Examining the potential impact of Iran conflict risks on equity markets through the lens of 2022 reveals a key concern: an inflation shock could increase correlations among stocks within indices and trigger a prolonged period of heightened volatility. Soaring oil and gas prices are rippling through supply chains, threatening not only gasoline prices but also the costs of various goods and services. This shift is drawing traders' focus away from individual stocks, as macroeconomic worries begin to overshadow more niche themes like artificial intelligence. Consequently, the volatility premium for single names relative to the S&P 500 has narrowed, accompanied by a decline in trading volume.

Although the VIX index remains more sensitive to declines in the S&P 500, its overall realized volatility has stayed relatively subdued compared to past crises. So far this year, the VIX has not closed above the 30-point level, whereas during the tariff turmoil last April, it remained above 30 for two consecutive weeks. In 2022, influenced by the Russia-Ukraine war, the VIX briefly surpassed 30 and averaged 25.64, more than 6 points higher than this year's average. That year, the S&P 500 fell 19% amid multiple interest rate hikes by the Federal Reserve.

Kieran Diamond, a derivatives strategist at UBS Group, stated, "Investors are closely watching the 2022 market moves for clues on how the current situation with Iran might affect markets. The risk is an inflation shock, which could lead to rising correlations within the equity market and potentially shift the VIX's volatility regime from sharp spikes and reversals to a scenario of a higher VIX floor with persistently elevated volatility."

Meanwhile, UBS strategists note that the market stress indicator, the Cboe Skew Index, has recently calmed. This may be due to investors losing confidence in plain index put options, leading to the unwinding of hedge positions. Additionally, the low level of realized downside volatility since the Middle East escalation could be another factor contributing to a broader repricing of the skew curve.

According to Michele Cancelli, Global Head of Structured Products at Citi's Multi-Asset Group and Global Head of QIS Trading & Structuring, while some systematic traders have shifted to short volatility positions via VIX put structures, there has not yet been a material change in investor behavior within the QIS space. He said, "Despite the high volatility risk premium in the S&P 500, there is little indication of investors rushing to short volatility. The volatility window triggered by Iran may not have been open long enough for investors to feel confident about profiting from it."

The low realized volatility of the S&P 500 contradicts the positioning strategies of options dealers. A consensus among most derivatives strategists is that dealers are short gamma ahead of the quarterly expiration. The significantly higher intraday realized volatility compared to the close could be a manifestation of dealer gamma exerting a greater influence on the market.

At the same time, the broader market microstructure does not appear to have changed significantly: there remains substantial overselling of index call options, along with persistent selling of one-day-to-expiration hawkish options. However, even as losses persist for index hedging strategies—whether direct shorts on the S&P 500 or long positions in VIX call options—the risk/reward of these positions would still be affected if a genuine market crash occurs.

Furthermore, some investors still see value in contrarian plays against popular strategies like volatility dispersion. David Elms, Head of Multi-Asset Alternatives at Janus Henderson Group Plc, commented, "From a risk/reward perspective, we believe being long index volatility and long intra-index correlations present better opportunities now. In this area, being long correlation via anti-dispersion is also interesting, given low implied correlation and the fact that the correlation floor is effectively zero." He noted that being long convexity is also attractive due to carry costs below historical averages, driven by flow imbalances.

Another market characteristic is intraday reversals, suggesting that although options dealers may be short gamma, they are not the primary price drivers in a macro-news-dominated environment. These reversals partly explain the smoother realized volatility around the market close—indicating that a segment of investors continues to engage in contrarian trading. Last Thursday, for instance, equities weakened during the day but staged a strong rebound into the close. Such price action reversals could potentially transform into genuine upward momentum, accelerating stock price gains as the trading day concludes.