Wagging the Dog

Today is a monthly options expiration.  Even with the advent of weekly and daily expiries, a monthly – and certainly a quarterly – expiration warrants extra attention.  The expiring monthly options have been in existence for months, if not years, meaning they have been building up positions from investors with much longer-term views than the traders who have gravitated to options expiring in a week or less. Yet those who seeming rent, rather than own, options positions are having an outsized effect on daily moves.

Noting their increased popularity, we recently discussed the risks and rewards of trading short-dated options.  It is clear that traders are more focused on the rewards and the excitement of intra-day moves, since some of these volumes have become extraordinary.  Here are midday snapshots of the volumes in SPY and SPX options:

SPY – Screenshot of IBKR Options Trader

Source: Interactive Brokers

SPX – Screenshot of IBKR Options Trader

Source: Interactive Brokers

Bear in mind that the notional amount of SPX options is 10x that of SPY options.  When we compare the options volumes to the volume of the SPY ETF to those of its options and those of the underlying SPX index, options hedging clearly must be having an enormous impact on SPY.  And by definition, if SPY is being moved around, so must SPX and the market as a whole.

When ETFs began to soar in popularity, some wondered whether the ETF tail was wagging the market’s dog.  In other words, were flows into and out of sectoral and broad market ETFs driving the market in a top-down manner more than those of bottom-up movements in individual stocks? 

At this point it is increasingly hard to discern the answer to that question, since intra-market correlations have been steadily increasing.  That has always been a feature of bear markets – people tend to be less selective about what they sell when they are nervous than when they are sanguine.  But we have to now wonder how much of that is increasingly self-reinforcing.  If you want to reduce your exposure to stocks, it is quite easy to do so by selling a broad market ETF.

But if enough short-term options traders clamor for calls on a day when stocks are already moving up, we can see an explosive gamma-induced ramp.  This was a frequent Friday phenomenon during the height of the 2021 bull market, something we noted at the time.  We haven’t seen it all that much this year.  Most Fridays have closed lower, and down days rarely offer the same combination of passion and FOMO that we see on up days.  A recent MarketWatch article offered an opinion from one of my counterparts that institutions have begun acting like Wall Street Bets driven traders, except that daily index options are their “meme stock” of choice.  I don’t fully share that opinion, but I do note that there are times when it can an does occur.  Today could be one of them.

I have seen SPX rise by nearly 1% in the time it’s taken me to write this piece.  The high open interest in expiring SPY 370 calls, and the rising volume in 371 and 372 calls make me think that we could see a repeat of 2021-vintage options-driven ramp into the end of the day if exogenous factors cooperate.