VIX signalling any correction could be steep; Nifty continues to ride up

The Nifty continues to ride up, driven by the usual pre-Budget optimism. All three segments of players - domestic institutions, retail investors/ traders and foreign portfolio investors (FPIs) appear to be bullish at the moment. However, option premiums have also spiked, and the VIX is up, indicating that there could be massive volatility in the next few sessions.

The long trend is obviously bullish but centred on Budget newsflow. It's impossible to calculate upside targets since the market is in a new zone. The VIX is signalling that any correction could be significant since it's risen to 12-month highs. However, a pullback would not be considered serious unless the Nifty slid below 10,550, which is the level from where the recent breakout came. If that is broken, the next key support would be at 10,325.

This is the BJP's last Budget before the next General Elections. Growth seems to be picking up but so is inflation. The GST has not yet settled and the Fiscal Deficit may exceed targeted levels. There are the usual rumours about changes in tax policy, etc.

So far in calendar 2018, domestic institutions, FPIs and retail investors, have all been strongly bullish. This has resulted in a broad movement across most sectors, and stocks of all levels of market cap. Corporate earnings in Q3 have been decent so far. By definition, the long-term, intermediate and short-term trends are up. Trend following signals suggest a buy on the Nifty with a stop at 10,900.

Traders must remain braced for currency volatility due to Brexit, among other factors. Worries about higher oil prices continue. The dollar has lost a lot of ground. A rebound is due and any pause in FPI inflows could trigger a dollar rebound.

This uptrend started, several months ago, from support at 9,675-9,700. The 200-Day Moving Average is now around 10,050. In the longer-term, the Nifty moved North in December 2016, from 7,900 levels to a high of 10,550, hitting that level twice in December 2017, before moving to the current high of 11,170. The Index has bounced twice from 9,675, since December 2016.

The Nifty Bank has also pulled up sharply. The "Bank" is currently at 27,500-levels after bouncing from 24,620. A strangle of long February 22, 28,500c (153), long February 22, 26,500p (200) costs 353, with breakevens at roughly 26,145, 28,855. This position is nearly zero-delta.

It could be hit in three or four trending sessions. If this is taken and the February 1, short 26,500p (45) and February 1, short 28,500c (45) is sold, the calendar spreads costs a net 263. This long-short position could give a big payoff if the financial index stays volatile. It's important to note that February 1 is Budget day, so there will be excess volatility at that settlement.

Put-Call Ratios are not useful this close to settlement. The Nifty closed at 11,138 on Friday. A bullspread of long February 11,300c (122), short 11,400c (86) costs 36, pays a maximum 64. This is 160 points from money. A bearspread of long February 11,000p (143), short 10,900p (113) costs 30, pays a maximum of 70 and is 140 points from money.

This wide strangle is tempting because the Budget guarantees big swings. Traders can also take even wider positions since the Budget will normally trigger at least a 3 per cent movement either way. However, the cautious trader will wait out the Budget session before committing to a large position in either direction. Historical data suggests that trends tend to get firmly established at the Budget and it's safer to wait out that session and take positions over the next two.