A week after JPMorgan Chase & Co.’s Marko Kolanovic issued a “Volmageddon 2.0” warning on the explosive rise in short-dated options, Bank of America Corp. strategists are pushing back.
Investor positioning in hot derivative-powered trades — like S&P 500 contracts that expire within 24 hours — looks less threatening to the wider marketplace compared with the mania that led up to the 2018 volatility rout, per BofA.
The sanguine conclusion takes aim at the likes of Kolanovic, who has issued what’s likely the loudest alarm on the boom in so-called zero-day-to-expiry options, or 0DTE. In the telling of the widely followed Wall Street quant, these fast-twitch options threaten to spur broader stock volatility, largely thanks to the hedging activity of dealers.
The reality is more nuanced, according to BofA strategists including Nitin Saksena. Given short-term options are used in so many different strategies, if one investing style were to falter, the shock to the broader equity market would likely be manageable.
Some are “raising the alarm that directional end-users are net short out-of-the-money 0DTEs, thus sowing the seeds for a ‘tail wags the dog’ event akin to the Feb-18 ‘Volmageddon,’” the strategists wrote in a note. “The evidence so far suggests that 0DTE positioning is more balanced/complex than a market that is simply one-way short tails.”
The rise of 0DTE options since mid-2022 has been often blamed for amplifying moves in underlying assets. By BofA’s estimate, such contracts now make up 40% to 45% of the index’s daily trading volume on average, up from 21% in 2021.
In Kolanovic’s view, the risk involves options dealers, who take the other side of trades and must buy and sell stocks to keep a market-neutral stance. On a big down day, such intraday selling would reach $30 billion, his model showed.
Not so fast, per BofA. To Saksena, the extreme investor positioning emboldened the 2018 “Volmageddon” episode, where everyone was betting on a decline in volatility that left the market vulnerable to a violent reversal.
Back then, the main culprits were exchange-traded products designed to pay investors the inverse of equity volatility. When turbulence in stocks ramped up in early February of that year, it triggered a snowballing effect that eventually sent many such strategies hurtling toward worthlessness, contributing to a 10% plunge in the S&P 500 over two weeks.
Right now, the ingredients for a market shock, such as extremely one-sided positioning, are largely absent, according to BofA’s Saksena. Take implied volatility, a gauge of the cost of options. For 0DTE contracts, they typically fetch a pricing premium that’s 2.5 times larger for longer-dated S&P 500 options — a level that the team said is “likely inconsistent with a market that has been overrun by option sellers.”
A JPMorgan spokesperson declined to comment on BofA’s market views.
Predicting equity moves in the modern era of fast trading has been nothing but vexing, not least when it comes to the threats posed by technical forces like dealer positioning. Oft-dreaded crashes typically fail to ensue, or break out in unexpected ways, making life harder for professional forecasters.
In any case, after tracking order flows over the day, Saksena and his colleagues found traders tend to buy options in the morning and dump them in the afternoon. The pattern applies to bullish and bearish contacts alike, again suggesting it’s not a one-way market.
Whether it’s calls or puts, owning S&P 500 options during one-hour intraday intervals would have made money, according to the bank’s study. To Saksena, that’s adding an incentive for investors to place wagers in both directions, as opposed to leaning one way that potentially exposes the market to trauma.
In 2018, “it had all the signs of a market that was very one-way short, and you knew if there was some catalyst that could light the spark. There was a huge risk waiting to unfold,” Saksena said by phone. “Right now, with positioning seeming to be more balanced — you could still get some intraday gap moves or surprising mean reversion that defies fundamentals — the hurdle rate to get a major shock is much higher.”
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