U.S. stocks could continue to swing wildly in the coming days as option contracts tied to trillions of dollars worth of securities expire on Friday, removing a buffer that some say has helped prevent the S&P 500 index from breaking out of a tight trading range.
Options contracts worth $2.8 trillion will expire during Friday’s ‘quadruple witches’ event, according to Goldman Sachs Group figures
GS
.
“Quadruple witching,” as it’s called, occurs when stock futures and options contracts linked to individual stocks and indices — as well as exchange-traded funds — all expire on the same day. Some option contracts expire in the morning, others expire in the afternoon. This usually happens four times a year, about once a quarter.
Days like this sometimes coincide with volatility in the markets as traders scramble to cut their losses or exercise “in the money” contracts to claim their profits.
However, a top derivatives analyst at Goldman sees the potential for stocks to see even wilder swings in the coming sessions as a burst of contracts that have helped quell stock market volatility.
Options expiring on Friday could “remove the 4k pinner that has been holding back big moves,” Scott Rubner, a general manager and top derivatives strategist at Goldman, said in a note to clients obtained by MarketWatch. This could make the S&P 500 more vulnerable to a big swing in either direction.
“Anyway. We’re moving next week.”
Since the start of the year, the S&P 500 has traded in a narrow channel of about 400 points bordered by 3,800 on the downside and 4,200 on the upside, according to data from FactSet.
These levels correspond to some of the most popular strike prices for options tied to the S&P 500, 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 one holds.
That’s no coincidence. Over the past year, trading expiring option contracts, also known as “zero-days to expiration” or “0DTE” options, has become increasingly popular.
One result of this trend is that they have helped keep the stock within a narrow range while fueling more intraday swings within that range, a pattern several traders have compared to a “game of ping pong.”
According to Goldman, 0DTEs represent more than 40% of the average daily trading volume in contracts linked to the S&P 500.
Earlier this week, trading 0DTEs helped prevent the S&P 500 from breaking below the 3,800 level as markets reeled after the closure of three U.S. banks, according to Brent Kochuba, founder of SpotGamma, a provider of data and analytics on the options market.
Analysts say this is one reason the Cboe Volatility Index
VI
,
also known as the Vix of Wall Street volatility meter, has remained so subdued compared to the ICE BofAML MOVE Index, a measure of implied volatility for the Treasury market, Kochuba and others told MarketWatch.
The MOVE index impressed traders earlier this week as volatility in normally calm government bonds pushed it to its highest level since the 2008 financial crisis. Meanwhile, the Vix VIX barely managed to break above 30, a level it last reached in October.
But some think that may change from Friday.
Certainly, Friday is not the only session where large volumes of options contracts expire in the coming week. On Wednesday, a series of contracts tied to the Vix will expire on the same day the Federal Reserve will announce its final rate hike decision.
“50% of all Vix outstanding interest due on Wednesday. That’s quite a lot,” Kochuba said during an interview with MarketWatch.
The end result is that this could help the Vix catch up with the MOVE, something that could result in a sharp sell-off in stocks, said Alon Rosin and Sam Skinner, two equity derivatives experts at Oppenheimer.
“The bottom line is this: More volatility is likely coming to the stock market,” Skinner said while speaking to MarketWatch. “And the Vix is priced too low.”
Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets, took a similar view. In comments shared by email with MarketWatch, she said she expects “volatility levels to remain high” ahead of next week’s Fed meeting.
Futures traders are estimating the likelihood that the Fed will raise its policy rate by 25 basis points. However, according to the CME’s FedWatch tool, traders still see a roughly 20% chance that the Fed could elect to leave interest rates unchanged.