The stock market's fear gauge spikes the most on recrod

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The relationship between volatility and stock prices broke down spectacularly this week, and it is being taken as good news for investors.

"Equity markets have finally woken-up after a period of low volatility and complacency that had led to rapid gains", said James Knightley, chief worldwide economist at ING.

"With the CBOE SPX Volatility Index.VIX nearly tripling over the last three trading days mark-to-market profit and losses have been significant", said Ihor Dusaniwsky, head of research at S3 Partners. That fluctuation is known as the implied volatility.

"But the path from here to that point is likely to be somewhat disorderly".

A strategy of betting against turbulence in equity markets.

If you own a VIX-related exchange-traded product, certainly. As a result of the spike in volatility, they may have to sell risky assets - or desist from buying them - to meet those limits.

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At the root of the selling are concerns over inflation and rising interest rates, which have pushed up bond yields at the expense of stocks.

Though estimates of how much money is actually parked in such strategies are hard to come by given a general lack of transparency, some broad numbers exist. And funds that have followed the strategy have attracted massive inflows. As for the wider global markets, funds and banks face limits on the amount of risk they can hold on their books. This may be what happened with the recent volatility spike.

The VIX has drifted lower since early 2016, staying at depressed levels below its 20-year average for almost two years with spikes only a handful of times in the last decade. There's also MOVE for the US Treasury bond market. Because there's been very little for more than two years, investors taking such bets have earned handsome returns.

Dusaniwsky said this could lead to higher volatility for XIV over the next few days as traders look to buy XIV to cover their short position.

"The party may be over for now but this could be more of a sobering correction than a rout", said Jacob Deppe, head of trading at Infinox. That could have implications for assets including and beyond stocks in the coming weeks and months.

"I am a bit surprised that we haven't seen the contagion effect on other markets and that makes me wary about the outlook in the near term", said Morgan Stanley's Redeker. Implied volatility is a key component of option pricing.

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