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Stylized patterns of implied volatility in India: a case study of NSE Nifty options

Imlak Shaikh (Department of Humanities and Social Sciences, Indian Institute of Technology Bombay, Mumbai, India)
Puja Padhi (Department of Humanities and Social Sciences, Indian Institute of Technology Bombay, Mumbai, India)

Journal of Indian Business Research

ISSN: 1755-4195

Article publication date: 12 August 2014

311

Abstract

Purpose

The aim of this study is to examine the “volatility smile” or/and “skew”, term structure and implied volatility surfaces based on those European options written in the standard and poor (S&P) Nifty equity index. The stochastic nature of implied volatility across strike price, time-to-expiration and moneyness violates the core assumption of the Black–Scholes option pricing model.

Design/methodology/approach

The potential determinants of implied volatility are the degree of moneyness, time-to-expiration and the liquidity of the strikes. The empirical work has been expressed by means of a simple ordinary least squares (OLS) framework and presents the estimation results according to moneyness, time-to-expiration and liquidity of options.

Findings

The options data give evidence of the existence of a classical U-shaped volatility smile for the Indian options market. Indeed, there is some evidence that the “volatility smirk” which pertains to 30-day options and also implied volatility remain higher for the shorter maturity options and decrease as the time-to-expiration increases. The results lead us to believe that in-the-money calls and out-of-the-money puts are of higher volatility than at-the-money options. Conclusion was drawn due to the persistence of the smile in the options market.

Practical implications

The practical implication of studying stylized patterns of implied volatility is that it educates the volatility traders about how in-the-money and out-of-the-money options are priced in the options market, and provides an estimate of volatility for the pricing of future options.

Originality/value

This study is an extension of previous work. The undertaking has been to examine the case of a more liquid and transparent options market, which is missing from the earlier work. The current study is more relevant because, since 2008, significant changes have been observed in the futures and options market in India.

Keywords

Citation

Shaikh, I. and Padhi, P. (2014), "Stylized patterns of implied volatility in India: a case study of NSE Nifty options", Journal of Indian Business Research, Vol. 6 No. 3, pp. 231-254. https://doi.org/10.1108/JIBR-12-2013-0103

Publisher

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Emerald Group Publishing Limited

Copyright © 2014, Emerald Group Publishing Limited

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