"FOMO Theory vs Bubble Theory": Wall Street believes US stock market volatility will remain high next year.

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Wall Street is preparing for continued turbulence in the US stock market in 2026, with investors oscillating between the fear of missing out (FOMO) on the AI rebound and anxiety over an impending asset bubble burst.

Strategists point out that the market over the past 18 months has exhibited simultaneous large-scale sell-offs and rapid reversals, a trend highly likely to persist into 2026. As the AI technology revolution goes through cycles of boom and bust, tech giants at the center of the investment frenzy will continue to exert immense influence on the market, with sharp fluctuations in their stock prices expected to become the norm.

Although the strong performance of tech stocks in 2025 was offset by weakness in other sectors, and this divergence among sectors somewhat suppressed actual market volatility, investors still need to be wary of the risks triggered by a potential decline in chip stocks. Once macro factors regain dominance, previously suppressed volatility could cause indicators like the Cboe Volatility Index (VIX) to spike sharply.

According to a survey by Bank of America, although rising stock prices have made fund managers consider bubble risk as the primary concern, the fear of missing opportunities by exiting prematurely is equally strong. The market widely expects that asset bubbles tend to become more unstable during periods of inflation, and investors need to be prepared for occasional pullbacks of over 10%, followed by record rebounds as traders realize the bubble has not yet burst.

Volatility Games Amidst the AI Craze

Kieran Diamond, derivatives strategist at UBS Group, points out that in 2025, the market predominantly featured rotation and a narrow leading trend, rather than broad risk preference, pushing implied correlation levels to historic lows. However, this low correlation is a double-edged sword: once macro factors dominate the market again, the VIX is at risk of persistent, extreme spikes.

For UBS strategists, whether the AI boom continues or collapses, holding high volatility contracts on the tech-heavy Nasdaq 100 index is a key strategy. Maxwell Grinacoff, Head of US Equity Derivatives Research at UBS, stated that regardless of an AI boom or bust, volatility bets on the Nasdaq 100 outperform those on the S&P 500. He views "buying Nasdaq 100 volatility while selling S&P 500 volatility" as the highest conviction trade for the coming year and suggests using straddles or OTC swaps for directional neutrality.

Strategists at JPMorgan believe that volatility will swing between technical, fundamental factors and the macro drivers underpinning markets. While they expect the median VIX to stay between 16 and 17 in 2026, periods of risk aversion will cause the index to surge, interspersed by longer spells of calm amid the turbulence.

Structural Imbalances in the Options Market

Beyond macro narratives, technical factors are also reshaping option pricing.

Antoine Porcheret, Head of Institutional Structuring for UK, Europe, Middle East and Africa at Citigroup, expects the volatility curve to become steeper in 2026. This is mainly due to imbalances in fund flows: at the short end of the curve, the rapid growth of quantitative investment strategies (QIS) and volatility-selling strategies supplies abundant liquidity, suppressing short-term volatility; at the long end, hedging flows will keep volatility elevated.

Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Industry Research, points out that investors’ fear of missing out, conflicting AI narratives, and the US government as a volatility source are combining to create a favorable backdrop for trading volatility. He emphasizes that hedging for left and right tail risks in 2026 is becoming critically important.

The Crowd and Dissent in Dispersion Trades

A strategy known as "dispersion trades"—betting that volatility in single stocks will rise more than index volatility—may be especially popular early next year but has sparked debate on whether it is too crowded. Some hedge funds believe the strategy is already overcrowded and have begun taking the opposite position.

Benn Eifert, Managing Partner and Co-Chief Investment Officer at QVR Advisors, says that dispersion investing has become an extremely popular and overcrowded "tourist industry," and his fund is engaged in reverse dispersion swaps. Alexis Maubourguet, Chief Investment Officer of Swiss hedge fund Adapt Investment Managers, also believes that much of the traditional alpha has disappeared, and investors need to extract returns from the strategy by improving execution, stock selection, or tactical swaps around positions.

Nonetheless, some expect capital to keep flowing into dispersion strategies. Citigroup's Antoine Porcheret notes that many dispersion baskets will expire in January, and hedge funds may reinvest in customized baskets, likely maintaining the single-stock volatility premium over index volatility.

Releverage Cycles and Tail Risks

On how to time sudden market moves, Jitesh Kumar, strategist at Société Générale, has proposed a volatility mechanism model based on the yield curve. The model shows that a flattening yield curve is usually a buy signal for volatility, while a steepening curve triggers short volatility trades. Though the model's long-term returns lag the S&P 500, it successfully avoided significant drawdowns in 2008 and 2020.

The model currently points to higher volatility in 2026. Strategists believe that although overall corporate sector leverage in the US is low, the country is on the verge of a new AI-driven releverage cycle, which will simultaneously increase credit spreads and equity volatility. This forecast further supports Wall Street’s core conclusion that US stock volatility will be hard to keep low next year.

Risk Warning and DisclaimerMarkets are risky; investors should be cautious. This article does not constitute personal investment advice and does not take into account individual users’ specific investment objectives, financial situations, or needs. Users should consider whether any opinions, views, or conclusions in this article are suitable for their particular circumstances. Invest accordingly at your own risk. ```