Market Insider

The 'fear index' is telling markets more right now than stocks are

Wall Street's fear index surges

A surge in the so-called "fear index" that accelerated Tuesday — coupled with a relatively less severe selloff in stocks — gave traders a taste of just how much the broader market is unprepared for the U.S. presidential election and other events.

The CBOE Volatility Index (.VIX), considered the best gauge of fear in the market, has climbed more than 40 percent over the last six days, while the S&P 500 has lost less than 2 percent in that time. That indicates more volatility could come.

"The pricing of the (volatility) options is based on what is perceived as greater risk in the next week or two than what the market is currently realizing," said Daniel Deming, managing director at KKM Financial.

S&P 500 (blue, left) vs VIX 10-day performance

Source: FactSet

U.S. stocks closed lower Tuesday, off their worst levels, but rattled by growing concerns of a Donald Trump presidential win and increased anticipation of tighter monetary policy. The Federal Reserve concludes its two-day November meeting Wednesday and is widely expected to raise rates in December.

The uncertainty accelerated the rise in the VIX, sending it above 20 to its highest since September 12. The S&P 500 briefly fell more than 1 percent to below the psychologically key 2,100 level before closing at 2,111.72.

Larry McDonald, creator of The Bear Traps Report, said it was "disturbing" how quickly traders were buying front-end VIX contracts, implying increased worries about volatility in the very near term.

"I'd say the election is a good chunk of it," he said, adding that Donald "Trump was not priced in, so the market is not ready for a surprise."

The VIX hasn't seen a six-day rise since one that ended on June 13, and the S&P hasn't had a six-day losing streak since one that ended August 25, 2015.

Both of those periods occurred just before major stock market drops. Most fresh in traders' minds is the surprise U.K. vote to leave the European Union on June 23, which sent the S&P 500 falling more than 5 percent over the next two trading days.

"Those who watched the Brexit referendum will be the first to agree" that a large number of dissatisfied voters aren't accurately accounted for in political polling, Carl J. Forcheski, director, corporate FX sales, America, at Societe Generale, said in a note.

"The risk for plain old volatility and a bigger market move is a Trump victory, and my sense is many who are exposed to that may be under-hedged. It would be prudent to take a look yourselves, to make sure the unexpected, if it happens, is not too painful," he said.