(Bloomberg) – Nowhere better illustrates Wall Street’s fervent sentiment than the derivatives market, where trading volume is breaking records ahead of the expiration of $2.1 trillion in options on Friday.
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The monthly event, known as OpEx, is notorious for causing volatility as traders and dealers rebalance their large exposures in bulk. Now, with demand for rising and falling index contracts exploding while hedging for single stocks is growing in popularity, OpEx comes at a precarious time.
Twice this week, the S&P 500 briefly crossed 4,000 – a battleground for traders with the highest open interest among the contracts due to launch on Friday. The benchmark index has fallen three of the past four sessions, after rising more than 5% last Thursday as promising inflation data sparked a wave of short-term offset buying and calls. The index fell 0.3% to close at 3,947 on Thursday.
Amateurs and pros have flocked to short-term contracts in response to the market boom at the end of the year, an activity that has had a major impact on the underlying stocks. That suggests Friday’s options outflow could send the stock swinging further.
Not everyone agrees with the idea that derivatives have such power. But for some market watchers, it’s no coincidence that OpEx week saw stocks fall for eight of the past 10 months.
“Options and tails have fallen sharply and present a good opportunity” to add hedging measures, said Amy Wu Silverman, strategist at RBC Capital Markets. said, at the same time citing the possibility that rising inflation will increase pressure on the stock market.
Market volatility caused by the Federal Reserve is encouraging investors to go all-in on options to bet bullish and bearish alike. About 46 million options contracts changed hands each day in November, poised for the busiest month on record, according to data compiled by Bloomberg. That’s a 12% increase from the previous month.
The boom was partly due to derivatives expiring within 24 hours. Such contracts accounted for 44 percent of S&P 500 options trading in the past month, according to estimates by Goldman Sachs Group Inc. strategists, including Rocky Fishman.
At the same time, hedging activity on single stocks has just exploded. The Cboe equity deal rate on Wednesday surged to its highest level since 1997. From soaring earnings for tech giants to the uncertain path of the Federal Reserve’s monetary policy Federal Reserve, volatility is the only certainty in the market.
However, there is nothing simple in this corner of Wall Street giving mixed signals about investor positioning to glean sentiment. For example, judging by the deviation of the S&P 500 — the relative cost of the put versus the call has hovered near multi-year lows — traders are more optimistic.
And thanks to the short shelf lives of options that are currently in demand, open interest on S&P 500 contracts has grown at a much slower pace, growing just 4% from the day before the last OpEx. . Although with 20 million outstanding contracts, open interest is the highest since March 2020.
“We’ve seen a lot of interest lately from short-term call and offset buyers,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “One could argue that puts us more exposed to the downside, but overall the mood remains hopeful. That is why Fed governors feel the need to constantly remind us of their resolve to fight inflation.”
While it is not easy to get a clear picture of an investor’s position in options, deviations create opportunities for traders.
According to Goldman’s Fishman, reducing interest rate volatility will help stabilize the stock market. He recommends buying a put on the Cboe Volatility Index, or VIX, for a bet on the possibility of stability at the end of the year. The Cboe VVIX index, a measure of the cost of VIX options, has been below the 20th percentile of the range for the past decade, an indication of attractive prices, according to Fishman.
“The low deflection and vol-of-volt suggest that concerns about tail risk have subsided,” he wrote in a note.
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