Wall Street’s ‘fear gauge,’ the VIX, is exhibiting unusual behavior by rising alongside the stock market during a period of record options trading volume. This trend is driven by a surge in call buying, particularly on the S&P 500 and Nasdaq 100, which inflates options prices and consequently boosts the VIX.
While this scenario presents opportunities for hedging strategies, it also creates potential risks for options buyers, especially those holding far out-of-the-money calls, as the price of the underlying asset and its volatility can both decline simultaneously. Traders are advised to be cautious of this dynamic.
Wall Street's 'Fear Gauge' Deviates: VIX Rises with Stocks Amidst Record Options Activity
By Oliver Renick
Traders work on the floor of the New York Stock Exchange. (NYSE)
Tuesday's stock market rally was so powerful it's causing unusual behavior in how volatility is priced, challenging traditional market assumptions. The Cboe Volatility Index (VIX), often dubbed the market's 'fear gauge,' climbed a full point even as the S&P 500 surged 1.8%. This trend continued into Wednesday morning, with the VIX rising alongside equities before falling as the market softened.
The VIX index and the S&P 500 in the past five trading days
This divergence, where stocks and the VIX move in the same direction, typically happens only about 20% of the time. It usually occurs when the VIX is already low and a significant amount of call buying takes place in a rapidly advancing market. This surge in call buying can push the VIX higher, even as stock prices climb.
On Tuesday, a record-breaking 4 million S&P 500 index calls traded on Cboe. Concurrently, the price for one-standard deviation call options on the Nasdaq 100 at Nasdaq saw its largest single-day jump in five years, soaring 42%. This extreme demand, while bullish in nature, inflates options prices and implied volatility, thereby supporting the VIX even as stocks ascend. Essentially, exuberant call buying is currently driving the VIX upward. The put-to-call ratio also hit its second-lowest reading on record at 0.83.
This scenario presents unique opportunities and risks for traders. For bulls, buying far out-of-the-money call options may become less attractive as their prices surge. When both the underlying asset's price and its volatility drop—as seen mid-Wednesday—call buyers can face a double loss. However, for investors concerned about market swings but unwilling to sell stocks, the current VIX levels, near long-term averages, offer potential hedging strategies. If the market experiences sharp downturns, the VIX is expected to rise, making volatility hedges more effective.
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