Shift From AI Rally to Bubble Concerns Drives Surge in Options Demand

No matter which direction the S&P 500 Index heads after a turbulent month, one thing seems clear market volatility is on the rise.

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After a three-week winning streak, the benchmark index pulled back, briefly driving the Cboe Volatility Index (VIX) above 20 on Friday a clear signal that investor anxiety is intensifying. This marked a shift from the steady climb to record highs seen earlier, when “spot up, vol up” days sessions where stock prices and volatility rise together became increasingly frequent. Typically, these two move in opposite directions, but not lately.

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Several forces have fueled this renewed bout of volatility in mid-October and beyond. Wild swings in individual stocks after earnings reports have exposed growing fragility in market sentiment. Meanwhile, the absence of official U.S. economic data has left analysts scrambling for alternative sources, all while uncertainty over the Trump administration’s economic policy adds another layer of unpredictability.

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Taken together, these factors suggest that the calm markets enjoyed over the summer are unlikely to return anytime soon. With a critical Federal Reserve rate decision looming in December, a prolonged government shutdown threatening to disrupt travel, and rising layoffs hinting at an economic slowdown, investors have plenty to worry about.

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“Market fragility is now front of mind for investors,” said Maxwell Grinacoff, head of U.S. equity derivatives research at UBS Group AG. “It takes very little to spark a 3% market drop or a five-point jump in the VIX like we saw on the 16th even when the S&P 500’s actual move is fairly contained.”

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In recent weeks, pullbacks in the VIX have been getting progressively smaller. The gauge bottomed just below 16 in October well above the lows reached during the summer or last year’s record calm. Over the summer, analysts debated where the “floor” for volatility might be, as the VIX consistently traded at a premium to realized volatility ahead of former President Trump’s tariff threats toward China.

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Grinacoff noted that investors have been asking why the VIX hasn’t dropped below 16 or 17 even when the S&P 500 hit new highs. The answer lies in traders’ dual behavior chasing the rally while simultaneously hedging against potential declines.
“As the market moved up, investors were definitely buying protection,” he explained. “At the same time, bullish call options were in high demand heading into the third quarter.”

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Others highlight that the ongoing U.S. government shutdown and the uncertainty it creates for Federal Reserve policy are additional contributors to elevated volatility.
“The VIX is sitting on a higher floor than last year, with a strong ‘spot-up, vol-up’ pattern emerging amid both the chase for upside and persistent policy uncertainty,” wrote Tanvir Sandhu, a strategist.

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Bank of America’s derivatives team added that volatility climbing alongside asset prices is one of the clearest warning signs of a market bubble. When momentum takes over, asset prices can become disconnected from fundamentals just as they did during the early 2000s tech boom. The strategists noted that during periods of economic uncertainty, forward visibility on corporate earnings tends to weaken, further supporting higher volatility levels.

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The recent mix of large realized moves and aggressive upside buying has also flattened the call skew in certain U.S. single stocks, particularly in the technology sector. The October AI-driven rally reminded many of the early-2000s tech bubble, prompting some traders to bid up call options on companies that could benefit from a potential “up-crash” scenario. In this context, the phrase “two-way risk” has become increasingly common among derivatives strategists, reflecting the growing potential for sharp moves in either direction.

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Still, identifying a bubble’s existence doesn’t automatically mean it’s about to burst. For now, option values continue to find support as the S&P 500’s 30-day realized volatility has more than doubled in the past month, hitting its highest level since June.

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The VVIX often called the “volatility of volatility” has also been climbing as traders hedge with VIX options. Some investors even unwound bets that volatility would fall earlier last week, another indication that the market expects elevated turbulence to persist.

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At the start of the earnings season, single-stock volatility surged far ahead of broader index measures. The Cboe S&P 500 Constituent Volatility Index hit record levels relative to the VIX as investors reacted to company-specific earnings surprises. But that dynamic has started to reverse as macroeconomic concerns dominate headlines. With the earnings season winding down, there’s less company-specific news to drive dramatic individual stock swings.

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“Upside demand pushed the gap between single-stock volatility and index volatility to extreme levels,” Sandhu explained. “Now that earnings reports are slowing, that spread is starting to normalize.”

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In essence, the market’s recent turbulence signals that volatility may not fade anytime soon. Between economic policy uncertainty, upcoming Fed decisions, and shifting investor behavior, Wall Street’s once-quiet landscape has given way to a more restless, risk-sensitive environment one that could define the months ahead.

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