Beware of the volatility of US stocks! FOMO and bubble fear intertwined, Wall Street predicts that the popular bet in 2026 is still "volatile trading"

Next year, the US stock market is expected to continue to be volatile. Investors are experiencing "FOMO" - fear of missing out on the rise brought by artificial intelligence, while also worrying that it may just be a bubble about to burst. Over the past 18 months, the US stock market has been characterized by significant selling and rapid rebounds. This trend may continue until 2026, with some strategists predicting that artificial intelligence will follow the boom and bust cycles of past technological revolutions. The core of the artificial intelligence investment frenzy - tech companies - has a huge influence. Although the tech sector's performance has diverged from other sectors in the S&P 500 index, to some extent, dampening the overall market volatility in 2025 as the rise of tech stocks offset the decline in other sectors, investors remain cautious about the possibility of a decline in chip stocks spreading. If such a scenario occurs, volatility indicators such as the Chicago Board Options Exchange Volatility Index (VIX) will surge. Kieran Diamond, a derivatives strategist at UBS Group, said, "2025 was generally a year dominated by market rotation and a few leading stocks, not a year of full-blown risk appetite or risk aversion. This helps to lower implied correlation levels to historical lows, thereby exposing the VIX index to the risk of a sustained sharp rise, especially when macroeconomic factors again take the lead." A recent survey by Bank of America shows that the magnitude of stock price surges has made bubble concerns the top concern for fund managers. Another concern is that if there is further upside potential in stock prices, investors may miss out on opportunities - selling too early could result in losses. Strategists anticipate that stock market volatility in 2026 will be supported, primarily because asset bubbles tend to become unstable as they inflate. Therefore, they believe investors should anticipate occasional drops of over 10%, but as traders realize that the bubble has not burst, the stock market will quickly rebound. For Grinacoff, betting on the continuation or end of the artificial intelligence frenzy, holding Nasdaq 100 index volatility contracts is key to managing both sides of the risk - profiting from the high volatility in the index. Maxwell Grinacoff, head of US equity derivatives research at UBS, said that regardless of the scenario, contracts based on the index's volatility perform better. He also added that a direction-neutral trading structure can be constructed through straddle options or over-the-counter swaps. Grinacoff said buying Nasdaq 100 index volatility while selling S&P 500 index volatility is "my most confident trade for next year." However, amid intense volatility, there might be periods of calm. Strategists at J.P. Morgan suggest that volatility is being tugged by technical and fundamental factors, suppressing volatility, while macro factors support volatility above average levels. They believe that while the median level of the VIX index in 2026 will remain around 16 to 17, the index will soar during times of heightened risk aversion. Antoine Porcheret, head of institutional structuring at Citigroup EMEA, said another technical factor affecting options pricing is the imbalance of investment flows, leading to a steeper volatility curve in 2026. He said, "In the short-term bond side, both retail and institutional investors are pouring in - QIS and volatility arbitrage strategies are significantly growing, and this trend may intensify next year. In the long-term bond market, hedge fund flows will push up long-term bond prices, so we expect long-term bond prices to exhibit a steep term structure." The popular strategy of diversification - betting on increased stock volatility and reduced index volatility - could be particularly hot at the beginning of the year, with investors launching new versions of such strategies. Some funds, however, have an opposite view, believing that this trading strategy has become overcrowded. Benn Eifert, managing partner and co-chief investment officer of volatility fund QVR Advisors based in San Francisco, said, "Diversification trading has now become an extremely popular and competitive short-term project, but what we are currently doing is reverse diversification trading." Alexis Maubourguet, Chief Investment Officer of Swiss hedge fund Adapt Investment Managers, said companies need to get more creative in order to extract more returns from diversified investment strategies. Investors seeking a competitive advantage will explore various strategies. Maubourguet noted, "Diversification strategies are now well known, and many excess returns have disappeared. You can improve strategy execution, you can improve stock selection. The third method is to improve timing and tactical trading around your positions." On the flip side, some believe that capital flowing into diversified strategies will keep the demand for individual stock volatility relatively high. Porcheret said, "Many diversified investment portfolios will mature in January, so hedge funds may reallocate custom baskets of diversified investment portfolios, which could maintain a premium on individual stock volatility relative to the index." Maubourguet added that some investors buy individual stock volatility, while others also sell a small amount of index volatility to help reduce holding costs during dull seasons. The biggest challenge for investors is timing sudden market volatility. Jitesh Kumar, a strategist at French Industrial Bank, introduced a basic volatility mechanism model in a client report, dynamically switching between long and short volatility trades using the model. Overall, a flattening yield curve is a buy signal for volatility, while a steepening yield curve triggers selling volatility trades. Although the model underperformed the total return of the S&P 500 index over the past twenty years, it avoided large drawdowns in 2008 and 2020. Strategists believe the model has a good track record in predicting volatility turning points and forecast an intensification of volatility in 2026. However, they also believe that overall leverage levels of US corporations are low, and the US is at the beginning of a new leverage cycle driven by artificial intelligence, which will lead to a rise in credit spreads and stock volatility. In general, hedging tail risks will be particularly important for investors in 2026; investors' FOMO sentiment, conflicting narratives about artificial intelligence, and the US government as a source of volatility create a favorable environment for trading volatility, so preparing for both the left and right tails of 2026 is crucial.