Surging Trading In VIX Options May Suggest A Market Sentiment Shift

In recent months, a shift has been observed in the trading volume of volatility-linked options, as renewed appetite for stocks drove investors' interest in volatility-linked options to help buffer their portfolios against stock swings. This change, primarily seen with the Cboe Volatility Index® (VIX®) options, is a direct response to evolving market sentiment and increasing adoption of volatility as an asset class.

Understanding The Surge In VIX Options Trading

With the S&P 500's robust 20% gain this year, compared to last year's 19% decline, and the anticipation that the U.S. Federal Reserve may halt further interest rate increases, investors are increasingly turning to VIX options as a hedging mechanism. 

The VIX, often referred to as Wall Street's fear gauge, has recorded an unprecedented average trading volume this year, surpassing its 2017 record. VIX options contracts averaged nearly 760,000 daily in 2023 as of November 27, marking a 42% increase from 2022 and up 5% from the previous record. Notably, VIX call options have seen a 54% rise, while put options have increased by 24%. 

This increase in trading activity implies investors may be seeing a greater chance of potentially volatile events on the horizon, including but not limited to wars, upcoming elections and the evolving state of interest rates. Regardless of the potential catalyst for future volatility, these trends underscore a growing reliance on VIX options as a strategic tool for hedging against economic uncertainties.

A Closer Look Inside The VIX Index

The VIX Index® is derived from the real-time prices of S&P 500 options and is crucial for providing overnight updates on expected market volatility. Meanwhile, VIX options are pivotal in reflecting market consensus around volatility and the demand for portfolio hedging, a practice that has served as a major contributor to VIX options’ growing popularity at the institutional and even retail levels. 

However, product enhancements are also contributing to the VIX’s popularity. VIX options are now available in more precise denominations, such as pennies and nickels, allowing for greater flexibility in trading while affording smaller investors access to volatility exposure. 

VIX contracts also come with various expiration options, both monthly and weekly, and can be traded during regular U.S. hours as well as during an additional global trading session. These enhancements have allowed a wider range of investors interested in volatility exposure to access the market.

Market Implications And Future Outlook

While the returns on volatility strategies can be unpredictable in the short term, the surge in VIX options trading volume hints at a renewed interest in equities and the acceptance of volatility as an investable asset class. This shift is in significant contrast to 2022 when investors were reducing equities exposure and hoarding cash. 

While the VIX is averaging just 17 this year, its trading volume as a share of overall options volume is at 1.76% – the highest since 2020 when the index averaged 29. As of mid-December, the VIX is at 12, significantly under its long-term median of 18. This low volatility level may be prompting the surge in trading volume as investors increasingly seek to hedge against potential volatility in the near future. Additionally, this suggests that VIX options, despite their growing volume, remain a cost-effective choice for portfolio hedging.

Navigating Market Uncertainty With VIX Options

The renewed interest in VIX options may be a reflection of the evolving market dynamics and investors' growing acceptance of volatility as an alternative asset class. With Cboe at the helm of this financial innovation, the landscape of investment strategies continues to evolve, offering diverse opportunities for market participants, large and small, to hedge uncertainties or directly trade volatility. 

Featured photo by Tyler Prahm from Unsplash.

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