The intraday fluctuations of the S&P 500 index are being constrained by a group of contrarian traders. UBS has observed that investors in zero-exercise date options are increasingly inclined to buy call options and sell put options when the index is falling, and to reverse these positions when the index is rising. These trades are helping to limit the index's volatility in both directions.
This force already has a sufficiently large trading volume to support it. Garrett DeSimone ( Garrett DeSimone ), from OptionMetrics, estimates that options expiring on that day accounted for about 66% of the total trading volume of S&P 500 index options. UBS believes that the impact of counter-trend trading flows has surpassed the impact of market makers' re-hedging, but this trading habit may change during a continuous decline.
UBS derivatives strategist Kieran Diamond ( Kieran Diamond ) referred to this change as a "counter-trend delta bias." Investors increase their bullish positions during downtrends and reduce them during uptrends, which overall results in buying low and selling high. Since 2024, smaller index movements have been able to attract larger volumes of such trading.
Diamond believes that this trading approach is a response to the range-bound market volatility. As the scale of funds increases, traders will in turn limit price movements, allowing the previously observed volatility to continue. This is UBS' assessment of the relationship between trading volume and prices.
Market makers' hedging represents another transmission path. Market makers with a positive gamma exposure typically need to buy when prices fall and sell when prices rise in order to maintain directional risk neutrality. The trading direction is similar to that of the aforementioned investors, but the operations are driven by the risk management needs of their existing option positions.
According to Bloomberg, the gamma state that frequently occurs in the S&P 500 options market among market makers is partly due to large institutional investors continuously selling day-duration iron eagle combinations, which involve using both put spreads and call spreads simultaneously. Investors who trade against the trend and market makers can work together to reduce volatility, but the scale and changes of both need to be observed separately.
The stabilizing role of market makers is not constant. A trading commentary from Goldman Sachs on Monday this week cited estimates from Squeezemetrics that at the beginning of last week, market makers' gamma exposure was close to $13 billion positive, but by last Friday it had dropped to near zero or slightly negative, representing the largest decline in five trading days in four years.
As of last Friday, according to the report data, Goldman Sachs concluded that the market would be more sensitive to short-term fluctuations before systematic option sellers replenished their gamma positions. The report also noted that on last Friday, VIX bullish options were traded in volumes of 1.85 million contracts, which was among the highest single-day trading volumes since 2018.
UBS pointed out that if zero-date option investors switch to buying put options as the market continues to decline, it may further exacerbate the downward trend and also expose market makers to negative gamma risk.
It is worth noting that the performance at the index level cannot be directly applied to each sector. Recent trading has shown that options funds are unable to mitigate the impact of news.
Premialab Chief Executive Officer Adrian Gellio ( Adrien Geliot ) stated that zero-date option hedging can either drive intraday trends or cause prices to revert, depending on the gamma state at the time. The institution observed that semiconductor momentum strategies performed strongly during the upward movement from April to June this year.
The investment and financing needs of technology companies, as well as the inflationary pressures brought about by rising oil prices, are the main concerns of the current market. Michael Feldman (Michael Feldman), a portfolio manager at AI, stated that an increasing amount of infrastructure investment relies on debt, and rising interest rates have made it a question how much capital companies can still borrow.
Entering a new week, the market awaits to observe the third-quarter financial reports of more companies as well as the results of the Federal Reserve's October interest rate meeting. Feldman stated that as companies begin to release their performance, investors need to see more evidence regarding the investment returns of AI.
