The Ratchet Effect in Action and Its Effect on VIX — 2026-05-26
Core thesis: Equity markets exhibit a "ratchet effect"—asymmetrically rallying on any hint of good news while shrugging off geopolitical risk—which is artificially suppressing VIX despite an inherently unstable global backdrop. This dynamic is being amplified by institutional "FOMO insurance" buying of out-of-the-money calls rather than traditional downside hedging.
Key points:
- Peace talk rumors (Strait of Hormuz deal) drove ES ~1% higher and COIL down >$8; half those moves reversed after US strikes and lack of fresh progress, showing the setup matters more than outcome to equity traders.
- VIX remains modest despite geopolitical instability; skews on SPX and tech products have become more symmetrical, with fewer investors demanding downside puts and call writers less eager to supply at higher levels.
- Institutional hedging has shifted from traditional put buying to buying upside calls as "FOMO Insurance"—protecting against underperformance in a tech-led rally rather than hedging downside—which paradoxically lifts VIX while inverting its role as a fear gauge.
- Bond yields down ~6 bps across the curve; oil market reactions are straightforward (supply relief = lower prices), but equity interpretation of geopolitical news is "malleable" and relentlessly positive.
Takeaway: The ratchet effect and FOMO-driven call buying are masking tail risk; traders should be alert that VIX elevation may reflect hedging demand for upside, not fear, leaving the market structurally vulnerable if the narrative shifts.