In financial markets, the lure of finding patterns can often lead to the misconception of spurious correlations. For instance, the apparent link between the rising Assets Under Management (AUM) of option selling Exchange Traded Funds (ETFs) and the simultaneous decline in the Volatility Index (VIX) may seem to suggest a direct impact on market volatility. However, this observation may not necessarily indicate a cause-and-effect relationship.

Savvy market analysts tend to eschew such superficial connections in favor of more robust, data-driven approaches. A comprehensive analysis involving a meticulous record of buying and selling activity for S&P 500 options, obtained directly from the exchange, provides a clearer picture of market dynamics. By examining the net gamma footprint of strategies employing standard and flex S&P options, we gain valuable insights. Recent data indicates that S&P gamma possibly reduced the S&P’s 1-month realized volatility by approximately 1.5 points, translating to a 15% decrease over the past month. At times, this reduction even approached 2 points, or 20%, highlighting moments of volatility compression. While the impact of gamma on volatility is certainly significant, it’s not the primary driver of the VIX’s maintained position in the lower teens.

Instead, a closer examination reveals other factors contributing to the current low volatility environment in equity markets. These factors include:

• The historically low correlation between individual stocks, which dampens the overall index-level volatility.
• The remarkable resilience of the S&P 500, which hasn’t experienced a sell-off exceeding 2% in an extraordinary number of trading sessions.
• The most notable outperformance of S&P realized volatility on days when the market rises compared to during sell-offs—a pattern not seen since at least 1985. This suggests a prevailing ‘buy-the-dip’ mentality among investors and a persistent apprehension of potential market upswings.

While it’s tempting to draw connections between various market trends, such as those involving ETFs and the VIX, or even whimsically noting the relationship to wheat prices, discerning investors and analysts should look beyond the surface. By delving into the underlying data and market mechanics, we can better understand the true drivers of market volatility and avoid the pitfalls of misleading correlations.