Another big data day is testing animal spirits that seem to be keeping stock markets from running off a cliff, despite rising bond yields and signs of a strong economy that may lock in tighter Fed policy for longer.
Producer prices came in hotter than expected and stock futures are falling.
Onto our call of the day, which warns of “Volmageddon” from an increasingly popular short-term options strategy that could cause market chaos. It comes from a team led by JPMorgan’s top strategist, Marko Kolanovic, who also warned of a U.S. stocks peak earlier this week.
Kolanovic and his team noted “very large volumes” on zero days to options expirations (0DTEs) — puts and calls on stocks and indexes that expire within 24 hours. Refresher: a call option gives an investor to buy an asset at a specific price by a specific date, while a put option allows an investor to sell that asset at a certain price by a certain date.
Kolanovic’s chart shows what he sees as pretty high daily notional volumes — around $1 trillion.
His main concern is a repeat of what was seen in February 2018, when a spike in volatility crushed short volatility strategies, dubbed “Volmaggedon.” By some estimates it wiped out $2 billion in investor assets.
“While history doesn’t repeat, it often rhymes, and current selling of 0DTE (zero day to expiry), daily and weekly options is having a similar impact on markets,” said Kolanovic.
“If there is a big move when these options get in the money, and sellers cannot support these positions, forced covering would result in very large directional flows. These flows could particularly impact markets given the current low liquidity environment,” he added.
As he explained, these are typically “low delta options that rarely get in the money and their impact is mostly through volatility suppression and an intraday buy-the-dip pattern that results from hedging,” Kolanovic says. Delta is a metric that measures how much the price of a derivative would change, given a $1 shift in its underlying security.
MarketWatch’s Joe Adinolfi noted last October that 0DTE strategies were getting increasingly common, notably among institutional traders, who wanted to profit by anticipating the hedging activity of large options dealers.
Others have warned about 0DTEs and the risk they pose for markets. Seabreeze Partners Management’s Doug Kass recently cautioned that investors had grown confident after the January market rally, but failed to realize how changing market structures had been influencing market direction, namely those options on the brink of expiring.
All this options talk comes as Bloomberg reports the possible return of the “50 Cent” VIX trader, who turned a loss into a profit of nearly $400 million, owing to tiny bets on a volatility spike during that February 2018 mayhem.
Transactions from late Tuesday showed an investor paid 50 cents each for 100,000 call contracts, with a value of $5 million. The bet is that the Cboe Volatility Index VIX, +8.61%, which currently stands at 18, will soar to 50 by May. A similar purchase on Wednesday saw 50,000 such contracts bought at 51 cents each — a total of $2.6 million.
Stocks SPX, -1.13% DJIA, -1.02% COMP, -1.21% are dropping post data, with bond yields TMUBMUSD10Y, 3.860% TMUBMUSD02Y, 4.665% rising and the dollar DXY, +0.13% reversing an earlier loss. Oil CL.1, +0.55% BRN00, +0.41% is flat. The FTSE 100 UKX, -0.15% hit a fresh record above 8,000, in part due to a weak pound GBPUSD, -0.43%.
Bitcoin BTCUSD, +0.97% is hovering at 6-month highs. That won’t do anything for Berkshire Hathaway’s vice chairman Charlie Munger, who has said referred to anyone investing in cryptos as “idiots.”
For more market updates plus actionable trade ideas for stocks, options and crypto, subscribe to MarketDiem by Investor’s Business Daily.
Fresh data shows producer prices rose 0.7% in January, higher than forecast, while core prices rose 0.6%. Weekly jobless claims slipped 1,000 to 194,000, building permits rose 0.1% and housing starts fell 4.5%. A Philly Fed manufacturing survey fell to a negative 24.3 in February.
Cisco’s stock CSCO, +6.07% is rising on an earnings and revenue beat and an upbeat outlook, having seemingly made it through a pandemic pothole.
Shopify stock SHOP, -16.35% is down 9% after the e-commerce company’s disappointing forecast. Roku ROKU, +11.64% is up 10% after the streaming-device maker’s sizable revenue beat. And Zillow shares Z, -0.38% are rising after the real estate services group also beat on revenue. WeWork WE, -4.91% stock is up after mixed results from the shared-office provider.
Chip-equipment maker Applied Materials AMAT, -2.06% will report after the close.
China slapped trade and investment sanctions on Lockheed Martin LMT, -1.92% and Raytheon RTX, -1.23% Thursday for supplying weapons to Taiwan.
The creator of famed Reddit community WallStreetBets is suing the social news aggregator for ousting him as moderator.
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This article was originally published by Marketwatch.com. Read the original article here.