Wall Street’s ‘fear gauge’ surges as selloff sinks stocks

The Cboe Volatility Index VIX ¨fear gauge¨ exploded higher on Friday, to its highest level since the 2010s

Wall Street's 'fear gauge' surges as panic grips stocks

Provided by Dow Jones

Aug 2, 2024 6:24pm

By Joseph Adinolfi

The Cboe Volatility Index, known as the Vix, snapped its longest streak without a close above 20 since February 2018 on Friday.

Wall Street's "fear gauge" roared back this week after a prolonged stretch of quiescence. Its rise is raising questions about how much longer the summer selloff in stocks might continue.

The Cboe Volatility Index VIX exploded higher on Friday, adding to gains from Thursday's session, as a disappointing reading on the labor-market data flashed a sign that the U.S. economy might be headed for recession.

The VIX finished at 23.57 after nearly touching 30 earlier in the day, a level unseen since the aftermath of the collapse of Silicon Valley Bank in March 2023, Dow Jones Market Data showed.

Although it closed well below this earlier peak, the fear gauge still tallied a gain of 27% on Friday, bringing its weekly advance to 43.7% - the biggest jump since the week ended Jan. 21, 2022, according to FactSet data.

The VIX's Friday jump was notable in another sense. It snapped a 190-day streak of closes below 20, a level roughly equivalent to the index's long-term average. The streak of below-average readings was the longest since February 2018, when an event known as "Volmageddon" caused the fear gauge to double in a day just months after hitting record lows.

This long stretch of low readings for the VIX had helped fuel arguments from some that the gauge was "broken" - that is, that a shift toward increasing reliance on shorter-dated options like those expiring within 24 hours had blunted its usefulness.

But Friday's spike helped to rebut these claims, said Matt and Mike Thompson, co-portfolio managers at Little Harbor Advisors, in an interview with MarketWatch on Friday.

"You've got some issues now that are bigger and slower moving, and those call for longer-term hedges," Matt Thompson said. "That's finally causing the VIX to move because the index is looking out 30 days."

The level of the VIX is determined by activity in out-of-the-money options tied to the S&P 500 SPX that are due to expire in roughly one month. Its rise signals that traders are bracing for more market pain over the near term.

As the index surged, it briefly helped to push the CNN fear and greed index into "extreme fear" territory. The CNN gauge relies on a handful of market-based indicators, including the VIX and the number of stocks hitting new 52-week highs on the New York Stock Exchange.

Earlier in the year, traders had eyed the VIX with growing nervousness, worrying that its consistently subdued readings might be a sign of complacency.

The index had traded at its lowest level since November 2019 as recently as May.

Those concerns were vindicated to a degree by Friday's spike. The jump in the VIX also helped to reinforce the notion that although periods of tranquil markets can persist longer than some might expect, they can't last forever.

Friday wasn't the first sign that markets might be entering a more turbulent period. Last month, the S&P 500 finally tallied a drop of 2% or more in a single day, snapping a 356-day streak - the longest since 2007 - without one, Dow Jones Market Data show.

By comparison, the index finished 1.8% lower on Friday at 5,346.56, well off its session lows. Some traders had also noted that markets often turn volatile during the three-month period beginning in August and ending in October.

"Stability breeds instability," said Nomura's Charlie McElligott in emailed commentary shared with MarketWatch earlier, repeating a line he has used regularly.

McElligott pointed out that Friday's selloff had sent traders scrambling for more downside protection, causing the put skew on options tied to the S&P 500 and other major indexes to surge. This reflected a jump in demand for contracts that would protect portfolios from further losses.

Another sign of the growing demand for hedges was the move in the Cboe VVIX index, which gauges demand for options tied to the VIX. The VVIX touched its highest level intraday since January 2022 on Friday. Meanwhile, the put-call ratio for VIX options stood at 0.74, signaling that investors preferred VIX calls to VIX puts. Vix calls would pay off if volatility continued to climb.

All of this contributed to what some described as a rather extreme move in the fear gauge relative to the drop in the S&P 500 on Friday.

"Volatility was massively outperforming the move in equities," said Danny Kirsch, head of options at Piper Sandler, in response to questions emailed by MarketWatch on Friday.

As strategists cast about for reasons for this divergence, some said it could be tied to popular hedge-fund strategies that involved betting against the index. These strategies had delivered reliable gains this year until late last month, when the VIX began to rise as major indexes like the S&P 500 started to sink.

"It has the same effect on the VIX as a short squeeze," said Michael Purves, CEO of Tallbacken Capital, in an interview with MarketWatch. "That's part of what's going on here. Traders who are effectively short the VIX are being forced to close their positions."

As for what the spike in the VIX might mean for markets in the near future, traders were divided. Some, including DataTrek co-founder Nicholas Colas, have said that the Vix needs to hit 30 in order to send a clear signal that stocks have reached "capitulation" territory. The index didn't quite get there on Friday.

Still, others saw signs that the worst of the selling might already be over. Katie Stockton, founder and managing partner of Fairlead Strategies, said in a report shared with MarketWatch that the spike in the VIX could signal that the near-term lows might already be in.

She will be watching on Monday for more signs about whether this week's action markets a lasting reversal, or a short-term shakeout.

Elsewhere in markets, the Nasdaq Composite COMP fell 417.98 points, or 2.4%, to 16,776.16 to finish Friday in correction - a pullback of at least 10% but not more than 20% from a recent high - for the first time since October, according to Dow Jones Market Data. The Dow Jones Industrial Average DJIA also fell 610.71 points, or 1.5%, to 39,737.26, capping off its worst two-day drop since September 2022.

-Joseph Adinolfi

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

https://www.morningstar.com/news/marketwatch/20240802820/wall-streets-fear-gauge-surges-as-panic-grips-stocks

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