The reason why the VIX has spiked by over 3 vols, or 3.13 to be precise, rising as high as 13.26 as this moment, is being attributed - by several buyside desks - to a "worst case" scenario analysis passed around the trader community from a prominent sellside analyst, according to whom a military outcome in North Korea now appears practically inevitable should North Korea launch its ICBM, as reports overnight have speculated it will do in the coming days.
The report claims that the Trump administration is now a position where it will be virtually impossible to not take military action against North Korea, as the sanctions route has achieved nothing, and absent a trade blockade of N.Korea's ally China, the strategy is unlikely to yield any benefits. Furthermore, as discussed earlier, Russia has officially joined China in publicly stating that it too is now against further sanctions on the rogue regime.
What has attracted particular attention is the listing of next steps, according to which if North Korea launches another ICBM, as it is gearing up to do, it would be impossible for the US to ignore this latest provocation, and some form of military response or retaliation would be forthcoming. It is unclear as this point if such a response would be joined by military reinforcement from South Korea, including ground troops and other military assets, or if it would be confined to limited surgical strikes against critical targets.
The question then posed by both the analyst and traders, is why the market response hasn't been more aggressive to the downside, with one offered response is that the market consensus, if only for the time being, is that the US will not take military action, and instead deterrence by the Trump team (and his close circle of retired military advisors) will be the most likely outcome according to risk assets, something we first suggested weeks ago when Kelly replaced Bannon as Trump's chief of staff.
Then again, with a sudden trapdoor emerging under the S&P, and the sharp move higher in the VIX, the "worst case" scenario appears to be taking hold...