India VIX crashes 20% on Monday after exit polls: Here’s what happened to option prices

After the exit polls announced over the weekend indicated a thumping victory for the national democratic alliance (NDA), virtually reducing the election result uncertainty, the India VIX crashed over 19% on Monday.

India VIX, an index that reflects the anticipated volatility in the market over the next 30 days, fell 19.31% on Monday morning to 19.86. In recent weeks, the index has been topping the levels of 24 as multiple sound bytes about election outcomes emanating from different corners appeared to be unsettling the markets.

It is a well-known fact that implied volatility is a major component of options pricing. The higher the IV, the higher the market prices the options. The IV tends to surge ahead of key events like elections, referendums, monetary policy announcements, and budgets among others. On Friday the India VIX was trending close to 24.7, pushing up option prices as traders began pricing in a premium for options due to uncertainty about the direction of the market during the election week.

However, with the exit polls projecting a landslide victory for the NDA, the uncertainty element has been taken away from the market. The Nifty 50 was trading up by 2.77% at 23,155 on Monday at 10:47 a.m. after having touched a record high of 23,338 on an intraday basis. Similarly, the Nifty Midcap Select, which has its expiry on Monday, rose 2.85% on Monday to trade at 11,681 at 10:48 a.m.

Impact on option prices

The Nifty Midcap Select closed near the 11,358 level on Friday. Despite the 300+ points rally in the index on Monday, the 11,350 Call which closed at ₹175.50 has only risen by just ₹154 as of 10:53 a.m. This means the at-the-money strike of the index as reflected on Friday’s closing failed to even double despite the index rising 300 points. Indeed, part of it could be attributed to the effect of theta decay (the erosion of option premium because of the passage of time) but the major erosion in the premium came from the fall in IV on Monday.

Another example is the 11,650 Call which as of 10:55 a.m. is the at-the-money strike for the index. The option which closed at ₹75.70 on Friday has lost almost ₹16 as of Monday morning despite the euphoria in the market. The out-of-the-money call options of the index till the next 200 points have lost as much as 75% of their value since Friday. This is the classic case of erosion in option prices due to a significant crash in India VIX.