VIX Surge Sparks Debate: Overvaluation or Misleading Buy Signal?

The recent dramatic fluctuations in the VIX, known as the "Wall Street Fear Gauge," have led to heated discussions about its potential overvaluation and possible misinterpretation as a buy signal. The surge in the VIX can be attributed to several technical factors, such as an apparent lack of liquidity, short covering of failed volatility bets, or merely the calculation approach of the volatility measure.

This week witnessed a roller-coaster ride in global financial markets. On Monday, the VIX spiked to over 65, an occurrence seen only thrice before — during the 1998 financial crisis, the 2008 financial crisis, and the onset of the 2020 pandemic. Despite the recent rebound in global markets, Wall Street has begun questioning the accuracy of this "fear gauge."

Experts suggest that Monday's surge in the VIX might be partly artificial due to the use of illiquid instruments in its calculations. Additionally, while the VIX soared, its futures saw more modest increases, leading some derivatives experts to argue that VIX futures better reflect actual cash flows and may more accurately gauge market sentiment.

Rocky Fishman, the founder of Asym 500, noted, "Trades are more important than quotes. In cases of significant market moves occurring outside regular trading hours, near-term VIX futures can be more indicative of hedging needs than the VIX itself."

For over three decades, the VIX has played a crucial role in many Wall Street stock market prediction models. Typically, such sudden spikes are seen as a sign of investors capitulating, potentially creating a foundation for a rebound. Indeed, the S&P 500 did rally for three consecutive days post the VIX spike, with investors pouring funds into equity ETFs.

However, Peter Tchir, Head of Macro Strategy at Academy Securities, cautioned against viewing the VIX's climb above 65 as a buy signal. In a report, he wrote, "So many people derive comfort from the 'fact' that we've undergone a volatility spike and now it's over. This makes me very nervous."

In conclusion, while historical data supports using a high VIX as an indicator of market bottoms, the current skepticism points to a need for careful interpretation. Sudden VIX spikes could be influenced by technical elements rather than solely by market fundamentals. As Wall Street continues to evaluate these dynamics, the relative movements of actual trades versus quotes will be crucial in determining the true state of market sentiment.