Stock market volatility approaching? Options market "revisiting" the script for 2022: Betting on high market volatility, increased correlation of individual stocks.

With 2022 as a reference, exploring how the risk of Iran war will impact the stock market, the key issue is that inflation impact will increase the correlation between stock indices and trigger a period of high volatility for a longer period of time. The soaring prices of oil and natural gas are affecting the entire supply chain, not only raising gasoline prices, but also potentially impacting prices of various goods and services. This shift in focus is causing traders to move away from individual stocks, and macroeconomic concerns are overshadowing more specific themes such as artificial intelligence. In turn, this has caused the volatility premium of individual stocks relative to the S&P 500 index to narrow, and trading volume has decreased as a result. Although the VIX index is more sensitive to a decline in the S&P 500 index, compared to past crises, the overall actual volatility levels of this index remain relatively moderate. So far this year, the VIX volatility index has not closed above 30 points, whereas during the tariff turmoil in April of last year, the index remained above 30 points for two consecutive weeks. In 2022, influenced by the Russia-Ukraine war, the VIX index briefly surpassed 30 points, averaging at 25.64 points, which is more than 6 points higher than the average level this year. During the same year, due to multiple interest rate hikes by the Federal Reserve, the S&P 500 index fell by 19%. Kieran Diamond, a derivative strategy strategist at UBS Group, stated, "Investors are closely watching the market trends in 2022, hoping to find clues on how the current situation in Iran will affect the market. The risk lies in inflation impact, which may lead to an increase in internal correlation in the stock market and potentially change the volatility mechanism of the VIX index from rapid rise and reversal to a situation of upward limit increase in VIX index and continuous volatility." Meanwhile, UBS strategists believe that the quieting of the Chicago Board Options Exchange's (Cboe) skew index in recent days may be due to investors losing confidence in bearish options on general indices, leading to closing of hedging trades. Additionally, the low levels of actual downside volatility since the escalation of tensions in the Middle East may also be one of the reasons for the overall re-pricing of the skew curve. According to Michele Cancelli, Global Head of Trading and Structured Global Manager at Citi Multi-Asset Group, although some individual traders have shifted towards shorting volatility trades through VIX put options structures, there has not been a substantial change in investor behavior in the QIS domain. He said, "Although the volatility risk premium of the S&P 500 index is high, there is little sign that investors are rushing to short volatility. The window of volatility caused by Iran may not have lasted long enough for investors to be sure they can profit from it." The low actual volatility of the S&P 500 index is contradictory to the position strategy of options traders. Most derivative strategists have reached a consensus that traders have been shorting gamma values before the quarterly expiration date. The intraday actual volatility is significantly higher than the closing price, which may be a reflection of the greater impact of trader gamma values on the market. At the same time, there doesn't seem to be much change in the broader market microstructure: there is still a lot of overselling of call options at an index level, as well as continuous selling of hawkish options with one day remaining until expiration. However, even though losses in index hedging strategies (whether directly shorting the S&P 500 index or longing VIX call options, etc.) persist, if the market really collapses, the risk-return of these positions will still be affected. Additionally, some investors still consider alternative trading strategies such as volatility dispersion strategies to hold value. David Elms, Head of Diversified Alternative Investments at Janus Henderson Group Plc, said, "In terms of risk/return, we believe that being long index volatility and being long inter-relatedness within indices is a better investment opportunity. In this area, given the low implied correlation and the fact that the minimum correlation is actually zero, being long correlation strategies through anti-dispersion is also very interesting." He noted that due to the imbalance of capital flows and holding costs lower than historical average levels, being long convexity is also attractive. Another characteristic of the market is the intraday reversal, which indicates that while options traders may be shorting gamma values, they are not the main driver of prices in an environment dominated by macroeconomic news. This reversal partly explains the relatively calm actual volatility before and after the closing price - indicating that there are still investors engaging in contrarian trades. Last Thursday, the stock market weakened during the day but saw a significant rebound before closing. This turnaround in price movement can turn into a true uptrend, accelerating the rise in stock prices as the trading day approaches its end.