Sudden decline in Vix indicates correction ahead

With ease in geopolitical tensions and recovery in global markets, IVs have declined in last 2 sessions.

In an unusual move, the volatility gauge India Vix cooled off by 19 percent on April 23 to 10.26, nearing the lowest levels seen in the past 5 months. This, traders say, is a sign of an impending correction in the next few trading sessions.

Vix, also known as the fear index, captures traders' expectations based on option prices. The number indicates the percentage change the underlying index (in this case, Nifty) could see over the next 30 days based on bets placed in the options market.

Normally, a drop in Vix is associated with reducing risk perception in the market. However, a significant reduction in Vix at elevated market levels indicates that traders may be gearing up for profit-booking, which could trigger a price correction. The last time Vix dipped to 10 was on September 15 when the Nifty was hovering close to its all-time high of around 20,200 levels. Over the next few sessions, until September 29, 2023, the Nifty dipped to 19,600 levels.

Experts said Vix cooling off to 10 when the Nifty is nearing the key resistance band of 22,400-22,450 is not a good sign for the near-term. Arun Kumar Mantri, founder of Mantri Finmart, said, "The sudden fall in Vix closer to key resistance levels of 22,400-22,450 is not a healthy sign. It’s best for traders to lighten their positions in the short-term and use proper hedging for their open positions in the upcoming trading sessions."

The Nifty Option chain, which shows the listing of all option contracts, shows significant open interest (OI) additions at the 22,400 straddle. A straddle is an option strategy wherein option sellers/buyers take both put and call options simultaneously at the same strike price, expiring on the same day, in order to restrict profits/losses within the desired range. This strategy makes money for the option seller when the index closes within the range and losses when the index settles beyond the range; the opposite is true for the buyer.

The straddle is currently priced at around Rs 205, indicating a range of Rs 22,200 to Rs 22,600 for the April series expiry. "Currently, traders are adding call positions at the 22,400 strike, suggesting some potential cooling off. We advise buying Nifty only above the 22,430 level," said JM Financial.

"Vix is currently reaching medium-term support levels from where volatility could increase and take a U-turn. This is possible as we approach the mid-phase of Union elections, and the possibility of increased global volatility," said Arun Kumar Mantri, Founder of Mantri Finmart.

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