Wall Street drives explosive stock market volatility as ‘YOLO-ing’ options set to expire
Reddit lovers day traders would be back to their day jobsaccording to the Wall Street Journal, but back in the world of high finance, professional traders have embraced one of their signature trading strategies, according to a closely followed market guru.
An explosion in options trading volume with one or even zero days to expiration is helping drive the large intraday swings in major U.S. stock indices that are becoming increasingly common lately, according to Charlie McElligott, a cross-asset strategist. equity derivatives at Nomura.
The big trading shops have been buying – or, as McElligott puts it “YOLO-ing” – these near-expiry options as part of a larger trading strategy that allows them to profit by anticipating trading activity. coverage of major options brokers.
In a note to clients, McElligott compared the behavior of these professional traders to the denizens of the popular day trading-focused subreddit “Wall Street Bets.”
“YOLO’ing in 0 and 1 Days-Til-Expiration (DTE) Options has now been ‘institutionalised’ by Vol traders in many of the high street’s top funds…. says McElligott.
‘WSB’ Readers Might Recognize the ‘Porn Loss’ Strategy posts and memes that litter the popular forum, which rose to prominence in early 2021 when its readers were credited (or rather blamed) for leading the massive rally in GameStop Corp. shares.
Retail traders once dominated trading in this corner of the options market, but that has changed in recent weeks as institutional traders have taken over as retail traders have retreated, McElligott said.
Instead of playing recklessly like amateurs using Robinhood, these professional volatility traders buy these options as part of a calculated strategy to force the big dealers to move the markets in their favor, as McElligott explains.
McElligott even has a name for this type of trading: “armed gamma” which refers to the hedging strategies that dealers employ to take the risk out of their clients’ options trades.
The strategy allowed these traders to generate profits in a volatile trading environment while minimizing their risk. Traders often close trades “just hours” after opening them.
In this regard, these professionals behave like “all-out day traders, using the certainty of the dealer hedge flows their orders create to then amplify and ‘juice’ the market’s predicted directional movement,” McElligott said.
To illustrate his point, Nomura’s managing director shared several charts showing how overnight and zero-day options trading volume increased significantly as a percentage of overall S&P 500 performance-linked options trading volume. SPX,
SPDR S&P 500 ETF Trust SPY,
and the Invesco QQQ Trust Series 1 QQQ,
which are among the most popular products for stock options traders.
Investors piled into these near-expiry options ahead of last Friday’s expiration, which likely contributed to the huge intraday reversal that occurred a week ago on Oct. 13, when the S&P 500 recorded its biggest intraday recovery in percentage points since 2008, according to Dow Jones Market Data.
Options related to stock indices, exchange-traded funds, and individual stocks often expire on Fridays, but some short-term options also expire on Wednesdays. Stock options with trillions of dollars in notional value will expire on Friday.
US stocks recorded another intraday reversal on Thursday when the S&P 500 rose sharply earlier in the day before falling 29.38 points, or 0.8%, to end at 3,665.78. The Dow Jones Industrial Average DJIA,
and the Nasdaq Composite COMP,
recorded similar intraday fluctuations.