Signal du Jour - Short Vol In INDA

A spicy trade before the CPI

As US markets brace for the latest CPI figures this morning, we're on the lookout for any spark of volatility. Not that we're rooting for a downturn, but a bit of market movement could certainly give our strategies a nudge in the right direction.

While we wait for that eventuality, our journey across the globe in search of regions where volatility is ripe continues. Last week, we ventured into South Korea and China as the odds of success for volatility sellers were promising.

Today, with much of Asia in the throes of New Year festivities, we turn our attention to another powerhouse in the region: India.

India isn't just about its culinary delights, Bollywood's global charm, or its worldwide diaspora of brilliant engineers. It's a country of immense cultural depth and undeniable economic strength, yet its emerging market status brings with it certain risks. These risks, however, present a perfect scenario for strategies focused on exploiting the volatility risk premium.

Let's explore what India has to offer.

The context

INDA, an ETF heavily weighted towards India's largest conglomerates, unsurprisingly includes major players like Reliance, HDFC Bank, and Tata Consulting. While these names might not be household in the West, they wield significant influence in their local markets and across Southeast Asia.

source - yahoo.com

Last year marked a period of renewed optimism, dispelling fears of a global recession. As investors sought promising opportunities in emerging markets, INDA emerged as a standout, boasting a nearly 30% gain over 12 months. This surge wasn't just the result of international capital inflow; it also reflected the burgeoning strength of India's domestic market. A growing middle class with increasing disposable income has shown a keen interest in investing locally, further fueling the index's ascent.

One could argue that the allure of international investors towards India intensified as they recognized the resilience of its local market.

The performance in INDA has been good and the realized volatility contained.

The upward trajectory of INDA since the COVID-19 lows showcase not just growth but stability, with realized volatility remaining relatively contained, barring sporadic spikes in early 2022 and 2023.

However, it's essential to remember that INDA represents an emerging market. Last year, one of its heavyweight constituents faced scrutiny from short seller Hindenburg, highlighting vulnerabilities. Moreover, the political landscape is often criticized for corruption issues.

This backdrop suggests that the cost of insuring investments in this market, or the insurance premium, is likely elevated.

It's time to dive into the data for a closer look.

The data and the trade methodology

Let's take a closer look at the volatility landscape of INDA by examining a VIX-like index constructed from the prices of 30-day options.

A reconstruction of a VIX index for INDA shows some heightened volatility period in 2023.

The past two years have shown that the index has navigated through challenging times, particularly throughout 2023, a period marked by INDA’s relatively flat performance.