Volatility gauge India VIX hovered around 10.45 in the afternoon on April 24, after cooling off to a 5-month low to below 10 yesterday. The sharp fall in the VIX indicates a narrow trading range for Nifty in the coming days, but traders advise watching out for any rebound.
A sudden rebound in volatility from such low levels could lead to sharp movement or even a correction in the benchmark indices.
“While optically declining VIX is positive and displays confidence in the ongoing rally, one must not be too complacent with over-leveraged positions within this current uptrend,” said Sudeep Shah, DVP and head of derivatives and technical research, SBI Securities.
“VIX generally tends to rebound from lower levels between 9-10 which has acted as a key support zone since the start of 2023,” Shah added.
Such sharp falls in India VIX were last seen when the election uncertainty was over after the results were announced. In 2014 and 2019, it dropped by almost 34 percent and 30 percent on the day of results.
Yesterday’s 20 percent drop was the biggest after these two falls, and came ahead of the outcome of general elections. Apurva Sheth, Head of Market Perspectives & Research, SAMCO Securities, decodes the three reasons behind it:
- End of geopolitical tensions in the Middle East
There have been tensions related to Israel and Iran over the last few days after both nations were involved in exchange of drones and missiles. Latest reports suggest Iran has downplayed the latest Israeli strike and have no plans of retaliation. Markets may have taken this news positively which led to cooling off in the volatility index not just in India but also in the US. CBOE VIX, which tracks volatility in the US markets, was down 10 percent yesterday.
2. Election uncertainty factored in
The markets may have factored in continuation of the current regime in the general elections. Normally, India VIX cools off after the election results are announced as the uncertainty is out. However, this time markets may have already factored in a victory for NDA led by BJP due to a weak show by the opposition.
3. Reduction in lot sizes of Nifty
The lot sizes of Nifty is reduced from 50 to 25 starting from the May expiry. This may lead to an increase in liquidity and reduction of bid-ask spread of OTM (out of money) calls and puts options. Reduction in spreads may have led to a fall in India VIX calculation which considers both the near and next month’s OTM options premiums for calculations.
A combination of the above factors and complacency
Further, it could be all of the above reasons along with some complacency too. The markets may be anticipating the uptrend to last irrespective of the election results.
“One must note that India VIX and markets are normally inversely related to each other. A low VIX means that the uptrend could be challenged in the near term. It also means that the market expects Nifty to trade in a narrow range in the near future. A VIX level of 10 means that the market’s expectation for Nifty is +/- 2.89 percent for the next one month,” added Sheth.
Sudeep Shah said that the India VIX tested a 5-month low largely on account of easing geopolitical tensions in West Asia and expectations of a strong mandate to the ruling party in the ongoing Lok Sabha Elections.
The India VIX gauges near-term market volatility expectations by analysing traders' outlooks reflected in option prices. It quantifies the projected percentage shift in the underlying index (e.g. Nifty) over the ensuing 30 days, derived from options market speculation.
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