Wall Street's 'fear gauge' is signaling the all-clear, despite myriad looming risks

Wall Street's "fear gauge" is signaling the all-clear.

Wall Street doesn't seem all that worried about the stock market taking a turbulent turn in the near future. That, in itself, could be one reason investors should stay on high alert.

As major U.S. equity indexes continue to seesaw, this could represent an opportunity for anxious investors looking to pick up some portfolio protection on the cheap. Investors might consider buying put options on the S&P 500 index SPX to help protect their portfolios from a sharp selloff. They also could purchase call options on the Cboe Volatility Index VIX, which tends to rise when markets turn rocky.

"Tail hedges remain ridiculously cheap," said Goldman Sachs' Rich Privorotsky in commentary obtained by MarketWatch.

Michael Kramer, portfolio manager at Mott Capital Management, sees a few reasons why it could be wise to buy some hedges. On Wednesday, a slew of options contracts tied to the VIX are due to expire, which could open the door to more volatility in the days ahead.

"I believe the VIX is currently being suppressed by options flows and other dynamics. Those effects should diminish after tomorrow's expiration," Kramer said.

The closing spread between realized and implied volatility is one telltale sign that investors might be too complacent, Kramer said. Usually, implied volatility sits higher than realized volatility, but when the gap starts to close, it can signal that investors are underestimating the risk of a selloff in the near term.

The VIX was on track to finish at around 15.66 on Tuesday, a notably low level considering that the S&P 500 was set to tally a third straight day of losses. A MarketWatch analysis of FactSet data showed the VIX hasn't been this low amid a three-day losing streak for U.S. stocks since December.

Despite the market's fairly cheery mood, investors have plenty to worry about right now, Kramer said.

September - historically the most volatile month of the entire calendar year - is set to begin in two weeks. Rising global bond yields are threatening a torrid stock-market rally. The war in Iran remains at a stalemate, with no end in sight. Looming earnings from Nvidia (NVDA) will likely be heavily scrutinized, as doubts about the sustainability of all of this AI investment persist. Worries about the soundness of private-credit lenders have started to perk back up. Investors still see a roughly 34% chance that the Federal Reserve will hike interest rates at its upcoming meeting in September.

Soon, investors will shift their attention toward the November midterm races. The chance that Democrats could take back one or both chambers of Congress is another risk worth monitoring, according to some on Wall Street.

-Joseph Adinolfi