VIX Soars on Geopolitics, but ‘Buy the Rumor, Sell the News’ May Lead to Reversal

VIX INDEX OUTLOOK:

• The VIX spikes higher after Russia launches a full-scale invasion of Ukraine
• Risk assets decline in the early trade, though the sell-off appears to be moderating
• A lot of bad news has been priced in already, so we shouldn’t rule out a relief rally in the near term once traders realize the crisis in Eastern Europe will not materially impact the global economy. This may pay the way for a sharp decline in the VIX index.

Most read: What is the VIX? A Guide to the S&P 500 Volatility Index

The VIX index soared Thursday amid rising geopolitical tensions in Eastern Europe after Russia launched a full-scale invasion of Ukraine from land and sea, targeting military installations and infrastructure in many cities in an effort to demilitarize the country and facilitate the incursion.

In early trading, the Cboe fear gauge spiked higher to 37.7, its highest level since January 24, before retreating slightly towards the 33.00 area. The volatility explosion coincided with a sharp pullback in stocks, with traders dumping risk assets and rushing into the safety of U.S. bonds and gold, as Europe plunged into its biggest security crisis since WW2.

The United States and Western allies said they will impose severe sanctions on Moscow for escalating the conflict and for waging war without reason. This scenario will fuel jitters and create more uncertainty, especially if President Putin retaliates by choosing to cut off energy supplies to the region. On Wall Street, uncertainty equals volatility, so we may continue to see turbulence in the coming days, but on a smaller scale.

However, it is important to note three key points: 1) much of the geopolitical crisis has already been priced in, 2) the ongoing events have reduced the likelihood of a super-sized interest rate hike by the Federal Reserve at its March meeting,3) the crisis in the region should be contained and should not derail the global recovery. At the same time, U.S. companies have low revenue exposure to both Russia and Ukraine, a situation that will limit the impact on the U.S. stock market.

For the reasons mentioned before, it would not be surprising to see a typical “buy the rumor, sell the news” episode in the coming days, setting the stage for a face-ripping rally in risk assets and a mean reversion in the VIX index (decline towards the 20 mark). To take advantage of the elevated volatility environment and position for a potential recovery in the equity space, selling premium at currently rich prices looks attractive, although traders should be aware that the strategy may backfire if geopolitics take an unexpected turn.

VIX INDEX DAILY CHART

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—Written by Diego Colman, Contributor