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Rise of near-term options trading carries risk of Volmageddon 2.0 -JPM's Kolanovic

Published 02/15/2023, 06:47 PM
Updated 02/15/2023, 06:52 PM
© Reuters. FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York City, U.S., November 15, 2022. REUTERS/Brendan McDermid

By Saqib Iqbal Ahmed

NEW YORK (Reuters) - The rise of trading in near-term U.S. equity options has the potential to deliver a volatility shock to markets, not unlike the "Volmageddon" crash of 2018, J.P. Morgan's chief global markets strategist, Marko Kolanovic, warned on Wednesday.

The U.S. equity options market has seen a rise in the trading of options contracts set to expire at the end of the trading day - dubbed 0DTE (zero day to expiry) options - with their daily notional value rising to about $1 trillion, according to J.P. Morgan data.

On net, these options are sold by investors taking a directional view, and have tended to suppress market volatility, JP Morgan's Kolanovic said in a note on Wednesday.

A large intra-day move in the market, however, may result in these options sellers being forced to cover these positions all at once and spark massive volatility, Kolanovic said.

"These flows could particularly impact markets given the current low liquidity environment," Kolanovic, who estimates that a large market move would cause these options positions to spark buying or selling to the tune of $30 billion.

That kind of shock would be similar to the one experienced by markets in February 2018, when a sudden rise in market volatility derailed several volatility-linked products that banked on low market gyrations, dealing investors billions of dollars in losses, an event that was eventually dubbed "Volmageddon."

"While history doesn't repeat, it often rhymes, and current selling of 0DTE daily and weekly options is having a similar impact on markets," Kolanovic said.

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For S&P 500 Index options, trading in 0DTE contracts accounts for about 44% of the 10-day average daily volume, up from about 19%, a year ago, according to analytic service SpotGamma's study of Cboe data.

"Overall we feel that 0DTE poses the potential to create a flash crash at the index level," SpotGamma founder Brent Kochuba said.

"(It) could draw large, sudden hedging requirements from options dealers. This could be particularly dangerous around an unexpected news event that catches people offsides," Kochuba said.

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They mad premiums are down
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