MW How single-stock turbulence presents 'asymmetric' downside risk for a rather calm S&P 500
By Tomi Kilgore
A 'dispersion trade' is being fueled by rising volatility for individual stocks while index volatility is falling - suggesting the risks of a selloff are rising
A divergence of volatility measures for individual stocks and the broader market depict turbulence beneath the surface - suggesting the market's calm will not last.
Calm markets don't tend to stay that way for long if turbulence beneath the surface is increasing.
Wednesday's market action, in which both the S&P 500 and market breadth were weak for a change, gave investors a little taste of how that calm could end.
There have been some unusually large moves in the shares of some large-cap companies over the past week, while the broader market has crept quietly higher.
Shares of Dell Technologies $(DELL)$ soared 33% in a day; Cboe Global Markets' stock $(CBOE)$ tumbled nearly 20% in two days; Hewlett Packard Enterprise's stock $(HPE)$ shot up 46% in three days; and IBM shares $(IBM)$ jumped up 30% in four days. All these moves happened in the course of the week through Tuesday - while the S&P 500 index SPX, of which all four of those stocks are components, gained just 1.2% over the same time.
While that divergence in volatility is not a telltale sign of future market direction, it sends a clear message that a big move is building. And there's an "asymmetric risk" that the big move will be to the downside, Adam Turnquist, chief technical strategist at LPL Financial, told MarketWatch.
While the saying goes that a rising tide lifts all boats, the recent action on Wall Street has been telling a different story. Stock correlations, or how in sync individual stocks are with the broader market, have dropped to nearly two-year lows.
The following chart shows that correlations can't stay so low for very long - and when they rise off such low levels, they tend to snap back like a stretched rubber band, with the S&P 500 seeing quick, sharp selloffs.
The drop in correlations has been coupled with a divergence between the Cboe S&P 500 Constituent Volatility Index, which had been trending higher over the past couple months, and the Cboe Volatility Index VIX, which has been declining
The VIX is viewed as the stock market's "fear gauge," given that it tends to rise when the market falls, and falls when the market rises. But fear can also be seen during rallies, as big surges in individual stocks reflect a fear of missing out among investors.
Volatility is a key ingredient in pricing options, as it is used to gauge how likely a contract is exercised depending on the timing of the option's expiration. What this divergence has fueled is what's referred to in the options market as the "dispersion trade." Options players are buying volatility in individual stocks so they can sell calls - obligations to buy a stock - to clients, then selling index volatility.
"Increased speculative activity, particularly through call-option buying in technology stocks, has also helped push single-stock volatility higher," LPL's Turnquist wrote in a recent note to clients. "It speaks to the level of complacency" among investors, he added.
While this type of divergence isn't necessarily rare, the recent trend has lasted longer than usual.
Garrett DeSimone, head quant at OptionMetrics, said it has led the dispersion trade to "become a bit overcrowded," which adds to the market's "frothiness."
"We all know this is going to be mean-reverting," DiSimone told MarketWatch. The question, he said, is "how violent" that reversion will be.
When the trade unwinds, it will entail the opposite of what's been happening - the selling of individual-stock volatility and the buying of index volatility, and a likely sharp rise in correlations. That means a rising VIX would coincide with an S&P 500 selloff, and that falling tide would lower all boats.
Read: Here's how investors can protect their portfolios from the next stock-market crash.
Both DiSimone and LPL's Turnquist believe what will trigger an unwind is something "macro," rather than something that impacts one individual stock, even if it's a major artificial-intelligence play.
"The macro story is what potentially kills this trade," DiSimone said. "The biggest risk to the market is the potential for a hawkish [Federal Reserve], and adjustment of the interest-rate path."
-Tomi Kilgore
This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.
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June 03, 2026 18:26 ET (22:26 GMT)
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