Capital Chases Gains After July Plunge, US Stock "Fear Index" Plummets, but Wall Street Turns Cautious

US stocks have staged a strong rebound from the intense deleveraging in July, with investors scrambling to chase gains and volatility indicators dropping rapidly to near-calm levels. However, Wall Street traders and strategists are issuing warnings: beneath the surface calm, the market structure hides fragility, and any external catalyst could trigger a rapid, self-reinforcing directional shock.

The VIX index plummeted from its July high of around 21 to near 15—a level historically equated with absolute market calm. Meanwhile, Goldman Sachs' internal fear indicator dropped sharply from 7.9 at the end of July to below 1, hitting its lowest point since June 2024. Bloomberg market strategist Jan-Patrick Barnert pointed out that the positioning structure left over from last month's massive deleveraging has made the market extremely vulnerable to directional shifts triggered by mechanical capital flows ahead of important risk events such as upcoming inflation data, NVIDIA's earnings report, and the Jackson Hole central bank symposium.

Three Wall Street trading desks gave nearly identical descriptions of the current August market conditions: Investors are selectively chasing gains, but not out of full conviction. Fundamentals may support current index levels, but market sentiment is far from universally optimistic.

Traces of the Rally: "Biblical" Distortions Appear in Options Market

After the brutal deleveraging in July, buy-side institutional positions were generally light, coinciding with one of the strongest earnings seasons in recent years. Meanwhile, market rotation began, with stocks outside the AI sector and high-quality AI targets becoming the core of risk-taking.

Nomura Securities cross-asset strategist Charlie McElligott stated, "Clients were caught off guard," and subsequently began chasing gains. The evidence of this chasing behavior is not reflected in price movements but is clearly imprinted in the options market: call options were snapped up, while put options rapidly lost value as indices soared away from everyone's hedging strike prices. McElligott described the resulting skew distortion as "biblical."

The one-month 25-Delta call option skew for both the S&P 500 and Nasdaq 100 indices fell to their flattest historical levels, while call option volume for the S&P 500 simultaneously hit record highs. Over the past week, realized volatility was significantly higher on up days than on down days—the market seems to worry about only one thing: missing out on subsequent gains.

Single-Stock Volatility Wiped Out, Risks Remain Beneath the Calm

Volatility at the individual stock level was largely flattened during this process. Lee Coppersmith, derivatives and flow expert at Goldman Sachs, noted that the average one-month implied volatility of Nasdaq 100 constituents fell by 9.1 percentage points in three trading days, while the decline for S&P 500 constituents reached 6 percentage points.

Coppersmith stated, "In the AI era, we have seen larger-scale volatility only during the volatility shock of August 2024 and the tariff events of April 2025." At that time, the VIX briefly broke above 60. In the past month, however, the VIX peaked at only around 21 before quickly falling back.

However, this may be precisely where the trouble lies. Although Goldman Sachs' internal fear indicator has hit a trough, a non-farm payrolls report showing a decrease of 23,000 jobs, US Treasury yields hovering near 4.7%, the latest episode of yen intervention, and the unresolved Iran conflict together paint a picture of significant macroeconomic risks. Earnings data are impressive, but the macroeconomic background fails to confirm that everything is improving.

AI Is No Longer a Broad Position, But a Stock-Picking List

At the index level, overall exposure appears to have fully shifted toward risk appetite. But beneath the surface, skepticism remains. AI trading is still the core of the market, but the thematic leading baskets are diverging. Not all targets heavily hit in July have seen a strong rebound—memory chip stocks are a typical case.

Nick Savone, Global Head of Institutional Equity Advisory & Client at Morgan Stanley, wrote: "This may be a broader lesson that familiar trades are coming back to life but not simply returning to the old script. Dispersion remains extremely high; after July's deleveraging, investors are putting capital back to work—but with more discernment."

Morgan Stanley data shows that dispersion among S&P 500 constituents is at the 92nd percentile of the past five years, while the ratio of inter-sector to intra-sector dispersion is only at the 35th percentile. This means stock-picking ability is overriding thematic allocation as the dominant market logic. AI is no longer a trade to hold broadly, but has become a list of targets from which to carefully select.

Positioning Structure: A Double-Edged Sword, Next Catalyst Could Trigger Chain Reaction

The current rally has turned the positioning structure into a double-edged sword. Aggregate dealer gamma is currently slightly short, and above the 7900 strike price, there is a batch of dealer short call positions. If the market rises further, it will accelerate the "melt-up" momentum.

The problem lies on the other side. Put options, previously "burned," are now priced well below spot prices, and the reversal point for short signals in trend-following strategies corresponds to a drop of about 4%—highly overlapping with the range where dealer short put options are concentrated.

Regarding the macro narrative, today's inflation data is not seen as the core risk for August; the market's focus is more on NVIDIA's earnings report at the end of the month and the Jackson Hole symposium. These two events align closely with the historical seasonal pattern of rising volatility in autumn.

Bloomberg strategist Barnert summarized that the gradual rebuilding of positions after the massive de-risking in July, combined with the continued demand for downside hedges, has created conditions for the market to move rapidly and violently when the next catalyst appears. Given that investors may hold neither sufficient downside protection nor sufficient upside exposure, the probability of the market remaining highly dynamic is quite high.

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