The long-neglected demand for VIX options surges as US stock investors embrace hedging strategies to protect their positions

According to the Wise Finance APP, as investors' concerns about all issues from the 2024 US presidential election to the second-quarter earnings season of tech giants, economic growth, and interest rate expectations intensify, the hedge protection strategy that was once collectively abandoned by the bulls is back. They are protecting their positions by buying classic hedging measures such as VIX index call options that have been ignored by the market for a long time.

Last week, the calls within the Democratic Party for current US President Biden to withdraw from the election have been increasing, and the US stocks also fell in response to the expectations of many uncertainties that Trump's return to power may bring. Last week, the Chicago Board Options Exchange Volatility Index (Cboe Volatility Index), which measures option prices and market pessimism, recorded its largest increase in over a year.

The VIX index, also known as the "fear index," is the most direct indicator analysts and investors use to gauge risk appetite in the US stock market. The VIX index is a real-time index that represents the expected relative strength of recent price changes in the S&P 500 index. This index is derived from the prices of S&P 500 index options with near-term expiration dates, creating a 30-day forward-looking volatility forecast indicator.

Volatility or the speed of price changes is often seen as a way to measure market sentiment, especially the level of fear among market participants. The VIX index is a significant index widely referenced by traders because it provides a quantitative measure of market risk appetite and investor sentiment. When the VIX index rises, it indicates a decline in market risk appetite, and the market expects more significant post-market volatility; conversely, if the VIX index falls, it indicates an increase in market risk appetite, and the market expects a moderation in post-market volatility. When the VIX index is abnormally high or low, it often indicates that market participants are in extreme panic, thus buying put options at all costs or being overly optimistic and refusing to hedge, but this is often a signal that the market is about to reverse.

Generally, VIX call options are used as hedging tools. When investors are concerned about a significant market downturn, they buy VIX call options as insurance to compensate for profits in a market decline.

Now that Biden has done so (formally announced withdrawal), pushing US politics into unknown territory, the VIX index futures prices rose 1.8% earlier in Asian trading and have since fallen. The October futures contract, used to measure election volatility, saw a larger increase, and by the afternoon in Asia, it continued to rise slightly.

Stuart Kaiser, head of US stock trading strategy at Citigroup's global markets division, said that after Biden confirmed his withdrawal, if the process confirms Vice President Kamala Harris as the Democratic candidate, risk pricing may be similar to the situation before the debates between Biden and Donald Trump "The continuity of policy implications will mean that she is Biden's closest proxy, so volatility pricing will be very similar," Kaiser said. "Considering the recent events on the Trump/Republican side that have increased the probability of Trump's victory, perhaps the market's risk premium will be higher, as Trump is often completely associated with uncertainty."

In the first half of the year, as the U.S. stock market repeatedly hit new highs, the cost of shorting the market was high, and traders have been avoiding hedging measures against selling that has never occurred. Now they are changing their approach. In addition to political factors, they are also watching whether the performance of the seven major tech giants such as Microsoft, Google, and Nvidia can meet Wall Street's very high expectations and support valuations at historical highs.

This week, Tesla (TSLA.US) and Google's parent company Alphabet (GOOGL.US) will release their financial reports, which are crucial for the actual revenue effects of AI large models behind generative AI technology. This will be one of the hardcore logics supporting all tech companies related to AI. The former's performance will reflect consumer demand for Tesla's FSD built on the AI supercomputing system, while the latter's performance will reflect whether global enterprises have strong demand for Google's AI large models embedded in its artificial intelligence cloud platform services.

Meanwhile, the discussion on when the Fed will start cutting interest rates will remain a focus. Therefore, if the core PCE price index released this week meets expectations or is even weaker, it may prompt the market to fully digest the expectation that the Fed will cut interest rates twice in September and December, potentially significantly increasing the probability of a rate cut in November.

"As tech giants continue to outperform expectations, the stock market will inevitably experience a bubble," said Scott Nations, President of volatility and options index developer Nations Indexes. "Only a few of the largest tech giants have a positive options skew index—meaning that call options are more expensive than put options, while most targets have more expensive put options." He noted that this has changed dramatically compared to earlier this month, when 7 out of the top 10 market cap stocks in the S&P 500 index saw declines.

"Investors seem to finally understand that stocks will fall anyway and want downside protection through options strategies," Nations said.

Last week, the VIX index reached its highest level since April, and the cost of call options on the index (usually used to hedge against significant selling in the U.S. stock market) also hit a three-month high. With over 170,000 bullish bets for August, the volatility index is expected to soar to 21, a level not seen since October last year, implying that there is still room for market bets on a downward adjustment in the S&P 500 index, hence buying VIX options to hedge against index declines According to Nations, in terms of stock options, not only are put options being bid up, but call options are also under pressure. Last Friday, the compiled call option volatility index dropped by 6.3% in his company, which may indicate that some traders are willing to take the risk of shorting call contracts, expecting that if the S&P 500 index rebounds, the implied volatility will decrease.

In the treasury futures market, on Wednesday, a large number of short positions were unwound in long-term U.S. treasury futures, helping to flatten the curve, indicating that bond market investors are beginning to lose patience in the short term with the so-called "Trump steepening trade." This shift may indicate that the recent yield curve is more likely to be influenced by the Federal Reserve's monetary policy, that is, the prices of U.S. bonds across all maturities are soaring under the push of rate cuts, rather than the prevailing trend of massive shorting of long-term risk bonds due to the "Trump trade."

In options linked to the closely monitored Federal Reserve policy expectations and secured overnight financing rates (SOFR), traders are hedging against a half-point rate change from the September meeting, while the swap market is pricing in a quarter-point change. Hedging measures will cover the most dovish scenarios of the Federal Reserve, such as the beginning of a rate cut cycle as early as this month, the unchanged rates in July, and the possibility of a dovish rate policy change of up to 50 basis points in September, or any sudden and unexpected rate policy adjustments during the July to September meetings.

Although it is still too early to determine whether the shift in market positions will continue, the calm summer days may exaggerate this change.

Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence, said: "The market has become accustomed to buying on dips and not choosing any hedging protection for most of this year, and the rapid recovery of short-term volatility means that the market concentration is still a risk." "In the summer when market liquidity may be relatively low, the market may be more susceptible to sharp fluctuations caused by some headline news than usual."