UBS recently released its global equity derivatives strategy report, positioning ahead of the end of the "September curse" and outlining key themes and investment approaches for the fourth quarter.

**1. Where is Volatility? Not Yet Reflected at Index Level, but Risks Are Gradually Rising**

The firm previously noted that after Q2 earnings releases, macro risks could become the market's focal point. Over the next month, implied volatility pricing for index options targeting major macro events remains below 80 basis points, appearing low, but this is primarily because the actual realization of these implied volatilities has been extremely limited.

While market fragility has increased, the core factors that previously suppressed volatility continue to operate. The firm has observed some "recovery signs" in volatility: as hedge activity restarts, volatility skew has risen to multi-year highs. Correlations across most sectors have increased, but the continued divergence within the technology sector (Tech+) remains a key factor suppressing index volatility.

Systematic strategies (such as volatility control strategies and commodity trading advisors CTAs) have seen their leverage levels return to pre-"liberation day" highs. According to the firm's model, CTAs currently tend to reduce exposure, with a long-short ratio of approximately 7:1.

UBS's analysis of market-wide gamma distribution shows that overall, hedge activity is more likely to trigger "pinning risk" or "upside risk" in local markets, and the renewed increase in options that expire during the trading day (ODTE) exposure may further intensify this trend.

Given the current complex market environment, the firm emphasizes the need to remain selective when choosing hedge and arbitrage opportunities across different indices and sectors.

**2. How to Hedge Stagflation Risk**

The firm believes market attention to stagflation risk remains insufficient, although recent movements in gold and gold mining stocks may suggest the market is beginning to gradually price in this risk. Using the "Market Cookbook" analytical framework, the firm explores the potential impact of stagflation shocks on equity markets in the coming months. Previously, the firm used this model to analyze a "growth-driven high-yield" scenario, which has now largely become reality.

From a sector perspective, the Gold Miners ETF (GDX) still shows strong upside attraction, though some of its gains have already been priced in by the market. Cyclical stocks, particularly financials, metals & mining, and homebuilders, appear to face the greatest risk.

At the index level, the firm's model estimates show relatively limited downside risk for indices, with upside volatility also remaining manageable. Investors may consider selling put options on gold mining stocks to fund purchases of put options on the Metals & Mining ETF (XME), creating a gold "alpha" relative value trade; alternatively, they could choose knockout put options on the S&P 500 for hedging.

**3. Will Small-Caps "Surrender"? Broad Market Rally Lacks Sustainable Trend**

Small-cap stocks have recently returned to market focus. Following the Jackson Hole central bank symposium, small-caps saw a rebound supported by expanding earnings breadth, but the firm has not found clear evidence of large-scale capital rotation from high-quality asset sectors to small-caps.

The options market signals similarly - there is no excessive optimism toward small-caps, contrasting sharply with market performance in Q4 2023 and July 2024. While this indicates the current rebound's health is relatively good, given that fundamentals have only slightly improved compared to last year, this rebound trend may be difficult to sustain.

The firm's "Theme-ometer" suggests that rather than tactically positioning for a "low-quality asset surrender" scenario, it would be better to focus on certain AI-related themes (such as software pioneers) or defensive sectors (such as pharmaceuticals).

**4. In a Rate-Cutting Cycle, Should We Choose Bond or Equity Volatility?**

Historical data shows that rate-cutting cycles typically accompany economic growth deceleration. Based on the firm's analysis, in this context, allocating to equity volatility remains more reasonable than allocating to bond volatility. However, the firm believes this conclusion's validity requires three conditions: 1) After the Fed begins cutting rates, certainty around its future policy path needs further improvement; 2) The offsetting of growth and inflation expectations needs to control long-duration risk; 3) After the Fed's first rate cut this month, stock-bond yield correlation needs to return to positive territory.

Investors may consider systematically selling US Treasury volatility through quantitative investment strategies (QIS) to fund S&P 500 downside risk exposure.

**5. VIX Contango Strategy - Capturing Carry Income During Market Calm**

VIX contango strategy popularity has reached its highest level in nearly five years. The firm believes this is mainly due to renewed attention to VIX exchange-traded products (ETPs), but notes that these strategies currently face two-way risks: on one hand, volatility term structure steepening has improved actual contango yields; on the other hand, there's potential for "self-reinforcing volatility spikes," though their magnitude is expected to be only a fraction of the volatility surge from late 2017 to early 2018.

The firm still prefers recommending VIX 1x2 put ratio strategies or put calendar spread strategies to capture carry income in a risk-mitigated manner. Investors may consider rolling September-expiring VIX 1x2 put ratio positions to October expiration.

**6. Dividend Discount - Focus on 2027 Range Upside Opportunities**

The firm has updated its bottom-up analysis of S&P 500 dividends, incorporating upward consensus estimate revisions following Q2 earnings (mainly from US banks and technology sectors). The firm recommends maintaining 2026 upside option trading positions to capture potential further upside while focusing on the 2027 range to construct new 1x2 call ratio positions or call risk reversal positions.

Additionally, the firm has updated its bottom-up dividend forecasts for the European STOXX 50 Index (SX5E), which appears to offer more attractive dividend discount levels compared to the US market.