VIX spread hits record 36 points as stocks reach all-time highs

Implied volatility on individual stocks hit a record 36-point premium over the S&P 500, even as the Dow closed at an all-time high.

The divergence suggests traders expect large but uncorrelated moves in individual names, according to an analysis of weekly options data dating to 2016.

The average implied volatility on individual stocks has held near 50 percent over the past 10 weeks, while at-the-money volatility on the SPY exchange-traded fund sat at about 13.5 percent. In the latest week, the ratio of the two reached 3.9, in the 92nd percentile of all readings since 2016.

Historically, that setup has made S&P 500 options look cheap. In the 65 weeks since 2016 when the ratio exceeded 3.75, SPY straddles averaged a 6.3 percent return per trade, while straddles on individual stocks lost 2.3 percent.

The Cboe Volatility Index, Wall Street's fear gauge, fell 4.2 percent to 15.81 on Wednesday even as the S&P 500 slipped 0.2 percent to 7,723.55 and the Nasdaq Composite dropped 0.8 percent to 26,363.44. The Dow Jones Industrial Average rose 0.5 percent to 54,349.12, its latest record close. Stocks and the VIX move together only about 20 percent of the time, according to the analysis.

Options Market Prices in Divergence

The gap between individual stock and index volatility has widened steadily this year as traders hedge single-name risk while betting the broad market stays calm. Over the past 10 weeks, the average implied volatility on individual stocks has run near 50 percent, roughly 36 points above the SPY's 13.5 percent — the widest spread in data going back to 2016.

That pattern implies traders expect big moves in individual stocks in both directions, which would leave the broad index little changed. It also suggests single-name options have grown expensive relative to index options, a shift that has pushed the spread between the two to its highest level in a decade of data.

SPY Options Look Cheap by History

The historical record favors index options in this environment. Since 2016, SPY calls have averaged a 12 percent return per trade and SPY puts have lost about 15 percent, while a straddle — buying both a call and a put — lost 1.28 percent on average. Options on individual stocks fared worse: calls averaged 3.1 percent and puts lost 6.4 percent.

When the stock-to-SPY volatility ratio exceeded 3.75, the edge shifted further toward index options. SPY calls averaged a 28 percent return, and SPY straddles returned 6.3 percent per trade. Calls on individual stocks lost more than 5 percent, and straddles on individual names lost 2.3 percent, while puts eked out a 0.6 percent gain.

For portfolio managers, the divergence argues for expressing directional views through index options rather than single-name contracts, where the volatility premium has stretched. The setup also leaves the market vulnerable to a sharp repricing if the calm in the S&P 500 breaks, since index volatility would have to catch up to the levels already embedded in individual stocks. A pullback in the benchmark would compress the gap quickly, while a continued grind higher would keep single-name hedging expensive into the next earnings cycle.

This article is for informational purposes only and does not constitute investment advice.