"FOMO Theory vs Bubble Theory," Wall Street believes that the volatility of U.S. stocks will not decrease next year

Wall Street is preparing for continued turbulence in the U.S. stock market in 2026, as investors oscillate 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 has exhibited characteristics of large-scale sell-offs and rapid reversals over the past 18 months, a trend likely to continue into 2026. As the AI technology revolution experiences cycles of boom and bust, the tech giants at the center of the investment frenzy will continue to exert significant influence over the market, with substantial fluctuations in their stock prices expected to become the norm.

Despite the strong performance of tech stocks in 2025 offsetting weakness in other sectors, this divergence among sectors has somewhat suppressed the actual volatility of the market. However, investors should remain vigilant about the risk contagion that a decline in chip stocks could trigger. Once macro drivers regain dominance, previously suppressed volatility could lead to a sharp spike in indicators such as the Cboe Volatility Index (VIX).

According to a survey by Bank of America, although the rise in stock prices has led fund managers to view bubble concerns as the primary risk, the fear of missing out due to premature exits is equally strong. The market generally expects that asset bubbles tend to become more unstable during inflationary periods, investors need to be prepared for occasional pullbacks exceeding 10%, followed by record rebounds triggered by traders realizing that the bubble has not yet burst.

Volatility Game Amid the AI Boom

Kieran Diamond, a derivatives strategist at UBS Group, noted that the overall market in 2025 exhibited rotation and narrow leadership characteristics, rather than broad risk appetite choices, which has driven implied correlation levels to historical lows. However, this low correlation is also a double-edged sword; once macro factors reassert control over the market, the VIX index will face the risk of sustained extreme spikes.

For UBS strategists, whether the AI boom continues or collapses makes holding high-volatility contracts on the Nasdaq 100 index, which is tech-heavy, a key strategy. Maxwell Grinacoff, head of U.S. equity derivatives research at UBS, stated that regardless of whether it is an AI boom or bust, the volatility bets on the Nasdaq 100 index outperform those on the S&P 500 index. He views “buying Nasdaq 100 volatility while selling S&P 500 volatility” as the most confident trade for the coming year and recommends achieving directional neutrality through straddles or over-the-counter swaps.

J.P. Morgan strategists believe that volatility will be tugged between technical factors, fundamental factors, and macro factors supporting the market. While they expect the median VIX in 2026 to remain between 16 and 17, risk aversion periods will drive the index to soar, interspersed with longer periods of calm between turbulent times.

Structural Imbalance in the Options Market

In addition to the macro narrative, technical factors are also reshaping options pricing.

Antoine Porcheret, head of institutional structuring for Citigroup in the UK, Europe, the Middle East, and Africa, anticipates that the volatility curve will steepen in 2026. This is primarily due to an imbalance in investment flows: at the short end of the curve, significant growth in quantitative investment strategies (QIS) and volatility selling strategies has provided ample supply, suppressing short-term volatility;On the long end, the flow of hedge funds will keep volatility elevated.

Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Industry Research, pointed out that investors' fear of missing out, conflicting AI narratives, and the U.S. government acting as a source of volatility are creating a favorable backdrop for trading fluctuations. He emphasized that it is crucial to hedge against tail risks around 2026.

Crowding and Divergence in Diversified Trading

A strategy known as "diversified trading"—betting on the volatility of a single stock while the index volatility remains low—may become particularly popular early next year, but it has also sparked debates about whether it is too crowded. Some hedge funds believe this strategy has become overly crowded and have begun to take the opposite stance.

Benn Eifert, Managing Partner and Co-Chief Investment Officer at QVR Advisors, stated that diversified investing has now become an extremely popular and overcrowded "tourism industry," and his fund is engaging in reverse diversified swaps. Alexis Maubourguet, Chief Investment Officer at Swiss hedge fund Adapt Investment Managers, also believes that many traditional Alpha returns have disappeared, and investors need to derive returns from this strategy through improved execution, stock selection, or tactical swaps around positions.

Nevertheless, there are still views that expect capital to continue flowing into diversified strategies. Citigroup's Antoine Porcheret noted that many diversified solutions will expire in January, and hedge funds may reinvest in customized basket diversified solutions, which is likely to maintain the premium of single stock volatility relative to the index.

Re-leveraging Cycle and Tail Risks

Regarding how to seize the timing of sudden market movements, Jitesh Kumar, a strategist at Société Générale, proposed a volatility mechanism model based on the yield curve. The model indicates that a flattening yield curve is typically a signal to buy volatility, while a steepening curve triggers short volatility trades. Although the model's long-term returns are lower than the S&P 500, it successfully avoided significant drawdowns in 2008 and 2020.

The model currently points to rising volatility in 2026. Strategists believe that although the overall corporate leverage in the U.S. is low, the country is on the brink of a new re-leveraging cycle driven by artificial intelligence, which will lead to simultaneous increases in credit spread and equity volatility. This prediction further supports Wall Street's core judgment that U.S. stock market volatility is unlikely to remain low next year