Hedging has once again become a hot topic as Jerome Powell's speech at the Jackson Hole symposium ignited market expectations for a September Fed rate cut, driving US stocks back up to near-record levels. With equity positions generally at elevated levels, investors are actively discussing the most effective ways to protect gains ahead of NVIDIA earnings, employment and inflation data releases, and the Fed's rate decision.

"Powell's remarks were more dovish than the market expected, and the market clearly responded positively," said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group. "We're seeing some investors increase protective positions on S&P 500 index ETFs and buy call spreads on SPDR Gold ETF as part of an inflation trading strategy."

As the market remains in "buy-the-dip" mode, many strategists are recommending S&P 500 put spreads. Recently, lookback or reset put options are also considered useful if the market continues its choppy upward trajectory in the near term.

However, there's one notable "absentee" among recent hedging tool choices: buying call options on the Chicago Board Options Exchange Volatility Index (VIX) - typically a common hedging tool for investors.

"In the current market environment, vanilla put options or put spreads on the S&P 500 might be more reliable hedging tools," noted Tanvir Sandhu, head of global derivatives strategy at Bloomberg Intelligence. "Additionally, the S&P 500's volatility skew is quite steep, which helps reduce the cost of put spreads."

JPMorgan strategists noted last week that the US fiscal deficit and Donald Trump's pressure on the Fed could begin to create a double squeeze on both Treasuries and stocks. They recommended a binary trading strategy: betting that the S&P 500 falls more than 5% by year-end while 10-year Treasury yields rise by 0.2%.

In European markets, digital put spreads on the Euro Stoxx 50 index are relatively cheap, with one-month out-of-the-money put volatility at strike prices 5% below current levels sitting around the 20th percentile of the past year.

One reason VIX options are "absent" from hedging choices is cost. Bank of America strategists highlighted in a research note last week that VIX call options appear overpriced compared to S&P 500 put options. This primarily reflects the rise in VIX option volatility relative to S&P 500 option volatility, with the latter under pressure due to extremely low realized volatility.

The so-called "volatility of volatility" (vol-of-vol) appears expensive on a relative basis, consistent with other convexity measures being generally elevated.

"Hedging is a balance between cost, time decay, reliability, and convexity," Sandhu said. "The market still exhibits strong buy-the-dip characteristics, with volatility spikes followed by record-speed declines, making VIX call options potentially unreliable and difficult to monetize."

Furthermore, the steepness of the VIX futures term structure leads to higher carrying costs. Since futures tend to roll down the curve to converge toward the spot index - rather than spot rising to futures levels over time - call options become increasingly out-of-the-money with continuously eroding value.

Why is the term structure so steep? A commonly cited reason is the renewed flow of funds into VIX exchange-traded products (ETPs). These products gained notoriety from the 2018 "Volmageddon" event when short-VIX ETPs attracted massive investment, leading to a short squeeze in VIX futures when volatility rose, ultimately causing complete liquidation of products like the VelocityShares Daily Inverse VIX Short-Term ETN.

JPMorgan strategists including Bram Kaplan noted that conversely, recent fund flows have shifted toward bullish funds: since April, bullish leveraged VIX ETPs have seen inflows exceeding $2.5 billion, while inverse VIX funds experienced outflows of over $1 billion.

The daily rebalancing operations of these products cause them to sell short-term VIX futures and buy long-term contracts, further exacerbating the steepness of the term structure.

Leveraged VIX ETPs may amplify volatility: to maintain target leverage ratios, they buy futures when volatility rises and sell when it falls. However, VIX call option buyers may be more concerned that during the next stock market decline, significant futures selling could occur as fund investors cash in profitable trades.

VIX call option buyers may still remember vividly: the late February stock selloff exhibited low-volatility characteristics, with S&P 500 put options performing better. Although investors who bought VIX call options before April 2nd saw better returns, the excess returns over simple stock put options may still be insufficient to justify large allocations in hedging portfolios.

The biggest event before the September Fed meeting is this week's NVIDIA earnings. The options market suggests the stock could see 5.8% volatility following the earnings announcement, consistent with the average volatility after earnings over the past eight quarters. One-month volatility sits at the 32nd percentile of the past year, with trading volume showing a declining trend since early 2025.

"As of yesterday, the options market wasn't paying much attention to NVIDIA earnings," said Steve Sosnick, chief strategist at Interactive Brokers, on Friday. "But they should be! Whether by weight or psychological impact, NVIDIA is the most important stock in the market. If the company fails to validate the AI enthusiasm supporting the current bull market, market sentiment could undergo a major shift."