Stock market's 'fear gauge' plunges as investors shift hedging … – S&P Global

Stock market’s ‘fear gauge’ plunges as investors shift hedging strategies
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Fear in financial markets has been falling steadily for weeks even as stocks have been in steep decline for much of 2022, the Federal Reserve is expected to continue its aggressive rate hikes into 2023, and the U.S. economy could soon be mired in another recession.
On Dec. 2, the CBOE Volatility Index — also known as the VIX and commonly called the stock market’s fear gauge — settled below 20 for the first time since early October. The VIX, which measures volatility in equities through moves in the options market, tends to rise as stocks fall. While U.S. stock indexes have fallen significantly from the all-time highs or near all-time highs reached in January, market fear seems to have dissipated since mid-October as equities have seen a modest rally. For example, the S&P 500 is up roughly 9% over the past seven weeks.

The decline in the VIX reflects changing hedging strategies as traders look to protect their investments from fast-moving economic developments and institutional investors shed equities. It may also be a sign that the S&P 500 has reached its near-term peak.
“Ultimately, the VIX just shows the sentiment of traders, and when that sentiment is overly benign, as we’re seeing now, it has tended to signal that we’re on the verge of a top forming,” said Matthew Weller, global head of research with FOREX.com and City Index.
Each time the VIX has dropped below 20 this year, the S&P 500 has fallen lower within a few days, and every time the VIX has neared 35, the S&P 500 has bottomed out shortly after, Weller said.
If a sell-off starts, the VIX will jump as the price of buying insurance in the options market rises, said Michael O’Rourke, chief market strategist at JonesTrading.
“The current behavior is very consistent with historic norms,” O’Rourke said.
Institutions liquidate
Still, the VIX has not behaved in its typical fashion for much of this year, said Tyler Richey, a co-editor at Sevens Report Research.
When the S&P 500 fell to new lows in the first quarter, the index did not rise to new highs, as many expected. The VIX did not see a substantial spike when stocks tumbled in May, June and October.
The traditional inverse relationship between the VIX and broader equity markets is taking place now, however, which Richey attributed to institutional investors selling long-term equity holdings.

Institutional money managers, the options market’s biggest players, hedge their long equity position during bull markets. During this current bear market, the VIX is falling to fresh lows due to fading demand for options hedging as these institutional investors continue to liquidate.
“The VIX is basically a measure of demand for hedges by the biggest investors in the market,” Richey said. “But when institutional investors are liquidating their equity positions, they no longer have a need for the associated hedges, so they unwind those positions in the derivatives markets and ultimately that pressures the VIX.”
Hedging changes
The VIX’s reflection of market fear has changed this year as investors have started using options differently, said Callie Cox, a U.S. investment analyst at eToro.
Rather than relying on the monthly options tracked by the index to guard against potential stock market losses, investors are increasingly turning to weekly and daily options to hedge against Fed decisions or market-moving data releases on inflation or jobs, Cox said.
“People are appropriately anxious,” Cox said. “They’re just hedging in a way we haven’t seen before.”

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