(Bloomberg) -- Traders struggling to keep up with gyrations in U.S. stocks just got jolted by a surge of trading volume and wild price swings.
Transactions in stocks spiked amid a quarterly event known as quadruple witching, when options and futures on indexes and equities expire. More than 16 billion shares changed hands, 30% above the average in the past three months, while the S&P 500 reversed earlier gains to close the session lower amid renewed concern over coronavirus reinfections.
Quadruple witching usually coincides with a rebalancing of major indexes such as the S&P 500 and can spark some of the busiest trading days of the year. While the global market turmoil in March prompted S&P Dow Jones Indices to postpone the last rebalancing, the quadruple witching alone was enough to trigger a volume surge.
This time, the need to adjust stock positions appeared to be higher than usual. About $1.8 trillion of S&P 500 options were scheduled to expire, making it the third-largest non-December expiration on record, data compiled by Goldman Sachs Group Inc. showed. The index rebalancing could force $48 billion of trades, up from $30 billion six months ago, S&P Dow Jones estimated. While spikes in volume usually occur around the open and close, providing windows of robust liquidity, large price swings can happen suddenly at any time of the day.
“When we see the run-up like we’ve seen and you have investors trying to protect their portfolios, protect the gains and having the uncertainty still out there, you’ve got some big options positions in the markets right now and the decisions to roll them or not on that day is what drives the volatility,” said Chris Gaffney, president of world markets at TIAA Bank.
After a relentless run that drove the S&P 500’s gain from its March trough to over 40%, the market has settled in a new range where traders have been whipsawed by hopes for a sharp economic recovery and fears over a second wave of coronavirus infections. Stocks last week posted their worst decline since the depths of the bear market, only to see the S&P 500 ending this week higher.
The turbulence came with higher trading volume. Halfway into June, more than 13 billion shares have changed hands each day on average, on course for the second-busiest month since at least 2008.
Still, Friday’s pace of trading paled in comparison to March, when the quadruple-witching day saw volume topping 18 billion. That’s partly because a lot of options contracts were way out of money, reducing the need to roll them over and trade stocks accordingly in portfolios.
Goldman Sachs found that despite an elevated level in open interest, fewer than 2 million expiring contracts were within 10% of where the underlying index trades. That’s the smallest amount in at least a decade and underscores how the velocity of the rebound left many hedges useless. That led to what strategists including Rocky Fishman called a “light” gamma. Put another way, the value of options contracts with high sensitivity to the S&P 500’s move is very low, making the expiration less likely to drive the index’s move on Friday. Estimated at $80 billion, the gross gamma of S&P 500 options sat at the 4th percentile of its three-year range.
“Despite a very large number of contracts expiring, many of these were hedges bought during March and April and are now significantly away from the index price,” said David Silber, head of institutional equity derivatives at Citadel Securities. “As a result of such a large percentage of the open interest being significantly out of the money, this expiration could be a significantly smaller catalyst and event for the market.”
Another way to look at the event is through the lens of options dealers, who typically need to hedge their positions by buying or selling underlying stocks. Their holdings are often scrutinized to gauge the potential impact, with “long gamma” indicating they’re pushing against the prevailing trend while “short gamma” points to a tendency to go with the trend.
To Charlie McElligott, a cross-asset strategist at Nomura Securities, the fact that the S&P 500 were anchored around the 3,100-3,150 level in recent days suggested that the overall dealer profile remained “moderately long- to neutral-Gamma.” After the event, the gamma-related equity exposure could shrink by nearly 42%, he estimated.
If history is any guide, investors may need to get ready for a market pullback or a wider trading range, McElligott warned. Since 1994, the options expiration in June has seen stocks falling 88% of the time over the following week, with the S&P 500 sliding 1.2% on average, the firm’s data showed.
That pattern, along with some deteriorating momentum and breadth indicators, is a recipe for market weakness to Russ Visch, a technical analyst with BMO Capital Markets.
“Between the current technicals and the historical tendencies, the bias appears to be the downside for equities all the way out into next week,” said Visch. “The short-term pullback which began last week is not over yet.”
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