Bank of America's derivatives team has issued a warning that when the AI bubble finally bursts, the market will behave in a manner completely different from the past several months — not "stocks down, bonds down" (meaning equities falling while Treasury yields rise), but rather stocks and yields declining simultaneously.
On October 8, the Financial Times disclosed that OpenAI's annualized revenue was far below the figures circulating in the market, triggering a more than 1% plunge in the Nasdaq index that day, a 3.4% drop in the Philadelphia Semiconductor Index, while Treasury yields also fell immediately — the bond market displayed a rare safe-haven quality. In its latest "Global Equity Volatility Insights" report, Bank of America's derivatives team characterized this single-day flash crash as "the best dress rehearsal for an AI unwind," noting that the more critical signal was that Treasury yields and stocks declined in tandem at that time, rather than exhibiting the "stocks down, bonds up" pattern that the market had grown accustomed to over the past few months.
This pattern was promptly replicated on October 14. On that day, inflation data exceeded expectations, the 10-year Treasury yield briefly spiked, and the probability of a rate hike briefly surpassed 50%. However, as cloud infrastructure company CoreWeave's stock crashed more than 15% and its credit default swap spread widened by 135 basis points, the bond market's yield rally quickly reversed, with yields ultimately closing nearly flat.
Bank of America believes this is precisely the "transmission chain" of an AI bubble burst: pressure from the private AI ecosystem first and most violently hits the Nasdaq while dragging the bond market into safe-haven mode.
AI-Specific Risk Shocks: Nasdaq Bears the Brunt
Bank of America's equity-linked team, including Benjamin Bowler, Nitin Saksena, and Arjun Goyal, pointed out that the Nasdaq's significant underperformance relative to the broader market on October 8 closely matched the behavior seen during every AI-specific risk event over the past several years — from the DeepSeek shock in January 2025 to this summer's semiconductor sector pullback, the pattern has been identical.
The report suggests this reflects the Nasdaq's high exposure to the "private AI ecosystem." Once cracks appear at private AI companies such as OpenAI and Anthropic, the Nasdaq 100 index becomes the first proxy in public markets to come under pressure. The bank designates it as the preferred index for AI trades — whether long or short.
This transmission pathway is now facing a new stress test. Anthropic opened its financial data to Wall Street on October 14, while OpenAI's $20 billion "gross revenue versus net revenue gap" remains unresolved. The transmission channel from the private side to public markets is expected to face continued scrutiny.
Bond Market Anomaly: Both AI Shocks Triggered Simultaneous Yield Declines
More noteworthy is the bond market's behavioral pattern. Over the past several months, U.S. stocks and Treasury yields had consistently exhibited an inverse relationship, with bonds' function as a hedging tool nearly failing. However, the two AI risk events on October 8 and October 14 both broke this pattern, with yields declining in tandem with stocks.
Bank of America attributes this to the macro logic of an AI slowdown: beyond traditional safe-haven inflows, a cooling AI investment cycle means reduced capital expenditures, lower electricity and resource consumption, combined with dual suppression of economic growth and inflation, which would provide additional benefits for bonds. In other words, if the AI bubble truly bursts, bonds will regain their hedging function.
The historical reference cited in the report is the 2000 internet bubble burst: at that time, the Nasdaq 100 collapsed, and the 10-year Treasury yield fell from approximately 6.5% to the mid-4% range. Bank of America acknowledges that two data points do not yet constitute a complete pattern, but believes that historical precedent and macro logic mutually reinforce each other, providing sufficient structural reference for investors.
CoreWeave Triggers Credit-Side Crisis; AI Stocks Underperform Broader Market by 840 Basis Points This Week
The October 14 market sell-off revealed another potential burst pathway for the AI bubble: the credit side.
CoreWeave (CRWV) was at the center of the storm. After its 2032-maturing bond G-spread broke through 1,000 basis points and its yield rose to 15%, the stock crashed more than 15%, marking its third-largest single-day decline since listing. D.A. Davidson analyst Gil Luria characterized CoreWeave as the "subprime mortgage tranche" of the AI sector, warning that if the company cannot service its debt, the stock will go to zero — its financing cost is approximately 9%, while its return on investment is only about 1%. CoreWeave's credit default swap spread widened by 135 basis points that day, with the market currently implying a 63% probability of default within five years.
Panic spread rapidly. DigitalOcean (DOCN) fell 14%, Hut 8 (HUT) dropped 10%, while Nebius (NBIS) and IREN each fell about 9%; Oracle (ORCL) declined 9%, with its divergence from credit default swap levels still unresolved. Market research firm Gartner subsequently issued a warning, projecting that 80% of emerging cloud computing companies will cease independent operations before 2030.
This week, the AI sector's cumulative underperformance relative to S&P 500 non-AI constituents has reached 840 basis points. BTIG strategist Jonathan Krinsky also believes that the current pain trade points toward "rates down, Nasdaq down," and if the "Magnificent Seven" also begin declining in tandem with rates like semiconductor stocks, it would further confirm his "Red October" thesis.
Bank of America Recommends Hedging Portfolio: Let the Bond Market Subsidize Option Costs
Facing this potential risk, Bank of America's derivatives team has proposed a "bonds subsidizing stocks" hedging structure.
The difficulty with traditional AI bubble hedging lies in timing: buying put options too early means a continuously rising market will keep pushing the strike price behind the market. Bank of America's solution is a "max lookback put" — its strike price continuously ratchets up as the market rises, but this feature itself is costly. The bank's innovation lies in structuring the option to activate only when the 10-year SOFR falls 25 basis points below the current forward rate, thereby converting rate decline expectations into premium subsidies.
The specific trade structure is: buy a Nasdaq 100 index daily-observed max lookback put expiring in September 2027 with a strike price at 90% of the current level, with an attached rate trigger clause. The indicative premium is 3.62%, a 46% discount to a pure lookback put, and also 23 basis points lower than a standard put option.
Backtesting data shows that simulating pricing for this structure over the past 30 years yields a trigger probability of 13% (versus 11% for a standard 90% put option), an average in-the-money payout multiple of 7.2 times (versus 6.1 times for standard puts and 3.9 times for pure lookback options), with the maximum excess return occurring during the internet bubble burst period.
The main risk of this structure lies in a 2022-style "stocks down, bonds up" scenario — that is, an inflation shock or unexpected Fed tightening causing stocks and bonds to decline in the same direction — which is precisely how the bond market operated for most of 2026 and is not a genuine tail risk.
Additionally, Bank of America simultaneously recommends a VIX call spread trade: buy the VIX November-expiry 19-24 point spread at an indicative cost of $0.63, with a maximum payout multiple of approximately 7.9 times, suitable for a judgment of moderate volatility increase around the midterm elections.
How Large Is the Bubble: Indicators Show Concentration Rather Than Broad-Based Froth
The latest reading of Bank of America's Bubble Risk Indicator (BRI) provides a more granular perspective. Currently, only 13 stocks in the S&P 500 have a BRI exceeding 0.8, collectively accounting for approximately 2.4% of index weight; by comparison, at the peak of the internet bubble, 50 to 100 stocks had reached that threshold, representing 20% to 40% of index weight.
Current bubble characteristics show clear concentration: at the individual stock level, Moderna (MRNA), CrowdStrike (CRWD), Hewlett Packard Enterprise (HPE), Zebra Technologies, Revvity, and Palo Alto Networks (PANW) rank highest; at the sector level, Bank of America's U.S. cybersecurity and Brazil election thematic baskets both have BRI readings as high as 0.92.
It is worth noting that price-level bubble indicators suggest the risk remains localized, but Jefferies has already characterized the current situation as "AI's 2008 moment," noting that two cash-burning AI laboratories collectively account for half of a $2.3 trillion order backlog. This means the true bubble risk may not be reflected at the stock price level but lurking within balance sheets.
Volatility Artificially Suppressed; Any Loosening Could Trigger Sharp Rebound
Beneath the surface calm, market structure is already churning. The S&P 500's 5-day intraday realized volatility is only 7.6%, at the third percentile of the past year. But Bank of America believes this calm is artificially maintained by the massive gamma exposure held by options market makers.
As of October 9, the S&P 500's hedged gamma reading was $14.5 billion, the fourth-highest in the past year. Large volumes of 0DTE/1DTE option selling flows and structural volatility supply from derivative income funds have together created the market's "guardrails," keeping intraday fluctuations within an extremely narrow range.
However, this buffer is loosening. According to Bloomberg macro strategist Michael Ball, the S&P 500 has broken below its first support level of 7,775 to 7,750 points; SpotGamma identifies the "volatility trigger point" at 7,775 — below this level, market makers' hedging activities will no longer serve to dampen volatility. Once the index breaks below around 7,700, positive gamma will rapidly thin out, and mean-reversion strategies of buying the dip may give way to a "sell as it falls" mode.
Meanwhile, clients have quietly been buying large volumes of VIX call options, with positioning levels approaching the summer 2024 highs — a period that previously triggered violent volatility. This forward-looking volatility demand has made the S&P 500 term structure unusually steep, with the ratio of 1-month to 1-week at-the-money implied volatility at the 95th percentile of the past year.
Bank of America estimates that if front-month VIX futures experience a 10-point jump, market makers would be forced to buy positions equivalent to approximately 90% of average daily VIX futures volume to maintain delta neutrality — the highest reading in the past year. Goldman Sachs recently reached a similar conclusion independently, believing the probability of VIX touching 25 is higher than the probability of the S&P 500 falling 2%. Both banks converge on the same conclusion: once volatility loosens, the intensity of the market reaction may far exceed the price decline itself.
Key upcoming catalysts: today's PPI data, Anthropic's financial disclosure, and the large-cap technology company earnings season later this month will directly stress-test the above logic. If the S&P 500 cannot reclaim 7,750 points, market makers' gamma shield will cease to exist.
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