Look closely at the contours of Tuesday’s tumble in the S&P 500 and fingerprints of a new market force come into focus.
They’re options tied to S&P 500 with a maturity of less than 24 hours. A flurry of trading in the contracts known as zero days to expiration, or 0DTE, was the backdrop to a jarring acceleration of the day’s decline, one in which the equity benchmark slid roughly 0.4% in 20 minutes, according to Goldman Sachs Group Inc.’s managing director Scott Rubner.
According to Rubner, market makers, whose need to keep books balanced often means they must buy or sell stock en masse when options orders cascade in, were forced into action by furious trading in bearish puts with a strike price at 4,440. Those options saw almost 100,000 contracts change hands during the session or $45 billion in notional value.
As their cost spiked to $9 from 70 cents in a short span near the session’s end, it sent market makers on the other side of transactions in a dash for hedges to stay market neutral. In this case, that meant an exodus from equities.
“There is not enough liquidity on the screens to handle market makers delta hedging such a dramatic move over a short 20 minute period,” Rubner, who has studied flow of funds for two decades, wrote in a note Wednesday.
His analysis is the latest to venture views on the impact of zero-day options on the underlying stock market. Earlier this week, research from Nomura Securities International and Citigroup Inc. showed that trading in 0DTE contracts has exploded to record highs this month, with traders pivoting toward puts. The mushrooming popularity, while likely a consequence of a break in the 10-month equity rally, may have been contributing to intensified intraday swings, according to Nomura.
UBS Group AG’s trading desk echoed the view. In a note from Tuesday, the team laid out case studies on three particularly busy sessions for zero-day options — July 27, when news about Bank of Japan’s potential hawkish move in monetary policy broke; Aug. 4, the day of the latest US monthly payrolls data; and Aug. 10, when America’s consumer price index was released.
The afternoon selloffs on July 27 and Aug. 4, the UBS team found, coincided with a wave of put purchases in zero-day options. On Aug. 10, a morning rout was similarly driven by put trading, and when investors started to book profits on these contracts later in the session, that fueled a market turnaround that then lured traders to chase gains via calls — further pushing stocks higher.
Amplifying the influence of zero-day options is a market where it’s getting harder to trade stocks without moving their prices, according to Goldman’s Rubner. By his estimate, the liquidity condition has worsened over the past two weeks, with a measure plunging 56%.
The S&P 500 on Tuesday closed below its 50-day moving average for the first time since late March. With its high-low movement averaging 1% in the past five sessions, the index’s gyration is almost double the level seen in July, data compiled by Bloomberg shows.
The pickup in volatility, along with receding momentum, threatens to turn rules-based investors into sellers, Rubner warned. Those strategies making asset allocations based on trend and price signals have been among this year’s largest equity buyers.
“There has been a clear shift in sentiment over the past few weeks across my persistent IB, zooms, trading calls,” Rubner wrote. “This is no longer a buy-the-dip market.”
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