U.S. stocks could see increasingly wild swings in the coming days as options contracts tied to trillions of dollars worth of securities are due to expire on Friday, removing a buffer that some say helped thwart the index S&P 500 to break out of a narrow trading range. .
Options contracts worth $2.8 trillion set to expire at Friday’s ‘quadruple sorcery’ event, according to figures from Goldman Sachs Group
GS
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The so-called “quadruple witchcraft” occurs when stock futures and option contracts tied to individual stocks and indices – as well as exchange-traded funds – all expire on the same day. Some option contracts expire in the morning, while others expire in the afternoon. This usually happens four times a year, about once a quarter.
Days like these sometimes coincide with market volatility as traders scramble to cut their losses or exercise “in the money” contracts to claim their gains.
However, a leading derivatives analyst at Goldman sees the potential for stocks to see even wilder swings in the coming sessions as a series of contracts that have helped suppress stock market volatility expire.
Options expiring on Friday could “remove the 4k pinner that has kept a lid on big moves,” said Scott Rubner, managing director and senior derivatives strategist at Goldman, in a note to clients obtained by MarketWatch. This could make the S&P 500 more vulnerable to a big swing in either direction.
“In both cases. We will be moving next week.”
Year-to-date, the S&P 500 has traded in a narrow channel of about 400 points bounded by 3,800 down and 4,200 up, according to FactSet data.
These levels correspond to some of the most popular strike prices for S&P 500-linked options, according to data from Rubner’s note. A strike price is the level at which the holder of a contract has the option, but not the obligation, to buy or sell a security, depending on the type of option he holds.
It is not a coincidence. Over the past year, trading options contracts that are about to expire, known as “zero-days to expiration” or “0DTE” options, has become increasingly popular.
One of the results of this trend is that they have helped to keep stocks within a narrow range, while fueling more intraday swings within that range, a pattern several traders have likened to a “game of ping-pong”. .
According to Goldman, 0DTEs represent more than 40% of the average daily trading volume of contracts linked to the S&P 500.
According to Brent Kochuba, founder of SpotGamma, an options market data and analysis provider, earlier this week trading in 0DTE helped prevent the S&P 500 from falling below the 3,800 level as markets collapsed after the closure of three US banks.
Analysts say this is one reason the Cboe Volatility Index
VIX
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otherwise known as the Vix or Wall Street volatility gauge, remained so subdued against the ICE BofAML MOVE Index, an implied volatility gauge for the Treasury market, Kochuba and others told MarketWatch.
The MOVE index wowed traders earlier this week as volatility in normally placid Treasuries sent it soaring to its highest level since the 2008 financial crisis. Meanwhile, the Vix VIX barely made it to exceed 30, a level it last reached in October.
But some think that could change from Friday.
To be sure, Friday isn’t the only session where large lots of options contracts are set to expire over the next week. On Wednesday, a series of Vix-linked contracts will expire on the same day the Federal Reserve is expected to announce its latest interest rate hike decision.
“50% of all Vix open interest expires Wednesday. It’s quite significant,” Kochuba said in an interview with MarketWatch.
The end result is that it could help the Vix “catch up” to the MOVE, which could lead to a strong sell-off in stocks, according to Alon Rosin and Sam Skinner, two equity derivatives experts at Oppenheimer.
“The bottom line is this: more volatility is likely to come to the equity market,” Skinner said on a call with MarketWatch. “And the Vix undervalues it.”
Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets, expressed a similar view. In email comments shared with MarketWatch, she said she expects “volatility levels to remain elevated” ahead of next week’s Fed meeting.
Futures traders are pricing in a strong likelihood that the Fed will raise its key rate by 25 basis points. However, traders still see around a 20% chance that the Fed could choose to leave interest rates unchanged, according to the CME’s FedWatch tool.