U.S. stocks could see increasingly wild swings in the coming days as options contracts tied to trillions of dollars in securities are set to expire on Friday, removing a buffer some say helped push the S&P 500 preventing the index from breaking out of a tight trading range.
$2.8 trillion in options contracts will expire during Friday’s “quadruple witching” event, according to figures from Goldman Sachs Group GS.
“Quadruple witching,” as it’s known, 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 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 “in the money” contracts to claim their profits.
However, a top derivatives analyst at Goldman sees the potential for stocks to experience even wilder swings in the coming sessions as a spate of contracts that have helped quell stock market volatility expires.
Options expiring Friday could “remove the 4k pinner that has been keeping large moves in check,” Scott Rubner, a managing director and top derivatives strategist at Goldman, said in a note to clients received by MarketWatch. This could make the S&P 500 more vulnerable to a large swing either way.
“Definitely. We’re moving next week.”
Since the beginning of the year, the S&P 500 has traded in a narrow channel of about 400 points, bounded 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 linked 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 you hold.
This is no coincidence. Over the past year, trading options contracts that are about to expire, known as “zero-days to expiration” or “0DTE” options, has become increasingly popular.
One result of this trend is that it has helped keep stocks rangebound while fueling more intraday swings within that range, a pattern that several traders have likened 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.
Earlier this week, trading in 0DTEs helped keep the S&P 500 from falling below 3,800 as markets reeled after the closure of three US banks, according to Brent Kochuba, founder of SpotGamma, a data provider and analysis of the options market.
Analysts say this is one reason the Cboe Volatility Index
VIX, also known as the Vix or Wall Street Volatility Gauge, has remained 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 quiet Treasuries 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 visited in October.
However, some believe that could change as of Friday.
Certainly, Friday isn’t the only session where large amounts of option contracts will expire next week. A number of contracts linked to the Vix expire on Wednesday, the same day the Federal Reserve is due to announce its latest rate hike decision.
“50% of all Vix open interests expire on Wednesday. That’s pretty significant,” Kochuba said in an interview with MarketWatch.
The bottom line is that this could help the Vix “catch up” on the MOVE, which could result in a sharp sell-off in stocks, according to Alon Rosin and Sam Skinner, two equity derivatives experts at Oppenheimer.
“The bottom line is there’s probably going to be more volatility coming into the stock market,” Skinner said during a conversation with MarketWatch. “And the Vix understates it.”
Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets, had a similar sentiment. In email comments shared with MarketWatch, she said she expects “volatility levels to remain elevated” and that the Fed meeting is next week.
Futures traders are pricing in a high probability that the Fed will hike interest rates by 25 basis points. However, according to the CME’s FedWatch tool, traders still see around a 20% chance that the Fed could decide to leave rates on hold.