(Fortune) - August has been a helter-skelter month for markets. Look no further than the CBOE Volatility Index (or VIX), a measure of volatility popularly known as Wall Street’s “fear gauge,” which surged at the height of the meltdown earlier in the month. On Aug. 5, the volatility index peaked above 65, its highest level since the onset of the COVID-19 pandemic and a mark hit only a few times this century.
The VIX soon recovered at record speed, however, plummeting over 50 points in a matter of weeks as markets stormed back to erase their losses. The index currently sits around 17, below its long-term average of 20, traditionally interpreted as a signal that investors are relatively calm.
But the index’s big swings, multiple experts told Fortune, serve as evidence the VIX doesn’t quite mean what it used to.
“It is some sort of measure of fear,” said Benjamin Bowler, the head of Bank of America’s global equity derivatives research team. “But perhaps it’s not the same measure of fear that people generally think.”
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The CBOE Volatility Index is derived from S&P 500 call and put options; nowadays, that means standard options that expire the third Friday of every month and weekly options which expire all other Fridays. Using these derivatives, the index measures the expected price fluctuations, or volatility, in those options over the next 30 days.
That ties the VIX to a specific date, said Michael Green, portfolio manager and chief strategist at ETF manager Simplify, making the index less useful as a broad measure of market sentiment. Also, the derivatives that constitute the VIX aren’t traded as much as they once were, with investors increasingly favoring single-day and zero-day options to cap exposure.
“Part of what you saw in that fantastic spike [of the VIX] was effectively the soreness that you feel after you work out for the first time,” Green said. “It hadn’t been used in a while.”
As Bowler explained, recession fears, the unwind of the yen carry trade, and other commonly cited causes of the market’s early-August plunge served as catalysts for the VIX to spike. He said the jump was greatly exacerbated, however, by the illiquidity of the S&P options that make up the index. The widening of these options’ bid-ask spreads—the difference between the highest price that a buyer is willing to pay and the lowest price a seller will accept—caused the VIX to overstate investor uncertainty.
“A VIX at 65 may not be equivalent to a VIX at 65 10 years ago, when liquidity wasn’t as fickle as it is today,” Bowler said.
Quant funds set to buy back $190 billion after VIX scare
That didn’t stop so-called systematic funds, which trade based on market signals like volatility rather than fundamentals, from selling en masse. Over the past month, these funds have sold the largest dollar-volume of equities in four years, Bloomberg reported. Their equity allocation dropped by more than half.
Typically, these quant funds, as they are also known, are quick to sell but take longer to rebuild their positions. This time, however, some believe that the funds will reallocate with greater urgency after volatility spiked and retraced so fast.
Among those who agree is Green, the portfolio manager at Simplify. If quant funds want to capture the rally, he said, it could become a self-fulfilling prophecy.
“More and more people recognize the value associated with the buy-the-dip approach,” he said, “which in turn means that they are more willing to step in and program their models to react more quickly to that type of dynamic.”
That shift from major passive players could cause roughly $190 billion to flow back into the market over the next three months, Bloomberg reported, assuming modest daily gains for the S&P.
Regardless, a mountain of research warns retail traders against trying to time the market. Many activist managers, meanwhile, see opportunity by looking long-term and focusing on company fundamentals.
“As Warren Buffett said, it is usually best to buy when others are fearful and sell when others are greedy,” Eric Beyrich, equity portfolio manager at Florida-based investment firm Sound Income Strategies, wrote in an email to Fortune. “A high VIX, especially when it seems to be due to a transient factor, can set up for a good buying time.”
In that case, uncertainty might equal opportunity.
By Greg McKenna
