The US stock market is poised to be kept on edge next year as investors are caught between fear of missing out (FOMO) on the artificial-intelligence (AI) rally and concern that it’s a bubble just waiting to burst.
Big selloffs and quick reversals have been a feature of stock markets for the past 18 months. That trend is likely to continue heading into 2026, with some strategists anticipating that AI will follow the boom-and-bust cycle of past technological revolutions.
The tech companies at the centre of the AI investment boom carry an outsized influence. While the divergence between the group and the rest of the S&P 500 has helped dampen realised volatility across the market in 2025 as gains in tech cancel out declines elsewhere, investors are alert for stumbles in chip names to spread. That would cause volatility gauges such as the Cboe Volatility Index to surge.
“2025 has generally been a year of rotation and narrow leadership, rather than one of broad risk-on versus risk-off,” said Kieran Diamond, derivatives strategist at UBS Group AG. “This has helped to drag implied correlation levels down to record lows, which in turn leaves the VIX at risk of ongoing outsized spikes whenever we see macro drivers taking over again.”
The scale of the stock-price runup has made angst about a bubble the top concern among fund managers, a recent Bank of America Corp survey found. But another is the classic risk of missing out if it still has more room to run — potentially punishing anyone who pulls back too early.
The strategists expect equity volatility to be supported in 2026 primarily because asset bubbles tend to get more unstable as they inflate. As a result, they say investors should expect occasional declines surpassing 10%, but with record-fast snapbacks as traders realise the bubble isn’t popping yet.
To UBS strategists, the question of whether the AI boom continues or busts makes owning contracts that profit from higher volatility on tech-heavy Nasdaq 100 Index key to playing both sides of the trade. Maxwell Grinacoff, head of US equity-derivatives research at the Swiss bank, says volatility wagers on the gauge perform better in both scenarios, adding that the trade can be structured to be directionally neutral using straddles or over-the-counter swaps.
Buying Nasdaq 100 volatility while selling S&P 500 volatility is “my highest conviction trade for the next year,” Grinacoff said.
There may be longer periods of calm in between moments of uproar, however. JPMorgan Chase & Co strategists say volatility is being tugged between technical and fundamental factors that suppress it and macro factors that support above-average levels. While the median VIX level will hold around 16 to 17 for 2026, risk-off periods will send the index surging, they argue.
One other technical factor that will affect options pricing is an imbalance of investment flows that should steepen the volatility curve in 2026, according to Antoine Porcheret, head of institutional structuring for the UK, Europe, the Middle East and Africa at Citigroup Inc.
“At the short end of the curve, you have a lot of supply coming from both retail and institutions — there’s been a significant growth in QIS and volume carry strategies, and that will likely amplify next year,” he said. “At the long end, you have hedging flows which will keep the long end elevated, so a steep term structure can be expected.”
The popular dispersion trade — which involves betting on higher single stock volatility and smaller index moves — will likely be especially popular early in the year, with investors putting on new versions of the strategies. Some funds are now taking the opposite position in what they argue has become an overcrowded trade.
“Dispersion is an extremely popular, overcrowded tourist trade these days,” said Benn Eifert, managing partner and co-chief investment officer of QVR Advisors, a San Francisco-based volatility fund. “We have the reverse dispersion trade on.”
Firms will need to get more creative to squeeze returns out of dispersion strategies, said Alexis Maubourguet, chief investment officer of Adapt Investment Managers, a Swiss hedge fund. Investors looking for more edge will explore variations.
“Dispersion now is a well-known strategy and a lot of the alpha has disappeared,” said Maubourguet. “You can improve your implementation, you can improve your name selection. The third way to do that is to improve your timing and trade tactically around your position.”
Others expect the flow of capital into dispersion strategies to keep demand for single-stock volatility relatively elevated.
“A lot of dispersion packages will expire in January, so hedge funds will be re-loading on custom basket dispersion, and that will likely maintain the single-stock volume premium over the index,” Porcheret said.
Some players are just buying single-stock volatility, while others are selling a smaller amount of index volatility at the same time to help cheapen the carry cost during quiet times, Maubourguet added.
The biggest question for investors is how to time any sudden moves. Strategists at Societe Generale SA including Jitesh Kumar presented in a client note a fundamental volatility regime model that they apply to dynamically switch between long and short volatility trades.
Broadly, a flattening yield curve is the signal for buying volatility, while the short volatility trade is triggered by a steepening curve. Although the model underperformed the S&P 500’s total return over a two-decade period, it avoided significant drawdowns in 2008 and 2020.
The model — which the strategists say has a good track record of forecasting turning points in volatility — points to higher volatility for 2026. The overall corporate sector in the US has low leverage, but the strategists believe it is at the cusp of a new AI driven re-leveraging cycle which should lead to both credit spreads and equity volatility moving higher.
Overall, hedging for tail risks will be especially important for investors in 2026, according to Tanvir Sandhu, Bloomberg Intelligence’s chief global derivatives strategist.
“Investor FOMO, conflicting AI narratives and the US administration as a source of volatility are creating a supportive backdrop for trading volatility, making preparation for both the left and right tails key in 2026,” he said.
