As Monthly Expirations Go, January is a Big One

By now, options traders have become quite inured to expirations.  They were a big deal when I started in the business.  Options expired on the third Friday of each month and index futures expired on the third Friday of months that contained a quarter’s end.  Over time we have become quite used to weekly expirations in the most active equity options classes and now have thrice-weekly expiry of key ETFs like SPY and QQQ.  Triple-witching (and for a while, quadruple-witching) was a big deal – a day when unexpected volatility could rear its head in strange ways.

As we have all experienced, the more you do something the easier it tends to get.^[i]  The same applies to options expirations.  Market makers, index rebalancers, and other market participants simply got better at anticipating outcomes and hedging them with minimal impact.  Although we have seen significant moves around recent quarterly expirations, and weekly expirations took on added significance in recent months as individual traders became increasingly enamored with options speculation, expirations generally don’t move markets simply because it’s the third Friday of the month anymore.

That said, January’s expiration is first among equals when it comes to monthly expirations.  We have the popularity of LEAPS to thank for that.  LEAPS is an acronym for Long-term Equity Anticipation Securities, a catchy way of branding options with 1-3 year expiries.  LEAPS have become popular with a wide range of investors, either as a lower-cost tool for speculation or as a long-term hedge against specific stocks, portfolios and even bonds.^[ii]  An interesting feature of LEAPS is that the listings are dynamic.  As a stock moves, the exchanges tend to list new strikes so that there will always be a reasonable range of strikes that are near the money.  That can lead to a ridiculous number of expiring strikes in a given January.

Take Tesla (TSLA) as an extreme example.  TSLA was trading around $50 (on a split-adjusted basis) in the fall of 2019, which is when this week’s expiring LEAPS were first listed.  As the stock was propelled from that level to its recent highs around $1250 (!), new strikes were added.  There are strikes in $1 increments from $1 to $200, in $2 increments from $200 to nearly $400, and a mix of $5 and $10 increments up to $1400 and $25 increments all the way to $2475.  As a result we have literally hundreds of strikes expiring in TSLA alone on Friday!  I always joked that the system breathed a sigh of relief on the Monday that followed January expiration, simply because there were so many fewer strikes to be priced and updated.

Much has been made of the fact that over $3 trillion in notional value is set to expire tomorrow.  I will assert that much of that figure is inflated by open interest in expiring LEAPS that are either deeply in- or out-of-the-money, with deltas of 0 or 100.  Those options are too far away to require much additional hedging.  That said, I do believe that some of the extraordinary movements that we have seen this week are at least peripherally related to this week’s monthly expiration.  Remember, every time a stock crosses an expiring strike, some trader needs to re-hedge.  We have crossed a significant number of strikes this week – first on the way down, and now some on the way back up after today’s bounce.  The LEAPS with extreme strikes, while a significant piece of the expiration cycle, are not causing the volatility tied to this week’s expiration.

[i] This is particularly appropriate if you’ve ever needed to assemble furniture armed only with a hex wrench and pictograms

[ii] This linkage took on great significance in 2008, when credit default swaps were being actively hedged with low-strike, long-term options.  The logic is sound – if a company is headed for bankruptcy, and hence a bond default, its will likely head toward zero.  Bond creditors rank above equity holders in settling a bankruptcy.