March 30, 2023

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US stocks are bracing for wild swings as trillions of options contracts are set to expire on Friday

US stocks could see increasingly wild volatility in the coming days as options contracts tied to trillions of dollars in securities are set to expire on Friday, removing the buffer that some say helped prevent the S&P 500 from breaking out of a narrow trading range. .

$2.8 trillion worth of options contracts are set to expire during Friday’s “Magic Quadruple” event, according to figures from Goldman Sachs Group.

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“Quadruple magic,” as it’s known, occurs when stock futures and option contracts tied to individual stocks and indices — as well as exchange-traded funds — expire on the same day. Some options 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 volatility in the markets as traders scramble to cut their losses or exercise “the money” contracts to claim their profits.

However, according to a senior derivatives analyst at Goldman Sachs, the possibility of stocks seeing sharper swings in the sessions comes with the expiration of a series of contracts that helped suppress volatility in the stock market.

Options expiring Friday may “remove the 4K ID token that kept a lid on large moves,” Scott Rubner, managing director and chief derivatives analyst at Goldman, said in a note to clients obtained by MarketWatch. This could make the S&P 500 more vulnerable to a significant swing in either direction.

“Either way. We’ll move 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.

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These levels correspond to some of the most popular strike prices for options associated with the S&P 500 index, according to data from Roebner’s note. The strike price is the level at which the contract holder has the opportunity – but not the obligation – to buy or sell a security, depending on the type of option the individual holds.

This is no coincidence. Over the past year, trading options contracts about to expire, known as “zero days to expiration” or “0DTE” options, has become increasingly popular.

One consequence of this trend is that it has helped keep stocks in a tight range, with more fueling intraday volatility within that range, a pattern many traders have compared to “a game of ping pong.”

According to Goldman, 0DTEs account for more than 40% of the average daily trading volume in contracts linked to the S&P 500 index.

Earlier this week, trading in 0DTEs helped prevent the S&P 500 from breaking below the 3,800 level as markets reeled after the closure of three US banks, according to Brent Kochuba, founder of SpotGamma, a provider of data and analytics on the options market.

Analysts say this is one of the reasons for the Cboe’s volatility index

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The measure, also known as the Vix or Wall Street volatility measure, remained very weak compared to the ICE BofAML MOVE Index, Kochuba and others told MarketWatch, which is a measure of the Treasury market’s implied volatility.

The MOVE Index spooked traders earlier this week as normally quiet volatility in Treasurys sent it climbing to the highest level since the 2008 financial crisis. Meanwhile, the Vix VIX He had barely managed to break through to level 30, which was the level he had visited as recently as October.

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But some believe that may change starting Friday.

Friday is certainly not the only session where large options contracts expire over the next week. On Wednesday, a group of contracts linked to the Vix will expire on the same day the Federal Reserve is set to announce its latest interest rate hike.

50% of all open Vix benefits expire on Wednesday. Kochuba said during an interview with MarketWatch.

The upshot is that this could help the Vix “catch up” to MOVE, something that could trigger a sharp sell-off in stocks, according to Alon Rosen and Sam Skinner, equity derivatives experts at Oppenheimer.

“The bottom line is: More volatility is likely to come to the stock market,” Skinner said during a call with MarketWatch. And Vix lowers its price.

Amy Wu Silverman, an equity derivatives analyst at RBC Capital Markets, expressed a similar view. In email comments shared with MarketWatch, she said she expects “volatility levels to remain elevated” as the Federal Reserve meets next week.

Futures traders are pricing in the high possibility that the Fed will raise its policy rate by 25 basis points. However, traders still see a roughly 20% chance that the Fed will choose to leave interest rates on hold, according to CME’s FedWatch tool.