Why Option Premiums Will Remain Low

Option premiums have come down in Nifty, Bank Nifty and related indices. This is in line with low realised volatility in Indian markets, further evidenced from relatively low drawdown in Indian equities, compared to what has been observed elsewhere across the world, even U.S. equities.

Option prices have historically followed cycles, periods of low premiums and low Vix, followed by sudden spurt in option prices and Vix. Even if extreme events of the past 15 years are taken out— 2008 global financial crisis and 2020 Covid pandemic—when option price spiked disproportionately, with Vix shooting up to 80 plus, there have been periods when option prices have gone up after prolonged periods of dormancy.

Going forward, the author strongly believes that option premiums will remain low, even with global uncertainties and 2024 national elections around the corner.

Option premiums were high before because we were a relatively High Beta market. Even as recent as 2020, when Nifty was down 29.3% the first three months of the year when S&P was down 10%, Indian markets would fall much more than global equities. The same year, Nifty would rally 62.6% from March till December end, when S&P would rise 45.3%— a classic manifestation of a High Beta market.

But since then, there has been a remarkable decoupling from global equities. Nifty gave 24.1% returns in 2022 when U.S. Index was up 26.9%, but the following year, Nifty was up 4.3% when S&P actually went down by 19.4%! Standard Deviation of daily returns, an indicator of risk, was down to 17.4% in 2022 and 9.6% in 2023, when the corresponding numbers for S&P index were 24.5% and 13.7%!!

The shift from a High Beta market to a Low Beta market has been stark. Not just equities, the currency market has been equally stable and that is the reason why option premiums are likely to be low, ex of a Covid kind of a scenario. After the state elections, even uncertainty around 2024 will not get priced as high as it got in 2019.

Bank Nifty ATM weekly Put options on Dec. 10, 2018 (a day before election results were out) were priced at around 1.4% of notional for Dec. 13 expiry. On Friday evening, Bank Nifty ATM Put option (44,800 Strike, Bank Nifty at 44,813) was trading at just 257.4, a mere 0.57% of notional! What is interesting is that exit polls were forecasting a better BJP performance this time around as compared to 2018, and yet option premiums were 60% plus lower!

Price discovery has also improved as option volumes have swelled up and for that reason, the premiums will remain lower than what they were in the past. The decoupling from global equities has further compressed market variation vis-a-vis global equities. Hence, option premiums will remain low in months to come and the most powerful manifestation of that will be seen in pricing—coming May should be nowhere close to what they were in May five seasons back.

Nandik Mallik is the chief investment officer of Avendus Capital Public Markets Alternate Strategies LLP.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.