U.S. and foreign investors have woken up to the fact that a Brexit could become a reality.

U.S. and foreign investors have woken up to the fact that a Brexit could become a reality.

You can see this in the rather strange action of the CBOE Volatility Index, which roughly measures investor demand for protection against market declines in the next 30 days.

The VIX moved five points — from roughly 15 to 20 — in two trading days. That is a fairly rapid move, but what's even stranger is the move in stocks.

Normally, when you get a five-point move in the VIX in a short period, you would expect the S&P 500 to move roughly 3 percent to 4 percent — but the S&P only moved about 1.7 percent.

That means there wasn't as much selling of stocks as you would expect, but there was suddenly a lot of demand for protection.

What would account for this surprisingly strong move in the VIX?

1) The VIX had a sharp move up yesterday at about 11:30 a.m. ET, almost exactly when a Guardian poll came out indicating surprisingly strong support for a "yes" vote on the U.K. leaving the European Union.

Traders had discounted the idea that a Brexit could happen, but they are now starting to change their minds. The concern is not just that a Brexit could weaken the British pound, it could also hurt British banks. A leave vote might also lower bond yields even further, weaken commodity prices (with the possible exception of gold), and hurt emerging market assets.

2) Many traders in volatility are likely positioned very short; that is, they have been betting volatility would remain low. Many are likely "covering" their shorts as Brexit has become more of a reality. At the very least, if you are short volatility, and volatility goes up, you would have to buy volatility just to keep your exposure at the same level.

3) Sellers of volatility were likely in short supply, which has driven up the price. The game of buying and selling volatility has become a business on Wall Street. Not just banks, but many hedge funds are active buyers and sellers.

Here's the problem: Suppose you are a guy at a hedge fund that buys and sells volatility. You know many of your hedge fund friends have had their faces ripped off on various other trades that have gone against them this year. You are a little cautious because, hey, your job could be on the line.

Suddenly, you get a lot of requests to buy volatility from you with the VIX at 20.

You know this is all on concerns over a Brexit. If you sell the VIX at 20, and there is a vote to stay in the EU, you figure the VIX will drop down to, say, 15. So you would have sold the VIX high. Buy low, sell high. You win.

But suppose there is a vote in favor of a Brexit. You have no idea what could happen, but for sure the VIX will jump. Maybe a lot. Maybe to 40.

Ouch. You are now in a position where you sold the VIX at 20 and it goes to 40. Very bad. Like, maybe-your-boss-calls-you-in-his-office bad.

My point: For some traders, the risk of selling the VIX may be far greater than the potential reward. They want higher prices.