The U.S. stock market, witnessing a notable rally, has led to a significant decrease in the Cboe Volatility Index (.VIX), a popular measure of market volatility. The VIX's current levels, hovering just above the post-pandemic low of 12.45, starkly contrast with its long-term average of about 20. This decline reflects the market's response to the Federal Reserve's interest rate decisions, which have spurred investor optimism and propelled the S&P 500 (SPY) to new heights. With a year-to-date increase of 19% and a 9% gain in November, its best since July 2022, the S&P 500 exemplifies the current bullish sentiment in the market.
Key to this trend is the behavior of volatility-targeting funds and options dealers. As market fluctuations have eased, volatility-targeting funds have transitioned to buying equities, with purchases totaling around $30 billion in the last week of November. If this trend of mild daily stock movements continues, these funds could inject an additional $21 billion into equities, potentially buoying the market further. Moreover, options dealers are currently net long on "gamma," indicating a strategy that naturally dampens market movements, according to Brent Kochuba of SpotGamma.
Historically, once the VIX falls to such low levels, it tends to remain subdued for extended periods. This stability in market expectations of volatility has benefited those betting against it, with the 1x Short VIX Futures ETF (VIXY) significantly up for the year. However, some market analysts, like Eric Johnston from Cantor Fitzgerald, caution that the current calm could be a precursor to more significant market shifts. Notably, previous instances where implied volatility fell below realized volatility were often followed by notable declines in the S&P 500.
As the market heads into the final stretch of the year, these dynamics around volatility and options trading could play a crucial role in sustaining or altering the current trajectory of U.S. equities. Investors and analysts alike will be keenly observing these indicators to gauge the market's direction in the coming months.
