Hedging Demand Spikes Amid AI-Driven Market Rotation

Link to Report: Macro Volatility Digest

WHAT STANDS OUT:

The accelerating sell-off in chip stocks last week renewed worries over the bigger AI trade, leading to weakness in both the Tech sector as well as the broader SPX^® Index. While SPX 1M implied volatility gained 2.6 pts wk/wk, QQQ 1M implied volatility jumped 3.8 pts, and SMH (Semis ETF) 1M implied volatility jumped 5 pts to a 1-year high of 59%. The SMH-SPX 1M implied volatility spread widened to a record high of 44%, now over 5 standard deviations above average.

The extreme volatility in chip stocks has helped fuel a significant sector and style rotation underneath the index surface – five of the S&P sectors were up last week even as the broader market sold off – as investors pivoted away from expensive Tech names to cheaper Value stocks in Energy, Financials, and Staples. This theme also explains why small-caps have outperformed in recent weeks and why the Russell 2000^® Index volatility remains more muted compared to its larger-cap counterparts. RTY 1M implied vol increased just 1 pt last week to 19% and remains in the 15th percentile low over the past year. While small caps have historically traded with higher volatility compared to Tech stocks, the RTY-QQQ vol spread has now fallen to a 5-year low of -6.6% (vs avg of +1.4%) as AI concerns escalate. See below.

Even though risks remain largely idiosyncratic right now (mostly driven by AI and earnings), we’re starting to see investors hedge against a potential broader market sell-off. This can be seen in the sharp steepening in index skew last week, with SPX 1M skew (25-delta ratio) surging from the 14th percentile low to the 82nd percentile high.

Chart: RTY-QQQ Volatility Spread Falls to 5-Year Low as AI Concerns Escalate

^{Source: Cboe}

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