AI is repeatedly impacting various industries, and Wall Street is shifting to "fancy" defenses.

AI-related shocks have repeatedly hammered individual US stocks, and Wall Street is turning its attention to more complex options and hedging strategies to cope with this unpredictable “whack-a-mole” selling wave.

On Monday, a lengthy blog post painted a pessimistic picture of AI eroding consumption by driving up unemployment, immediately triggering a fresh round of selloffs in the software and private equity sectors. Hours later, Anthropic announced that its new generation Claude Code tool might replace a mainstream programming language, leading to an abrupt 13% plunge in IBM’s stock, marking its biggest single-day drop in over 25 years. Jones Trading analyst Mike O’Rourke remarked that in such a volatile market environment, stock selection has evolved into an art of “avoiding landmines.”

Currently, the S&P 500 index has risen by only about 1% this year, staying relatively stable at the index level, but severe volatility among individual stocks marks the largest divergence since the global financial crisis in 2009. This “macro calm, micro turbulence” pattern is prompting institutional investors to accelerate diversified trading and complex hedging tools, with participants expanding from hedge funds to pension funds.

Index calm masks stock turbulence, divergence at a sixteen-year high

Barclays analysts noted that the S&P 500 has gained only about 1% year-to-date, and its trading range narrowed to 2.7%, “the tightest range in nearly a century except for 1964 and 1966.” However, this macro-level calm hides significant micro-level volatility.

Market maker Citadel Securities noted last week that the gap between individual stock volatility and the relative stability of the S&P 500 index has widened to its greatest level since the 2009 financial crisis.

Hedge fund ValueWorks founder Charles Lemonides described the phenomenon more vividly: “For years all stocks moved in lockstep, but recently, moves are extreme in both directions, with swings so dramatic it’s shocking.”

Diversified trading heats up, spreading from hedge funds to pension funds

Faced with this market structure, “dispersion trades” are becoming the hottest strategy on Wall Street—this strategy captures price spread returns by buying individual stock volatility while selling index volatility, seizing on the big moves for individual stocks versus relative stability of the index.

Barclays head of quantitative investment strategy Anshul Gupta said funds chasing dispersion trades are “larger than ever before.” He noted that “fast money” accounts like hedge funds are getting more involved, but more notably, the strategy’s scope has expanded far beyond hedge funds, with asset managers and pensions increasingly active as well.

Capstone Investment Advisors senior portfolio manager and dispersion trading expert Jason Goldberg said the ratio of short-term individual stock option prices to index option prices has climbed significantly, “The options market is telling you it expects a highly dispersed environment.”

Manish Kabra, Societe Generale’s US equity strategy head, also revealed that wealth management clients have recently been inquiring about dispersion products, aiming to capitalize on the divergence between AI winners and losers in the tech sector. “Someone will always win, we just don’t know who, but we want to capture absolute dispersion returns,” Kabra said.

Institutions accelerate purchase of downside protection, J.P. Morgan rolls out ‘Triple Edge Hedging Framework’

Meanwhile, demand for overall portfolio defense is also heating up. Nomura global equity derivatives executive director Charlie McElligott noted that, faced with “a flood of negative catalysts” and repeated “end-of-market whack-a-mole games,” “institutional clients’ need for hedging never stops.”

McElligott revealed that Nomura clients are accelerating purchases of puts on the Invesco Senior Loan ETF and iShares High Yield Corporate Bond ETF—both ETFs’ top ten holdings include many software companies.

This week, J.P. Morgan promoted its so-called ‘Triple Edge Hedging Framework’ in a client note, tailored for investors seeking “a disciplined method to manage phase-based pullbacks.” The bank advises buying “convexity” short-term S&P 500 puts when market volatility indicators rise—these options appreciate rapidly in sudden market drops and are more cost-effective during calm periods.

Morgan Stanley Wealth Management’s global investment office head Lisa Shalett pointed out that traders appear to be shorting consumer discretionary stocks while going long industrials—a “pair trade” that reflects shying away from signs of weakening consumption and betting on stocks benefiting from large language model infrastructure construction.

Dispersion is not a panacea; systemic risk remains a concern

Although dispersion trades are currently in vogue, industry insiders remain wary of their potential risks. Ruffer fund manager Jasmine Yeo warned that if the market faces a broader systemic shock—such as escalated geopolitical risks or worsening trade wars—leading to collective stock declines, the dispersion trade strategy may fail.

In such scenarios, investors betting on dispersion may be forced to shift to index-level volatility protection, which could in turn intensify sell-off pressure across the market, forming a negative feedback loop. This means the effectiveness of these “fancy” defensive strategies ultimately depends on whether AI shocks remain “structurally dispersed” or turn into “systemic collapse.”

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