Why Implied Volatility So Low?

The implied volatility of an underlying may be low (i.e relatively lower than realised volatility of the underlying) due to numerous possible reasons – e.g future expectation that the underlying may go up (for put warrants) or go down (for call warrants), low liquidity for the derivative (possibly newly traded), declining market risks and other tonnes of reasons. What surprises me is that the newly traded structured call warrant FBMKLCI-C3E (06503E) (underlying: FBMKLCI) has a relatively low implied volatility.

The following are salient terms of the instrument, of which it is currently has an implied volatility of 2.8%

Warrant Terms.png

Source: malaysiawarrants.com

If you compare this instrument to other KLCI-call structured warrants (as shown below), given its remaining days to maturity & warrant premium, it is not trading at relative premium valuation.

290817-call warrants KLCI

If you compare to current realised volatility of FBMKLCI (now at historical low, 7.52%), the implied volatility is still lower. In most cases, the implied volatility is expected to be higher than the realised volatility.

RealisedVol.png

Assuming the implied volatility rises to 7.5% (using Macquarie warrant calculator), we may see a much higher value for FBMKLCI-C3E:

SensitisedWarrant.png

So, it is a good bet to bet on FBMKLCI-C3E?

No idea. If the implied volatility is truly a good future predictor of the underlying’s price, perhaps, there may be valid reasons for such low implied volatility for the instrument (e.g KLCI is expected to fall further?). Nevertheless, from a technical perspective, due to sudden spike in geopolitical risk (North Korea), it appears that the underlying KLCI has fallen below its lower Bolinger Band, thereby could potentially (?) be in an oversold (?) position.

UnderlyingKLCI29082017.png

 

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Author: Ken Utau

Markets Observer + Food Lover

2 thoughts on “Why Implied Volatility So Low?”

  1. Ken,

    CIMB’s structured warrants can have lower implied volatility compared to other issuers. It is possible that CIMB has lower cost of business, due to economies of scale and cheaper cost of borrowing the required capital.

    This is reflected in the lower interest rate [r] variable in the Black-Scholes-Merton option pricing model. Yes, [r] can be used to represent the issuer’s cost of “manufacturing” the structured warrants.

    Liked by 1 person

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