It's essential to recognize that low implied volatility (IV) levels in the market cannot be solely attributed to traders speculating on short volatility. There are additional factors at play, particularly the systematic flows within the market that influence index volatility. One key factor contributing to lower volatility and/or rapid contraction is the increasing prevalence of short volatility exchange-traded funds (ETFs), which have been experiencing substantial growth.
Although the data we're referring to is a bit outdated, dating back to August 2023, it still provides insight into the ongoing trend. The largest short volatility ETFs typically employ call overwriting strategies, which systematically injects positive gamma into dealer positions. As these ETFs accumulate more assets and the market trends towards the strike prices of the call options they hold, the positive gamma effect becomes more pronounced. Consequently, this heightened positive gamma leads to a suppression of volatility, effectively driving down index IV levels and thereby contributing to market stability.
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