Faced with a banking crisis and raging recession worries, Wall Street’s fear gauge has seemed surprisingly nonchalant. The Cboe Volatility Index , known as the VIX, only briefly topped the 30 level in mid-March at the height of the banking turmoil. For the past two years, the gauge has also stayed stubbornly under 40, more than half of its record high of 82.69 reached in March 2020. The index gets its value derived from option prices on short-term bets being made on the S & P 500. A rising value means investors are growing more fearful and a falling value means they are getting more confident. Market strategists say one explanation for the muted VIX is the explosion of zero-day-to-expiration options (ODTEs), contracts that expire the same day that they’re traded. More and more investors are using these vehicle instead of the options tracked by the VIX to bet on short-term volatility and hedge risk. “The VIX Index might have become obsolete as a risk barometer,” Doug Ramsey, Leuthold Group’s chief investment officer, said in a note. “The bulk of option market activities has shifted to ultrashort maturity options. They are highly speculative trading pursuits and are not captured by the VIX.” The VIX uses contracts that expire in the 23-37 day range, whereas ODTEs have a shelf life of 24 hours. So-called 0DTE contracts accounted for more than 40% of the S & P 500′s total options volume at the end of September, almost doubling from six months earlier, according to Goldman data. Daily notional volumes in these 0DTE options that track the S & P 500 index have exploded to reach a record $1 trillion, according to JPMorgan. “The proliferation of zero days to expiration option activity over the last year has likely limited VIX demand. These options provide an alternative to the VIX for hedging known event risk,” said Adam Turnquist, technical strategist at LPL Financial. For example, if an investor is worried about the Federal Reserve’s rate decision on May 3, she could buy a 0DTE S & P 500 put contract to hedge long positions instead of hedging with VIX options or even derivatives based on the VIX. The VIX’s subdued response to the market sell-off is even more obvious when comparing to the years before ODTEs gained popularity. LPL Financial analyzed VIX levels for all trading days when the S & P 500 was in a drawdown ranging from 18.5% to 28.5%. The fear gauge was more reactive to sell-offs during the period from 1990 to 2021 than 2022. Marko Kolanovic, the top strategist at JPMorgan, has warned of the risk of “Volmageddon 2.0 ” if the activity continues to accelerate.
