Ahead of the most significant options expiration on record for S&P 500-linked derivatives, with approximately $5 trillion in U.S. stock options set to expire on Friday, market participants suggest that dealers squaring their books may contribute to subdued volatility in U.S. stocks.
According to Asym500 MRA Institutional, 80% of the options set to expire are in S&P 500-linked contracts, marking the largest such expiration in at least two decades. While significant options expirations can typically amplify market volatility, strategic behavior leading up to this expiration has contributed to muted stock gyrations.
The S&P 500, which has gained 21% this year, experienced a period of subdued market moves, with the benchmark index not witnessing a move greater than 1% in either direction for 19 consecutive sessions. During this time, the Cboe Volatility Index (VIX) reached a near four-year low at 12.07. Additionally, the 10-day realized volatility for the S&P 500, measuring the index’s swings over the last ten sessions, is 6.8%, reflecting the market’s recent stability.
Options dealers, serving as intermediaries between buyers and sellers of derivatives, have played a role in constraining stock swings. Robust options trading volume, on pace for a record year with an average daily volume of 44 million contracts, has been fueled partly by the popularity of exchange-traded funds (ETFs) engaged in options selling to generate income. These ETFs will double in size in 2023, controlling around $60 billion. The resulting selling activity has left dealers with substantial options contracts, positioning them as net long “gamma.”
Nomura strategist Charlie McElligott suggests that the dealers’ net long “gamma” position, requiring continuous selling of stock futures during equity rallies and buying during market declines to maintain neutrality, will likely prevent a deeper selloff between now and year-end. Market participants have also attributed the subdued stock moves to factors such as volatility targeting funds, commodity trading advisers, and the historical tendency of the VIX to stay subdued once it hits the bottom of its trading range.
While the Federal Reserve meeting on Wednesday is anticipated to maintain unchanged interest rates, investors are eager for signals regarding potential rate-cutting shifts. Despite the expiration potentially easing the grip of the options market on stocks, market observers draw parallels to a similar situation two years ago when a large options expiration subdued volatility temporarily, followed by a 3% rally in the last two weeks of the year.
