Bank of America: Rising market volatility signals a bubble is forming, but it is still in the early stages.

Bank of America says that the recent "rising stock prices and rising volatility" scene in the market is an early sign of an asset bubble, but the AI-driven bubble this time may still be far from its end. On November 5, according to news from Wind Chaser Trading Desk, BofA Global Research stated in its latest report that US stocks have frequently seen both VIX futures and the S&P 500 Index rise at the same time, a combination of "stock price up, volatility up" that has historically been a hallmark of asset bubbles. However, the strategy team led by Benjamin Bowler notes that, unlike the late stages of historical bubbles, the current VIX index still sits near its historical median, and realized index volatility is relatively mild, meaning both market valuations and volatility have room for further upside. Analysts believe this indicates that the main risk ("pain trade") in the current market is missing out on further gains, rather than a major pullback. But given signs of hawkishness from the Federal Reserve and ongoing macro uncertainties, the risk of a correction persists. Therefore, Bank of America suggests that investors shouldn’t quit the market entirely, but use asymmetric instruments such as options to participate in further upside, to seek leveraged gains while managing risk. “Stock Prices and Volatility Both Rise”: A Clear Signal of a Bubble The report notes that the "calm seas" of the summer have seemingly been broken. One notable shift is that the US market has more frequently seen synchronous gains in the S&P 500 Index and VIX futures. This is in stark contrast to their usual negative correlation. Historically, this "spot-up, vol-up" dynamic is a signal of bubble formation. (IMAGE) Meanwhile, individual stock fragility is increasing sharply, especially among major tech stocks. The report cites the recent earnings season as examples: Meta plunged 11.3% on October 30, with single-day volatility about 8.3 times its prior realized volatility. Amazon soared 9.6% on October 31, with volatility about 5.5 times its previous realized volatility. (IMAGE) The report points out that these dramatic swings far exceeded the options market’s expectations. Data shows that since 2025, large moves in US tech stocks (single-day moves above three times standard deviation) have reached historic highs, surpassing even the dotcom bubble era. This suggests that although the index keeps climbing, undercurrents have already emerged among individual stocks. Bank of America clearly states in the report that this abnormal phenomenon is a hallmark of bubbling markets, a scene seen many times historically. When market sentiment surges and investors chase the rally while also buying options for hedging or speculation, this positive correlation can emerge. Why is the Bubble Still Early? Although we are seeing bubble signals, Bank of America stresses we may still be in an early stage. Their main basis comes from several key volatility indicators: VIX Index Levels Are Not Extreme: While the VIX bottom has risen from around 12 in 2024 to about 15, the current level is still close to its long-term median of 17.60. This is far from the VIX surging above 40 in the late dotcom bubble. (IMAGE) Realized Volatility is Relatively Controlled: The report notes that the Nasdaq 100 (NDX) 1-month realized volatility is still "quite sanguine" compared to the dotcom bubble peak. In late 1999, realized NDX volatility averaged as high as 93%; current levels are much lower. (IMAGE) Overall, these "tame" indicators suggest the current AI bubble could have considerable room to develop before reaching the "irrational exuberance" peak and eventual collapse. As the report says: "Even though the tandem of rising stock prices and volatility has always flagged market bubbles... current index realized volatility remains mild (especially compared with the dotcom bubble era), suggesting both price and volatility could see further upside before the final break. This fits our broader bubble framework analysis." Based on the judgement that "the AI bubble will keep inflating," and acknowledging that risks of a pullback still exist, Bank of America suggests investors use options to build asymmetric positions. Specific strategies include: Selling VIX put options to construct S&P 500 call spreads at zero cost, using the solid VIX bottom to reduce the cost of gaining upside exposure; Or, from a longer-term perspective, buying S&P 500 up-variance to directly go long delta and volatility, capturing the bubble’s longer-term expansion. ~~~~~~~~~~~~~~~~~~~~~~~~ The above featured content is from Wind Chaser Trading Desk. 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