(Corrects closing price for VIX in third paragraph to 37.32 from 22.2)
NEW YORK, Feb 5 (Reuters) - Wall Street's 'fear gauge' notched its biggest one-day jump in more than two years on Monday, as U.S. stocks slumped and investors took to the options market in search of protection against a further slide in prices.
Stocks fell in highly volatile trading on Monday, with the benchmark S&P 500 and the Dow Jones industrials suffering their biggest percentage drops since August 2011 as a long-awaited pullback from record highs deepened. For the Dow, the drop of nearly 1,600 points was the biggest intraday point loss in history.
The CBOE Volatility Index, better known as the VIX, is the most widely followed barometer of expected near-term volatility for the S&P 500 Index. On Monday, the index ended up 20.01 points at 37.32, its highest close since August 2015.
"The day started out fairly orderly, but somehow it took a turn for a worse, and then panic set in," Randy Frederick, vice president of trading and derivatives for Charles Schwab in Austin, Texas.
"There may have been some pretty sizeable program trades that were clicked in. It just looks like some institutional program selling," said.
The intensity of the sell-off drove traders to the options market and trading volume surged to 35.5 million contracts, the third busiest day ever, and the busiest day since Aug. 21, 2015, according to options analytics firm Trade Alert.
VIX call options, primarily used to protect against a spike in volatility, accounted for nine of the 10 most heavily traded contracts on Monday. Overall VIX options volume hit 3.6 million contracts, or about three times its average daily volume.
Options on S&P 500 Index and the tracking exchange traded fund known as the SPDR S&P 500 ETF Trust also drew higher-than-usual trading volume.
The robust hedging activity was in line with a spike in equity market volatility rising to a level not seen in months, Jim Strugger, derivatives strategist at MKM Partners in New York, said.
"We have come through such a statistically anomalous period that even if we just go back to average it is going to scare people," he said.
The VIX's long-term average stands at 19.34. Through Friday, the VIX had lingered below that level for 312 consecutive sessions.
SHORT VOLATILITY PAIN
Months of extended calm in the stock market has made selling volatility a lucrative affair. The pick-up in stock market gyrations early last week drove more people to bet on subdued stock market gyrations, said Anand Omprakash, director of equity and derivative strategy at BNP Paribas in New York.
"We have been in this paradigm where when volatility spikes a little bit, a lot of cash comes out of the sidelines to get long some of these short volatility ETPs (exchange traded products)," Omprakash said.
VIX-linked ETP's net short exposure hit a record high on Thursday, Omprakash, estimates.
"(It's) impossible to verify, but you'd have to figure that the recent move has caught many of these people off guard and has added some volatility to the recent moves," said Matt Thompson, co-head of the Volatility Group at Typhon Capital LLC, in Chicago.
The intensity of the sell-off is likely to keep investors from quickly piling back into short volatility bets, market participants said.
"Even though at some point investors will show up to buy the dip in stocks, we don't think short volatility is a buy here," said Stephen Aniston, president of investment adviser Black Peak Capital, in Connecticut.
The spike in volatility does open up some attractive options market opportunities.
"If you were looking to deploy into the equity market, premium levels have expanded, so using cash secured puts is a way to gain exposure," said Eric Metz, chief investment officer at SpiderRock Advisors LLC, in Chicago.
Selling a cash-secured put is a strategy that allows an investor to be paid a premium for the obligation to buy a particular stock at a fixed price in the future, usually for less than the current price.
"For the first time in quite a long while I think it is extremely enticing," Metz said.
(Reporting by Saqib Iqbal Ahmed; Editing by Matthew Lewis and Richard Chang)