(Bloomberg) — Nowhere is Wall Street’s febrile mood better reflected than in the stock derivatives market, where Friday’s $2.1 trillion options expiration saw record-breaking trading volumes.
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The monthly event, known as OpEx, is known for maintaining volatility as traders and dealers rebalance their large exposures en masse. Now, with demand for bullish and bearish index contracts growing and hedging in individual stocks becoming increasingly popular, OpEx comes at a precarious time.
Twice this week, the S&P 500 has briefly crossed 4,000 — a threshold for traders who have received the highest open interest among contracts due to roll out on Friday. The benchmark measure has fallen in three of the past four sessions, after jumping more than 5% last Thursday on promising inflation data that sparked a wave of short covering and call buying. The index fell 0.3% to close at 3,947 on Thursday.
Amateurs and professionals alike are turning to short-term contracts to deal with the recent market whiplash, an activity that has had a profound effect on common stocks. That suggests Friday’s options run could expose stocks to another price swing.
Not everyone buys the idea that derivatives have this kind of power. But for some market watchers, it’s no coincidence that stocks fell in eight of the past 10 months during OpEx week.
“Options prices and tails have come down a lot and provide a good opportunity” to add protective hedges, said Amy Wu Silverman, strategist at RBC Capital Markets, citing the possibility of renewed inflationary pressure. on equity.
Market gyrations caused by the Federal Reserve are encouraging investors to make all-in options to place both bullish and bearish bets. About 46 million options contracts changed hands each day in November, on pace for the busiest month on record, data compiled by Bloomberg show. That’s up 12% from last month.
The boom was driven in part by derivatives maturing within 24 hours. Such contracts accounted for 44% of S&P 500 options traded in the past month, according to estimates by Goldman Sachs Group Inc. strategists. including Rocky Fishman.
At the same time hedging activity in individual stocks had just exploded. The Cboe equity call ratio rose on Wednesday to its highest level since 1997. From rising earnings at tech giants to the uncertain path of the Federal Reserve’s monetary policy, volatility is the only certainty in the market.
Still, nothing is ever simple in this corner of Wall Street when investors’ site to get sentiment is given mixed signals. For example, catching the skew of the S&P 500 — the relative cost of calls versus calls that have stayed near multi-year lows — makes traders look smarter.
And thanks to the short shelf life of currently popular options, open interest in S&P 500 contracts has increased at a much slower pace, rising just 4% from the day before the last OpEx. While there are 20 million contracts outstanding, open interest was the highest since March 2020.
“Buyers of calls and short covering have seen a lot of interest recently,” said Steve Sosnick, chief strategist at Interactive Brokers LLC. “It could be argued that leaves us a bit more exposed to a move down, but the mood tends to be optimistic. That’s why Fed governors feel the need to continually remind us of their intention to fight inflation.”
Although it is not easy to get a clear picture of the position of investors in options, dislocations create opportunities for traders.
Interest rate volatility will help keep the equity market healthy, according to Goldman’s Fishman. He suggests buying instruments on the Cboe Volatility Index, or VIX, to bet on a possible calm at the end of the year. The Cboe VVIX Index, a measure of the cost of VIX options, was below its 20th percentile of a decade-long range, an indication of attractive pricing, against the Fish.
“Low skew and volume indicate reduced concern about tail risk,” he wrote in a note.
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