Cboe’s Mandy Xu talks why single stock volatility is rising

Key Concepts

• Sector Rotation: Shifting investment focus from one industry sector to another, often based on economic cycles or performance expectations.
• Idiosyncratic Risk: Risk specific to a single company or asset, as opposed to systemic or market-wide risk.
• Implied Volatility: A forward-looking measure of expected price fluctuations of an asset, derived from options prices.
• Correlation (Positive/Negative): A statistical measure of how two assets move in relation to each other. Positive correlation means they tend to move in the same direction, negative means they move in opposite directions.
• Option-Based ETFs: Exchange-Traded Funds that utilize options strategies to achieve specific investment objectives, often related to hedging or income generation.
• MAG 7: Refers to the seven largest US technology companies (typically Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta).
• Safe Haven Asset: An investment that is expected to retain or increase in value during times of market turmoil. Gold is traditionally considered a safe haven.

Market Shift from Macro to Single Stock/Sector Risks

The discussion centers on a noticeable shift in investor behavior, moving away from broad macroeconomic risk and towards risks associated with individual stocks and specific sectors. Mandy Hsu, Head of Derivatives Market Intelligence, observes that this trend is evidenced by sector rotation, with underperforming sectors from the previous year now leading performance in the current year. Specifically, she notes a move away from the “MAG 7” tech stocks and into sectors like defense and other previously underperforming areas. This isn’t simply a rotation within tech, but a broader thematic shift. The increasing volatility at the single stock level, relative to the overall index, further supports the idea that investors are focusing on idiosyncratic risks.

The Decline of the MAG 7 Dominance

Hsu confirms that the move away from the MAG 7 is occurring, and risk is increasingly being priced into the tech sector. This is visible in the options market, specifically in instruments like the QQQ ETF and the newly launched options on the MAC 10 Index (MAG 7 plus three additional AI stocks). Both are exhibiting increasing implied volatility relative to the broader market. This suggests a growing expectation of price swings in these tech giants.

Gold’s Changing Role as a Hedge

Traditionally, gold has been considered a safe haven asset and a hedge against equity market downturns. However, Hsu points out a significant change: over the past few months, gold has become positively correlated with stocks, having previously been negatively correlated. Gold’s price has risen significantly, with a 60%+ increase in the last year. This positive correlation means gold is now behaving more like a risk asset than a diversifying hedge. Hsu advises investors holding gold specifically for diversification purposes to “reevaluate” and consider alternative hedges. She acknowledges other bullish arguments for gold but cautions against relying on it as a hedge in the current environment. As Hsu states, “Gold has been on a phenomenal run…but as a hedge, I would say that that is something that I would be aware of.”

Rise of Option-Based ETFs

A notable trend in derivatives is the increasing popularity of option-based ETFs. While the underlying strategies aren’t new, these ETFs provide a more accessible way for investors to utilize options strategies without needing in-depth knowledge of calls, puts, and option chains. Investors can simply buy a ticker symbol representing a managed options strategy. This popularity is partly driven by the search for alternative hedging strategies following the bond sell-off and stock market volatility of 2022. Hsu explains, “Instead of learning about calls and puts what option chain what strikes now you buy it’s a ticker right. You buy a ticker. And that fund manages the option strategy on your behalf.”

Logical Connections & Data Points

The conversation flows logically from a broad observation of market shifts (macro to micro risk) to specific examples (sector rotation, MAG 7 decline, gold’s changing correlation) and then to emerging products (option-based ETFs) that cater to these changes. The data points include:

• Gold’s 60%+ price increase in the last year.
• Increasing implied volatility in the QQQ ETF and MAC 10 Index options.
• The shift in correlation between gold and stocks from negative to positive.
• The growth in Assets Under Management (AUM) for option-based ETFs.

Synthesis/Conclusion

The key takeaway is that the investment landscape is undergoing a significant shift. Investors are becoming more discerning, moving beyond broad market bets and focusing on individual stock and sector-specific opportunities. Traditional hedges, like gold, are losing their effectiveness, prompting a search for new risk management tools. Option-based ETFs are emerging as a popular solution, offering a simplified way to access sophisticated options strategies. This environment demands a more active and nuanced approach to portfolio construction, with a greater emphasis on understanding idiosyncratic risks and adapting to changing market dynamics.