It is expected that the market will remain calm in 2025, and investors should stay vigilant as the uncertainty of Trump's tax and tariff policies could trigger market turbulence similar to that of August this year.
Strategists from Bank of America, JPMorgan, and BBVA expect that ongoing option selling will generally suppress volatility. JPMorgan anticipates an average value of around 16 for the Chicago Board Options Exchange Volatility Index (VIX), while the average for 2024 is expected to be around 15.5. However, BBVA noted that a series of factors—including rising uncertainty over U.S. tariff policies, geopolitical tensions, excessive concentration and valuation, signs of pressure in the financing market, and a weak job market—could trigger greater volatility.
BBVA strategist Michalis Onisiforou wrote in a report to clients, 'Sustained growth and the increasing popularity of volatility selling strategies should support a structurally low volatility environment in Europe and the U.S. However, some factors indicate that broader volatility levels will increase, and volatility will erupt more frequently.'
Bank of America believes that the market features a long period of calm followed by 'fat tail' events (i.e., sudden and severe fluctuations). The institution anticipates that the frequency of vulnerability shocks to the S&P 500 index will increase fivefold compared to the past 80 years, and that another major shock event affecting the entire index could occur sooner than expected.
Zero-day options, quant investment strategies sold by banks, and selling options to enhance returns in ETFs will increase market supply, causing traders to hold more gamma positions, which often suppresses market volatility because traders need to buy more futures or stocks when the market falls and sell when the market rises to maintain position balance.
JPMorgan also noted that while technical factors are suppressing volatility, macro indicators suggest that volatility should be higher, with data showing that the reasonable average level of VIX is around 19. While investors in the U.S. and Europe will continue to sell volatility, market traders in Asia may have a higher demand for volatility.
Pierre de Saab, partner and investment director at Dominice & Co. Asset Management, stated, 'The current low volatility state may only be temporary: investors have digested all the good news brought by the impending Trump policies, but they are ignoring the potential negative impacts of these policies. I expect that the upward space for the market in 2025 will weaken, and the risk of severe disruption due to Trump's unconventional policies will be greater than in 2024 or 2017.'
UBS strategists pointed out that the policy offset between tariffs and tax cuts could lead to greater volatility. Max Grinacoff, head of U.S. equity derivatives research at the bank, stated, 'In the first half of next year, we may directly enter a relatively high stock volatility environment.'
UBS believes that potential tariff escalations will lead the Federal Reserve to adopt a more accommodative policy and make its policy more certain, thereby reducing bond volatility. The company suggests that investors finance by selling iShares 20+ Year Treasury Bond ETF and use this to establish straddle options on the S&P 500 index that expire in June.
Strategists at Société Générale also believe that the room for declining volatility is shrinking. 'Our model predicts that volatility will rise in 2025 and 2026,' said the bank's derivatives strategist Jitesh Kumar. 'We recommend going long on volatility on dips.'
Bank of America and JPMorgan stated that one method to hedge against the risk of large sell-offs, which has a low cost of funds, is to buy VIX call options and sell S&P 500 put options. The volatility index tends to respond quickly to market turmoil, and long positions can act as a buffer, while traders can also profit from rising stock prices by collecting premiums from S&P 500 put options.
Both JPMorgan and Bank of America are strongly recommending customized baskets of spread trades. Bank of America pointed out that record-high stock vulnerabilities (or abnormally sudden fluctuations relative to historical volatility) are driving the stock market. 'In 2024, the magnitude of vulnerability shocks for the largest stocks in the S&P 500 reached a peak not seen in over 30 years, and there are almost no signs of retreat if the artificial intelligence boom continues,' wrote strategists at Bank of America, including Benjamin Bowler.
Following a surge in interest in 2024, cross-asset trading may remain popular at the start of 2025. JPMorgan highlighted a dual binary option that bets on the decline of the Euro Stoxx 50 index and the rise of U.S. 10-year yields, adding that this is used to bet on 'the incoming Trump administration executing its campaign promises more aggressively on issues like expelling illegal immigrants, tariffs, and onshore business.'
Antoine Bracq, head of advisory at Lighthouse Canton, a $3.5 billion family office in Singapore, stated, 'We are cautious about the potential impact of higher interest rates and new tariffs. While risk assets may maintain strong momentum for longer than expected, we now see an opportunity to protect your equity investments by taking advantage of low volatility levels.'
Article reposted from: Jinshi Data