Traders brace for a blowup as cost of protection for U.S. stocks hits highest level since October

The VIX, often referred to as Wall Street’s “fear gauge,” is meant to reflect how volatile traders expect the market to be over the following 30 days based on demand for options contracts, which some investors use to hedge their exposure.

See: Is the VIX ‘broken’? Here’s why Wall Street’s ‘fear gauge’ no longer reflects the sorry state of stocks

The VIX itself, which is calculated based on trading volume in a subset of options contracts tied to the S&P 500, has risen to its highest level since early January, a sign that investors anticipate a bumpy ride ahead for stocks.

Rising prices for options tied to the VIX are a sign that investors are rushing to buy protection for their portfolios, market analysts said.

Danny Kirsch, head of the options desk at Piper Sandler & Co., said the rise in the VVIX is a sign that “uncertainty is increasing” ahead of next week’s U.S. January consumer-price index reading which is due out Tuesday.

Later in the week, investors will also contend with Friday’s expiration of monthly and weekly U.S. equity options, which could exacerbate swings in the market.

Charlie McElligott, managing director of cross-asset strategy and global equity derivatives at Nomura, highlighted the move in the VVIX in a note to clients published early Friday.

McElligott said the surge was part of the market’s reaction to the U.S. economic data released last week, including the January jobs report and ISM services-sector survey, among other reports. The data have prompted investors to second-guess expectations that inflation will continue to ease in an orderly manner.

“The data lit this match, and all of a sudden VVIX is exploding and rate volatility is exploding,” McElligott said during a phone call with MarketWatch.

Over the past two weeks, Treasury debt yields have seen some sharp moves also, which has caused the ICE BofA MOVE Index to tick back above 100 after finishing January at its lowest level since August.

McElligott also noted that demand for hedges has increased since the start of the year as both institutional traders and retail traders have bought back stocks following last year’s market rout.

“People have exposure that they need to hedge again,” McElligott said.

The S&P 500 SPX, +0.22% is on track to finish this week down 1.4% after trading essentially unchanged on the session Friday afternoon, leaving it on track for its worst week since Dec. 16. The Nasdaq Composite COMP, -0.61% is also on track for its worst week since mid-December, while the Dow Jones Industrial Average DJIA, +0.50% is headed for its worst week since Jan. 20.

U.S. stocks hit a five-month high in early February as the S&P 500 surged to start the year, recouping some of its losses from 2022, when stocks suffered their worst pullback since 2008.