Trillions in Options Contracts Mature Amid Market Complexity and Uncertainty
Wall Street's attention has been caught by the surge of stock options that expire within 24 hours, which $Goldman Sachs (GS.US)$ warns may be contributing to the recent market selloff.
The monthly OpEx (options expiration) event is back in the spotlight as $2.2 trillion of longer-dated contracts tied to stocks and indexes are set to mature on Friday. Investors must decide whether to roll over their options or start new positions, resulting in a spike in trading and sudden price swings. This occurs at a crucial moment, with the $S&P 500 Index (.SPX.US)$ 's big rally this year starting to falter amid bets that the resilient US economy will force the Federal Reserve to increase interest rates even higher.
While the options event usually provides a window of liquidity for anyone hoping to shuffle large positions, it adds another wrinkle of complexity for a capricious equity market — prone to intraday selloffs and frequent reversals.
While stocks have often risen after the OpEx event, predicting its outcome is still uncertain. Therefore, investors are advised to consider buying protection, especially with the upcoming Jackson Hole event (Kansas City Fed's annual policy forum in Jackson Hole). According to Brent Kochuba of SpotGamma, the current low cost of options makes it reasonable to purchase longer-dated put hedges as implied volatility has not yet reacted to the S&P 500 downside.
The OpEx frees up some directional movement, which is catalyzed by next week's Jackson Hole," he said. "It's a reasonable time to pick up some longer-dated put hedges as implied volatility has not (yet) reacted to SPX downside."
The S&P 500 has fallen for three consecutive weeks and is down by almost 5% in August, which may lead investors to hedge against losses. Funds like the Global X Nasdaq 100 Covered Call ETF that rebalance their holdings monthly add uncertainty to the market.
$JPMorgan (JPM.US)$'s trading desk believes that the current market pullback is temporary, and equities will eventually reach all-time highs again due to increasing earnings estimates and stronger-than-expected economic data.
Head of derivatives strategy at RBC Capital Markets, Amy Wu Silverman, warns that the upcoming Jackson Hole event could increase market volatility, and dealers' stance can worsen any equity pullback rapidly.
There has been a lot of talk of the market flipping from 'long gamma' to 'short gamma,'" she said. "It means that as we sell off we are hitting more points where there are put buyers not put sellers. Put buyers tend to exacerbate negative moves because dealers sell shares."
Source: Bloomberg
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