Stocks Drive VIX Options as Investors Protect Portfolios: An Analysis

By Laura Matthews

NEW YORK (Reuters) – Investors are showing a renewed interest in volatility-linked options to protect their portfolios against stock swings as the appetite for stocks grows. This trend is propelling these contracts to record trading volume this year.

The S&P 500 has surged by 18% compared to last year’s 19% decline, fueled by the expectations that the U.S. Federal Reserve is done raising interest rates.

Amidst this backdrop, there has been a surge in trading volume in contracts betting on the Cboe Volatility Index or VIX, also known as Wall Street’s fear gauge. Economic and geopolitical risks are driving the cautious sentiment among investors regarding a potential resurgence of volatility.

“This indicates people are nervous,” said Mandy Xu, head of derivatives market intelligence at Cboe. “This year, the consensus is that we are at or near the end of the hiking cycle but there is no good consensus view of what is next.”

“Markets appear tranquil now,” she added, “but such an environment is one where a black swan event could make volatility spike with its unpredictability and far-reaching consequences.”

VIX options contracts averaged nearly 760,000 daily, surpassing the record set in 2017, according to Cboe Global Markets data as of Nov. 27. This marks a 42% increase from 2022 and up 5% from the previous record, with VIX options-trading in October at a high for the year.

Trading in VIX call options, which would profit if the VIX rises, rose by 54% this year. Put options on the VIX, which benefit from declining volatility, rose by 24%.

Joe Ferrara, investment strategist at Gateway Investment Advisers, pointed out that investors see a growing list of potentially volatile events on the horizon, such as wars and elections. Such investors are “looking at trading VIX options as a way to potentially monetize their thinking,” he said.

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The VIX tends to move inversely with the S&P 500, rising when stocks fall.

Currently at 13, the VIX is below its long-term median of 18, meaning investors can buy relatively cheap insurance and position in potentially profitable trades.

“What we’re seeing now is inexpensive given the amount of potential turmoil in the market,” said JJ Kinahan, president of tastytrade, a retail broker.

This rise in VIX options trading is a change from 2022 when investors were reducing equities exposure and hoarding cash, according to CBOE data.

With the VIX averaging 17 this year, VIX options’ trading volume as a share of overall options volume is at 1.76%, the highest since 2020. This was a much more volatile year when the VIX averaged 29, according to a Reuters analysis based on Trade Alert data.

Seth Hickle, derivatives portfolio manager at Innovative Portfolios in Indiana, said returns on volatility strategies can be erratic in the short term, but can be consistent over long periods.

“In an average volatility year, I would not be shocked to see volume trends continue to rise in VIX options as more market participants accept and embrace volatility as an alternative asset class and the need to hedge that exposure grows,” said Hickle.

Timing profit-taking on VIX options in an environment where jumps in the volatility index are fleeting can be difficult, said Roni Israelov, chief investment officer at NDVR.

The potential for the index to make huge moves in very short periods also makes it “an attractive instrument” for speculators, said Hickle.

“I think there’s speculators out there saying with a 14 handle on the VIX, maybe it’s worth taking that bet and making that trade.”

(Reporting by Laura Matthews in New York; additional reporting by Saqib Iqbal Ahmed in New York; Editing by Megan Davies and Chizu Nomiyama)