Stock market fear is exploding as North Korean tensions mount

The stock market has been shocked back to attention by the escalating North Korean situation, and traders look scared silly.

The CBOE Volatility Index - or VIX, commonly known as the stock market fear gauge - burst from near-record lows on Thursday, spiking 44%, its biggest increase since May. The measure closed the day at 16.04, its highest level since the presidential election on November 8.

The increase continued on Friday as VIX futures signaled an additional 5.5% increase. The fear gauge's 70% surge over the past four sessions is the biggest since August 2015 for a period of that length.

Markets Insider

The VIX, or stock market fear gauge, has surged to the highest since the presidential election.

What's more, trading volume in VIX options and futures reached new all-time highs on Thursday, with more than 2.5 million contracts changing hands, according to CBOE data.

It's a stunning about-face for the fear gauge, which has been locked at historically low levels for the better part of the past three months. For a resilient market that's made a habit of shrugging off geopolitical risk, traders seem to be treating the looming nuclear threat as an entirely different beast.

If so, that's bad news for investors who have been raking in easy profits betting on a stationary market. Through mid-week, shorting volatility was one of the most crowded trades around. Now that the VIX is soaring, those traders may be forced to closed their short positions, exacerbating the index's move higher.

Surges in the VIX are almost always accompanied by a decline in the S&P 500 - after all, the two indexes trade in opposite fashion 80% of the time - and that's certainly been true this week. The benchmark equity gauge slipped 1.5% on Thursday, its biggest decline since May.

Leading up to the slide, the S&P 500 went 15 straight days without a 0.3% closing move in either direction, the longest such streak on record. Those quieter days appear over for now.

Still, it's within the realm of possibility that traders will use this sudden weakness in stocks to add to bullish positions. It's a scenario that's played out many times over the course of the eight-year bull market, and as recently as May.

On May 17, the S&P 500 plunged 1.8% in a single day, accompanied by a 46% VIX spike to 15.59. The benchmark stock index then ripped off seven straight days of gains, rising 2.5% and more than making up that loss. Meanwhile, the VIX dipped back below 10.

The question now becomes: Is this time different? That's a question the market will have to answer - and quick.