A breakout after low volatility may be on the cards

A breakout after low volatility may be on the cards

Investor sentiment in India is relatively calm, with the volatility index (India VIX) closing at an over three-year low of 10.95 on April 28. The previous low by the index was 10.53 on December 27, 2019.

Also known as the “fear index”, the VIX is a measure of volatility. A low level indicates a good run for the indices, as volatility is deemed low for the next month, given the inverse relationship between the two.

“Markets are supposed to show a period of stability in theory but in times of low volatility when indices are at higher levels, there is some correction mean reversion,” says Deepak Jasani, head of retail research at HDFC Securities.

Mean reversion refers to prices having a tendency to return to normal/average levels after an extreme upward or downward move. “Selling pressure does build up if indices remain at higher levels beyond a certain point,” added Jasani.

Following a low of 12.37 in September 2014, the Nifty fell 2.73% over the next month — on concerns building up over the US Fed’s stance on rate hikes — showing a subsequent reversal to rise 3.43% the month after.

Similarly, there was an over 1% fall through January 2020 as the market was in a sell-off mode in the run-up to the Union Budget. February saw a fall of 5% following the Union Budget. Interestingly, this period coincided with the rising cases of Covid-19 especially in Asia, which wreaked havoc in March 2020, triggering a 30% slump in the Nifty.

“It is the nature of the markets that a correction takes place whenever the indices are at a high for extended periods, with or without a trigger. Therefore, we see sell-offs and price corrections even if the VIX indicates otherwise,” says Kranthi Bathini, Director (Equity Strategy), WealthMills Securities.

Agrees Jasani, saying that at times of low volatility, even the slightest trigger — domestic or global — could have a larger impact as investors may interpret it as a sign of reversal in the indices.

While 2020 was an aberration owing to the sudden Covid outbreak, market players say that even otherwise, the market seeks cues from overseas markets, geopolitical situations and actions by central banks.

For instance, in 2021, the VIX moved on the higher side — above 20 — for almost the first half of the year. This was when the “Delta” variant of Coronavirus resurfaced. It went as high as 28 at the end of February when cases had peaked. However, the index slipped to below 15 after mid-June, when the worst was behind and economic recovery started reviving.

The second half of the year saw the VIX at relatively lower levels, once recovery was back on track — with a near-low of 11.71. Subsequently, a beaten-down market saw a strong revival, raking in gains of 4% over the next month and 10.7% the month after.

Friday’s low of 10.95 indicates a period of calm ahead for the markets. “A decent earnings season especially for the large-caps, except the IT sector, along with cooling inflation and a pause in the rate hike, makes a strong case for the going to be smooth for now,” said an analyst at a brokerage.

“Any surprise on the global geopolitical front or a fresh crisis in the financial sector could, however, be a trigger for a negative turn once again,” the analyst added.

The Nifty50 gave returns of 4.06% in April, marking a strong start to FY24.

According to the NSE, the VIX is “a volatility index based on the NIFTY Index Option prices”. A figure (%) is calculated from the best bid-ask prices of NIFTY Options contracts, indicating the expected volatility over the next 30 calendar days.

Market players say there is no ‘ideal’ level, but a figure below 15 is usually indicative of low volatility. The 15-20 range indicates relatively high volatility, while that above 20 shows extreme volatility.