Is the VIX 65 Spike Real ? Market Fear Versus Reality Examined

Is the VIX 65 Spike Real? Market Fear Versus Reality Examined 

The official VIX calculation did indeed report a level of 65.73 on Monday at 8:34 am EST, a figure now being used by many to justify taking long positions in equities. The reasoning behind this is that a significant surge in volatility signaled panic, which has since subsided, thus creating a potential buying opportunity. It's important to clarify that while many use "VIX" and "volatility" interchangeably, they are not the same thing.

Typically, this might not warrant much concern, but the confidence people are placing in the supposed "fact" that we experienced a volatility spike, which has now passed, is unsettling. Understanding why this is problematic requires looking back at past observations.

In September 2017, the Wall Street Journal published an article titled Could Some VIX-Related Funds Go "Poof" in a Day?, which I contributed to. At that time, we were among the few who anticipated potential issues, despite significant pushback from ETF providers. Their argument was based on the assumption that VIX had never spiked so drastically in a single day, making such an event impossible. Our counterargument was rooted in the idea that while VIX had historically been a mere calculation, the introduction of tradeable products based on VIX futures altered its dynamics. The need to rebalance these products after market close, especially during the 4 to 4:15 pm window, created unusual demand that traders could exploit.

The VIX calculation itself is prone to manipulation. Those aiming to disrupt VIX ETPs could exploit this by influencing the futures market. On March 4, 2018, the WSJ published A VIX-Related Fund Did Go "Poof", which validated our concerns. We had devoted significant time to studying VIX calculations, even developing our own VIX-style tools for monitoring fixed income markets.

The VIX methodology involves the entire option chain, including illiquid options, which can distort the calculation. Moreover, the calculation considers bid/offer spreads rather than just traded prices. If market makers widen spreads on deep out-of-the-money options during volatile periods, this can significantly inflate VIX without any actual trades occurring. This is a key issue with the 65.73 reading on Monday morning.

In discussions with Robert E. Whaley, the creator of VIX, valuable insights were gained. One important point is that VIX only includes options expiring between 23 and 37 days. With the rise of 0DTE (zero days to expiration) options, fewer trades impact VIX, potentially leading to distortions when market participants shift from short-term options to those that affect VIX.

There was certainly fear in the markets, but we argue that there was no real panic. The difference between traded prices and calculated values underscores this. The VIX futures contract, where actual money is at risk, did not mirror the spike seen in the VIX calculation. As the U.S. stock market opened, the VIX calculation quickly dropped, while VIX futures remained more aligned with market conditions. Many traders reported poor liquidity in options on Monday morning, further casting doubt on the VIX calculation's accuracy.

During the peak of the COVID crisis, the VIX and VIX futures moved in tandem, reflecting genuine fear. This time, however, the behavior was different, which is not reassuring.

On Monday, large ETFs like QQQ and SPY saw inflows, and even leveraged ETFs had inflows or minor outflows, indicating that investors were not panicking but rather taking advantage of the situation. This lack of panic, coupled with reliance on a questionable VIX calculation, raises concerns about the market's current complacency.

In conclusion, there was no real panic on Monday, and relying on the VIX calculation to justify bullish positions is troubling. The actual market indicators, such as VIX futures and ETF flows, suggest a different story—one of fear mixed with greed. This complacency could set the stage for further market tests, particularly as auctions, earnings, and economic data come into play. The VIX 65 reading appears unreliable, and using it as a basis for investment decisions could be risky. While there may be some stability ahead, underlying issues of limited liquidity and market overextension remain, making caution advisable.