A $4 Trillion Options Event Endangers Stock Market Calm

All week, stock traders have shrugged off everything from hot inflation data in the US to another recession-threatening hike in interest rates over in Europe.

(Bloomberg) — All week, stock traders have shrugged off everything from hot inflation data in the US to another recession-threatening hike in interest rates over in Europe. 

Now comes a $4 trillion options event that has historically stoked turbulence, just as equities are mired in the most subdued trading in two years. 

In a quarterly episode ominously known as triple witching, piles of derivatives contracts tied to stocks, index options and futures are scheduled to mature Friday — compelling traders en masse to roll over their existing positions or to start new ones. This time, it coincides with the rebalancing of benchmark indexes including the S&P 500, another catalyst for more share transactions.  

Though the risk is sometimes overblown by Wall Street players, the options event has a reputation for causing sudden price moves. And the one in September has typically been followed by an equity swoon the ensuing week.

One player to watch: Dealers on the other side of options transactions who are obliged to buy and sell stocks to maintain a market-neutral stance. A shift in their stock exposure, known by esoteric concepts like gamma, was cited as fueling the August selloff and is now blamed for this month’s inertia. 

“It’s possible that the September open interest leans ‘long gamma’, which would have contributed to low realized vol in the last few days,” said Rocky Fishman, founder of derivatives analytical firm Asym 500. “Taking away that long gamma could potentially lead to a return to more normal volatility environment over the next week or two.”

The S&P 500 climbed 0.8% on Thursday, extending its streak without a 1% daily move all month. Over the stretch, up and down session were almost even, and fewer than 10 billion shares changed hands for each day, a streak of anemic trading not seen since October 2021. 

Despite August’s decline and the subsequent bounce, the market has yet to make meaningful progress either way. The S&P 500 has hovered within 2% of its 50-day moving average — a trendline widely watched by traders — for 27 days in a row, the longest run in six years.

Going by seasonal patterns, next week is ominous for stock bulls. Since 1990, the S&P 500 has fallen in the week following September’s triple witching 79% of the time, losing an average 1% in all instances.

Still, there are bigger bullish forces at play. Scott Rubner, Goldman Sachs Group Inc.’s managing director, notes growing optimism among institutional clients, who are starting to discuss allocating more money to stocks in preparation for a potential fourth-quarter rally.

Broadly, many investors have missed the stunning 2023 equity advance, favoring cash and fixed income. Since January, global money market funds have drawn $1 trillion while inflows to bond funds reached $236 billion, each dwarfing a mere addition of $90 billion for equities, data compiled by Goldman showed.

As the calendar flips to a new quarter in coming weeks, individual investors are likely to rotate money out of cash and into stocks to catch up to a buoyant market, according to Rubner, who has studied flow of funds for two decades.  

“Equity allocations remain low and there is an interest to close this gap in October,” he wrote in a note. “I would think that higher prices bring out more buyers.” 

–With assistance from Terrell Holt.

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