The fear index is ready to push higher

The volatility index (VIX) or, as it is often called, the ‘fear index’, measures the expected fluctuations in stock prices. VIX is an average of put and call implied volatility. Low VIX values are associated with a lower average and vice versa. Lower VIX values also mean higher complacency in the market; high VIX values mean a panic situation. Both sentiments are cyclical. After complacency (extreme confidence) comes fear (panic), repetitively.

The reason VIX is used as a fear gauge is also because it is good in highlighting extremes. We have talked about extremes on prior occasions and their significance in determining reversals. Just like sentiment cyclicality, even Nifty and VIX diverge and converge cyclically. Nifty and VIX diverged on May 16, 2008, converged on October 13, 2008, and now have diverged yet again to an extreme.

This means the current situation should be followed by a convergence in Nifty and its VIX. For that to happen, VIX should rise. A rising VIX means rising fear and that is generally accompanied by some negativity. We may keep on saying that everybody is waiting for a crash, so the crash may not come.

What we should rather be watching or saying is that after a divergence comes convergence, after an extreme comes a neutral position. The markets are trading on an extreme when it comes to NIFTY VIX. How much per cent Nifty has to correct to balance this extremity is another subject of study. What the fear gauge is saying is that the odds are against the calls and in favour of the puts.

Above this, we have the Orpheus numeric ranking. A low-ranking NIFTY VIX suggests outperformance among 54 assets. This is another reason for us to remain long on NIFTY VIX and short on the rest of the market. As we can see on the chart illustrated here, the Indian VIX is at a minor low, near 16 levels. The structure looks like bottoming and the key reversal bar (KR) suggests we could see a rise in volatility next. A clear break above minor trend channel resistances would give us further positive confirmation.

Our first target lies at previous (x) wave highs, at 24-levels. The performance cycles are also heading to a bottom and suggest that VIX should outperform in the next weeks. In fact, Nifty VIX is still the top potential outperformer, according to the Numeric Ranking.

Nifty VIX is preceded by ITC, Suzlon and Reliance. Tata Steel is the top potential underperformer, followed by Idea, Tata Power and SBI. On the sector side, consumer durables and BSE Metals remain at the two extremes.

We have been talking about the potential outperformance of metals since mid-July. We had then highlighted three potential outperformer metal stocks, plus the sector itself. These three stocks were Sterlite, Tata Steel and Hindalco. Sterlite andHindalco are still outperforming (somewhere in the middle of the numeric rankings). The metals sector is still low in rankings, suggesting further outperformance for the group, but Tata Steel has already reached the top ranking. This can indicate a few things. First, Tata Steel is indeed the sector leader. Second, a Tata Steel reversal could trigger the top for metals.

Our long only–short only tracker, along with the numeric ranking filter, suggests Reliance Communications as the best sell and Infosys as the best buy. The top winner remains SBI with 16 per cent gains, followed by NSEBank and ICICI Bank with 12 per cent and 10 per cent gains, respectively. We are also on alert regarding potential new signals on pairs.

The overall market view remains up but topping, as the Nifty is heading to the highlighted resistances at 5,600-levels. We believe it is more likely that the rise of VIX will mean fear of volatility on the downside rather than on the upside. The structure looks like a completing correction to us and we are not expecting further minor positivity at this stage.

The author is employed with Orpheus CAPITALS, a global alternative research firm