The market has been very placid for two months now. Low volatility period is always followed by a period of high volatility. So, fasten your seatbelts against some major surprises

India VIX, a volatility index based on the index option prices of Nifty index has collapsed to its lowest level since March 2009, from when the data is available. Market players are assuming that volatility will remain low and the market will continue to be range-bound but the current low volatility may only presage a big surprise (positive or negative) in the coming weeks.

The daily VIX hit its lowest close of 17 on 9th August in these 17 months. The index was around 25-30 on most days in the first two months of the year. The 50-share Nifty had hit 5,367 on 21st June and has moved in a narrow trading range since then. It fell to 5,225 on 2nd July and rose to 5,492 on 9th August and is at around 5,400 at the time of writing this piece. This has been an extremely tight trading band for an extended period of time. As a result VIX, the measure of volatility, is sharply down. How should we interpret this, since low volatility period is invariably followed by a high volatility period?

"Low volatility can have two meanings. One is that the market is becoming very complacent and to that extent people are not expecting wild swings on either side. Therefore, volatility is reducing. People are not taking the market risk into account. The second reason could be that we are in the middle of a new long bull market. Typically, when a long bull market starts, the volatility subsides and remains low for a prolonged period of time. This is what has happened in two bull markets. We could be entering that phase now. As that happens, we could see steady upward move in the market intertwined by corrective phases, like what happened in May 2004, 2006 and 2007," said Sandip Sabharwal, CEO - Portfolio Management Services, Prabhudas Lilladher Pvt Ltd.  If Mr Sabharwal is right, the low volatility will be resolved by extreme downside volatility as happened in May-June 2006, before the market resumes its upward journey.

"The market is at an indecisive phase and therefore it is in a narrow range with low volatility. If the market starts correcting you will see more volatility. The market is waiting for some correction," said a Mumbai-based head of an institutional equity firm.

The highest daily VIX was on 19 May 2009 (it hit 56.07), following the decisive victory of the Congress party in the 2009 elections. VIX then slipped to its lowest level on 9 August 2010 to 17. "Lower volatility is associated with stability. The markets are not expecting any huge moves and generally huge moves are associated with falls and not the increments.

The volatility aspect is very closely watched but you don't know how low is low," said a Mumbai-based analyst. Jintendra Panda, senior vice president & business associate, Motilal Oswal Financial Services Ltd observes that volatility will remain low in the near-term. "Over the last 6-8 months, the market has consolidated within a small range after an upturn in 2009. The volatility is expected to remain low for the next one or two quarters." 

Indian markets, like all emerging markets, are supposed to be more volatile than US markets. But the Indian market has been so placid that it is less volatile than the broad market index, S&P 500 whose volatility index now is around 22 now. On 24 October 2008, fears of a financial meltdown sent the VIX to a historic high of 89.53.

While traders are unhappy that volatility has collapsed and that there are lot of tiny whipsaws now which are inflicting losses, Deena Mehta, MD of Asit C Mehta Investment Intermediates Ltd says that low volatility is good for long-term investors who should not take cues from short-term volatile movements.

"It's good for investors as they will not be in for shocks and surprises. Too high volatility is not considered to be good. Low volatility is good for people who have a long-term view on the market. If you have a long-term view then you are not bothered about short-term shocks. People who have a short-term view of 15-30 days are not happy with low volatility as there are fewer opportunities to enter and exit in the market."  — Moneylife Digital Team