With Nasdaq 'VIX' reaching 15-year highs relative to S&P 'VIX' in the last week, we suspect tomorrow's quad-witching will be a little more noisy than normal as traders scramble to cope with $1.3 trillion of expiring S&P options...
JPMorgan's Marko Kolanovic lays out the details...
In our view, it will be difficult for the market to go much higher from these levels (~2,450) unless there is meaningful progress on US fiscal reform (i.e. tax cut).
Current positioning of various investors is already quite high and that poses additional risk going into weak seasonals.
Low volatility and positive price momentum resulted in high leverage of systematic investors: CTAs are likely at their ~95th percentile of equity exposure, Volatility targeting funds are likely at maximum equity exposure, and other investors (such as equity long-short and risk parity funds) also have above average equity exposure and leverage.
Certainly, the last month has seen a regime shift in Risk Parity funds from the year-to-date upward thrust...
But it is tomorrow's quad witch which has Kolanovic most worried...
The impact of S&P 500 derivatives has been supporting the market going higher in the first few days of this week (expiry momentum)...
...and will turn into a headwind next and the following week (reversion of expiry effect, and reversion due to monthly/quarterly rebalances).
$1.3T of S&P 500 options expire on Friday, and this will change dealers’ positioning (half of the long gamma positions will expire).
This can result in market volatility starting on Friday and into next week.
In english, Friday's expiration could change options dealers' positions in a manner that could leave them more likely to feed into any uptick in stock market volatility going forward, and after tomorrow, dealers' positions in S&P 500 options will change so that any stock market selloff could quickly see dealers boosting volatility as they hedge their positions.
Or even more simply put, the foot on the throat of volatility could well be lifted tomorrow... and positioning suggests any pain will quickly feed on itself.