the real interest rate in Japan is still high due to deflation, and
decreasing the rate can contribute to its long-run fiscal condition.[31]
Goldman Sachs chief economist Naohiko Baba has criticized the infrastructure spending
component of Abenomics, arguing that the Japanese construction industry is inefficient and
short of workers.[14]


In terms of monetary policy influencing global liquidity flows, it has clearly been a tale of
two central banks. On one side of the pacific, the US Federal Reserve is winding up its
unprecedented bond buying program. On the other side, the Bank of Japan has undertaken the
largest bond buying program (as a percentage of its monetary base) in financial history.
The Japanese move has counterbalanced the ejection of liquidity in the system. The Bank of
Japan (BOJ) has done so for primarily three reasons. One, fight deflationary pressures which
have haunted to economy for much of the last 20 years. Two, weaken the Yen to boost
exports and also import inflation via higher energy bills. Three, boost general asset prices to
create a real wealth effect that would lead to a boost in domestic spending.
To this point, the efforts of the BOJ must be classified as successful till date. The Nikkei 225
has rallied from sub-10,000 levels to 15,000 in just over one-and-a-half years. The yen, too,
has depreciated from 80 to 103 against the US dollar, while inflation expectations have shown
a consistent uptick.
The consumer price index rose 1.3 percent in February for a third straight month. The
unemployment rate is currently 3.6 percent, the lowest since 1998. This has raised hopes of
wage increases that would further put an upward pressure on prices. The BOJ has set an
inflation target of 2 percent which seems within the realms of possibility if recent data is
anything to go by.
But Japan's economy still faces its biggest challenge after Prime Minister Shinzo Abe's
government hiked sales tax effective Tuesday. The sales tax has been increased, from 5
percent to 8 percent, for the first time in 17 years. This increase is intended to fund Japan's
increasing social welfare costs and its ballooning public debt, which is twice the size of the
economy, making it the largest among the developed nations.
It is feared the Japanese consumer would cut back on expenditure post this sales tax hike. Till
now, consumer spending has been at the forefront of the improvement in GDP growth. As
mentioned in previous report, the yen will move in response to the yield spreads of short-term
and long-term US bonds.
However, history can also be used as a guide to help in predicting the movements in equities
and the yen in the coming months. According to Kathy Lien, a currency strategist, in the
months leading up to the tax increase in 1997, the economy grew rapidly with the fourth
quarter (Q4) GDP growth in 1996 hitting a high of 6.1 percent.
Growth remained strong in Q1 of 1997, with GDP rising 3 percent. In the quarter of the
increase, the economy contracted by 3.8 percent. Over the next month following the tax hike,
the USD/JPY declined 13 percent and the Nikkei fell 28 percent over the next six months.
Officials in Tokyo would have this price action at the back of their minds. Thus, they would
be ready to get into stimulus mode if weak data persists, post the hike.
For now, bulls on the Nikkei and the USD/JPY exchange rate would be banking on additional
stimulus by the BOJ. A slowdown in coming weeks due to the sales tax hike would be treated
as a bullish indicator. The Nikkei can see levels of 17,000-18,000 and the Yen can depreciate
to levels around 110 to the US dollar in the quarters following Abenomics Version 2.