Inside the January Options Expiration

[00:00:00] Welcome to the OpEx Effect, a joint podcast from excess returns in spot gamma, where we take a deep

[00:00:03] dive into the world of options and the flows to generate in the markets. Join Brent DeChuba and

[00:00:07] Jack Forehand every month on Options Exploration Week as they look at the major developments in the

[00:00:11] options world and how they impact all of our portfolios. No information on this podcast should

[00:00:15] be construed as investment advice. Security is discussed in the podcast, maybe holdings of clients

[00:00:19] of the Lady Capo. Brent, welcome back. Thanks so much, glad to be here. First, uh, OpEx of 2024.

[00:00:25] Yeah, I was thinking given what's going on a daily basis here now in the S&P 500 requests across equities in general, we think options, flows are becoming more impactful to the underlying stocks. And the way that we look at this and the reason that we focus on options exploration is because we believe it's this cycle. And so what happens is we have options

[00:01:45] exploration, like which is coming up here. You can see, especially looking back, some of these options explorations were very, very significant for the market. And some of them weren't. And can you talk a little bit about what the criteria you look for when we're heading into an options expiration to determine, could this be significant or not? Yeah, absolutely. And I have a couple of slides where we can really dig in on this.

[00:03:00] And what you see here is there, a lot of people look at this and rightfully so, say,

[00:03:04] hey, there's a lot of Xs the board right now is the 4800 strike. And in orange, we have calls and in blue, we have puts. And what you can see here is that from a dollar notional perspective, there's about $400 million of call gamma there is across all this and P 500 index and about call it $250 million

[00:04:24] of put gamma there.

[00:04:25] Now, a lot of these positions may net at, say, 3000 in the S&P and maybe there's hundreds of millions of contracts at 3000 in the S&P, but they're so far away,

[00:05:42] there's no hedging value associated to them,

[00:05:44] they're just sitting there dormant.

[00:05:47] And the gamut of those positions, what we'd say is up and out, meaning that I'm gonna sell rather than selling the 4800 call for February because we're so close to that strike, I'm gonna sell the February 4850 calls or the 4900 calls, right? Cause that's 30 days out from now, I'm gonna roll that position up in value and price and out in time. So the gamma associated with the new call position

[00:07:02] would be lower, right?

[00:07:03] Cause I'm selling at the money call

[00:07:06] for an out of the money call

[00:07:07] as a longer balanced expiration. So does that tell you anything? We're talking about the market moving more freely. Does it tell you anything about which direction it might move or because it's a balanced expiration, could it really go either way? You know, we're just allowing it to move more freely once this expiration goes through. That's a great question. So we believe at the extremes, when you have a lot of call buying or a lot of puts buying

[00:08:21] and the markets are really moving sharply, that these options expiration is being bring

[00:08:24] mean reversion after the expiration. stocks oftentimes as well, where you have everyone piling in to say, in video calls, and when those calls expire, the stock will mean revert a little bit. In these situations, what's interesting is that you often have a lot of short calls being sold in the S&P 500. So I think that the OPEX effect is not quite as obvious when things are a little bit more

[00:09:42] average.

[00:09:43] And to your earlier point, this is a very balanced expiration in that there's a fair amount of

[00:09:47] calls and there's a fair amount of the main data point that we have to compare this current environment to the last environment. One other point on this gamma just back to the idea of the optic cycle. The reason that this gamma matters in the way that we project this game, I just want to interject on this quickly, is that we talked about the bounce. And what that bounce brings us is along the x-axis is our daily

[00:12:21] gamer reading. So how much gamma is in the S&P 500 and currently we're around a 1. expiration. It's a much bigger single stock expiration. And why is that? So in this chart before we had these interesting orange and blue bars, oranges, calls and blue puts, just to make things confusing, this chart which I just built this morning, in purple as calls and in teals puts. So what's interesting about this chart as well is that we didn't measure it by gamma, we measured this by delta.

[00:13:42] And so why would we measure something by delta?

[00:13:45] Delta tells us the value the option is worth in stock equivalent. So this is hundreds of billions of dollars here. Whereas what GAMA is telling us is how much do those deltas have to change if the stock market moves up or down a little bit? Delta is telling us in theory the amount of hedges, the size of the notion of value of

[00:15:02] hedges that have to get removed at options expiration. if the stock market started to really drop. And in theory, this pressure or this potential exists in through, I would say, Monday of next week. So only got another couple of days, trading days here of this potential expiration impact. So as I said, my investment strategy for 2024 is the big question is Nancy gonna buy the leaps again? Yeah, well, to your point about rolling,

[00:16:20] it's the exact question, right?

[00:16:21] If you have a deep in the money and video call,

[00:16:24] you go, I still love NVIDIA,

[00:16:25] you're not gonna buy that same deep in the money reward, so options are leverage number one. And the risk reward, particularly when you get very big market moves, the risk reward, obviously, of only options versus the stock is much better. You have fixed risk when you buy a call, right? If I'd spend $1,000 on an NVIDIA call, that's my max risk. But if a NVIDIA goes up 100% like it did, or 200%, 300%, you make a ton of money there

[00:17:45] for very little year, right, in the equity drawdown. You know, if you own $100,000 within video stock,

[00:19:04] and it goes down 50%, well, that hurts, right. And if you look at volatility, the way the volatility has been reacting, the S&P doesn't react. One could argue the same way in volatility terms as it used to, I think, meaning that the underlying components seem to move a lot more independently from the index itself in various ways.

[00:20:22] But obviously, if the MAG 7s go down 10% tomorrow,

[00:20:26] the S&P is going to go down, right?

[00:20:28] And maybe it doesn't go down 10% or the implied volatility value for other money calls was increasing. And when that happens, that tells us that there's a lot of long-call demands. So people were buying calls in the IWM trying to chase, right? That was a big theme. Would the IWMs play catch-up? And turns out, IWMs did very well from December op-ex into this current period.

[00:21:42] Second one, we talked a lot about this December 2021 analogy.

[00:21:46] We made mention of the week off OpEx. You can make that maybe argument.

[00:23:02] The black line here being options expiration.

[00:23:04] We moved up about 1 to 2% into the end of the year, and we're still really in the same

[00:23:09] zone. that people love these trades like selling zero DT or short dated options, the S&P for example. They'll say, hey, I'm right eight out of 10 times, and that means that, you know, how can I possibly lose money at this? I'm gonna be filthy rich because I'm right eight out of 10 times. Problem is on the eight times you're right, you make, I don't know, a dime or nickel of 25 cents, right?

[00:24:21] But when you're wrong, you lose five bucks.

[00:24:23] And that's the idea of the path being skewed incorrectly.

[00:24:27] It's very hard to do, kind of like 0DT, the better the trades do, the more people pile on. I mean, you know, you and I have been in this business for a long time and we know that if there is edge, you know, it only exists for a small amount of time and it gets exploited pretty quickly. I think those of us who are more retail traders, you know, like myself, there are these smaller edges that bigger funds

[00:25:43] can't take advantage of maybe. They don't bother playing if they can't make enough And then what happened was we had two big selloffs. There was one initial round of selloffs that dropped the S&P 23% and then this exact week, which is the week leading the options expiration, the S&P dropped about 5.6%. And it made its low on the Monday after options expiration.

[00:27:01] The VIX made its intraday high on that same day.

[00:27:04] And then that led right into S&P, excuse me, FOMC.

[00:28:08] Forces arguably right here. Now, obviously the big difference is Powell is about to go off a whole bunch of rate increases. He's saying he's going to decrease rates right now. But

[00:28:15] It's, you know, there's, there's just a lot of just synergies here. And again, you can see that kind of 8% decline

[00:28:23] From the start of January, roughly to this January, OpEx, FMC this time is on the first February 1st, I believe. So about two weeks out.

[00:29:41] The other interesting thing is at the start of the decline could really accelerate based on all these different options and positions. And as you pointed out, we've got a CPI report in January and we had a hot one in the same analogy there.

[00:29:42] There was a hot one that got the market going down a little bit.

[00:29:44] Yeah.

[00:29:45] I mean, the initial reaction to the CPI that just came out was, oh, this is a little bit on it. We touched on some of these ideas, but what I really want to talk on is two different concepts. We talked a lot about these in our subscriber notes this morning. Number one is volatility just in general. So on your screen here is realized or historical volatility for the S&P 500. So a measure or rolling windows of how much has the market been moving?

[00:31:01] And if you look, the most of us in the options land pay

[00:31:05] initial attention at least to one month implied

[00:31:08] realized volatility, excuse me. at what's a fair value? Well, if you take this 10, right, one month realize a 10 and you add three points to it. That's this historical average. Then you would say, okay, VIX 13 is about fair value. And that's a very finger in the air assumption. A lot of these, a lot of you who are options aficionados will scoff a little bit, but if you just look at the long term average, that's what it is. And so you can see here, the VIX currently is 13 So another way to look at this is to say, hey, if at the money applied volatility for most explorations here going out in time is roughly 10, 11%, that tells us the market's pricing in, I don't know, 60, 70 basis point daily moves in the S&P 500. Those are pretty tight ranges, right?

[00:33:41] That's not a lot of movement in the S&P.

[00:33:43] The one day that the little bit elevated here is FOMC for that February 2nd or first time is a, you know, it's in vogue right now, selling volatility is in vogue because when it works, it works great because not only do you not need the market, you know, if the market goes up, it profits. If volatility just comes down at profits, you don't even need the market necessarily go your way. But the problem is when you're wrong, back to the positively negative skewed payouts, if your short puts in the market goes down, it hurts. And naturally,

[00:35:02] what happens is to the other point is these move more. So, it's a feedback loop that has to unwind and suddenly start to feedback in the other direction. Yeah, those trades have always struck me and there's a lot of trades like this in investing where you sort of know what the eventual outcome will be, but you don't know the timing.

[00:36:20] And so there's not much you can do about it.

[00:36:21] So people will always say,

[00:36:22] oh, this short volatility trade has to blow up.

[00:36:24] And then it'll go on for two years or something.

[00:36:26] And then eventually it'll blow up,

[00:36:28] but unfortunately they've lost so much money, to sit there and say, I can't really milk this cow anymore, right? Like the value's been extracted. And if the trade keeps going for six more months, well, I would have missed a lot, right? And you will. But the problem is, again, one wrong move causes just a world of hurt. And so, the question is, hey, are we at this world of possible hurt where there could be this downside jump? And I'm

[00:37:41] not making a market top for 2024 call. I'm just simply saying we could have a sharp

[00:38:44] The lowest implied voles that we've seen over the last 60 days, again, this printed pretty low risk 60 days.

[00:38:46] So these voles are are low relative to history, you know, recent history.

[00:38:52] Uh, now low volatility, the famous saying is doesn't mean cheap volatility.

[00:38:56] And that's true.

[00:38:57] But if you are full up in equity portfolio right now, you're fully exposed and you're

[00:39:02] happy with those gains, you could make the fact that implied volatility values are at extreme lows here. And we measure them in this Z score metric. And so you see the C of red. This is telling you that even though the market is,

[00:40:22] you know, marks went pinned to this range. Not only are people aren't familiar. Can you talk about the idea of fixed strike of all versus the VIX? Because the VIX is what people are seeing out in the market every day. What's the difference in why is fixed strike of all important? That's a great question. So what fixed strike vol is simply showing you? And if you had our dashboard, if you hovered over any one of these cells, it would tell you what the implied volatility is for a given strike at a given expiration. And there's a lot of value

[00:41:41] in monitoring what the strike implied volatility is for a this moment. So what does that mean? That means that rate, oh, the S&P is at 47.75. So the VIX is using 47.75 options 30,000 time as the bulk of its calculation. If the market goes up, if the S&P goes up to 48.25, then the VIX will be using or out over waiting that 48.25.

[00:43:03] Well, as we all know, say, February expiration, if that value itself went from, say, 20 to 30, then you know there was true demand for downside protection because that volatility went up on a fixed strike basis.

[00:44:25] So the more it's a cleaner measure, basically.

[00:45:24] downside. So that's that's that embedded risk and 4700 if that breaks in the S and P certainly doesn't appear is going to break. Yeah, at least today. That is the embedded risk. The

[00:45:30] second thing is this idea that, you know, where's the upside right now? There was a,

[00:45:36] there was a 5% move down in the max sevens writ large. This is the MGK index. It's a growth

[00:45:42] ETF from Vanguard that has an overweight measurement here, the trend just stops. So to dig into this

[00:47:00] kind of concept, if you look at Nvidia, I think not betting on downside, but again, the point here is that they're also not betting on upside, right? We're literally just sort of floating in kind of thin air. And so I think that, you know, we're really looking for another moment of volatility here.

[00:48:24] And that volatility means pretty sharp choose just the MAG 7s. And the idea is here is like, well, what do these things look like as they head in this big exploration? The idea being that if these names start to sell off here, that at some point these objects hedging flows could pick up and start to impact to the downside. Now, it's important to note that I don't see that

[00:49:40] OpEx query any kind of a lift anymore

[00:49:42] because these calls that are set to expire

[00:49:45] are arguably fully hedged out.

[00:49:47] Meaning that if the market starts to go up 1% of the money calls in these stocks, well, those are now significantly in the money, and that gives you really good visuals to why there's so much options value built up there, right? So I pulled just metaphor an example. In our systems, we measure different metrics, right? One of those is what we call our key delta strike, and what that tells you is the strike

[00:51:00] that has the biggest delta, right?

[00:51:02] So where's the biggest stock value essentially?

[00:51:05] Which option has the biggest option position

[00:51:07] relative to stock value? that pressure was relieved, that selling pressure was relieved, that selling pressure in theory could last for a good 10% down in the stock. So this total is the floor is not that close, right? That's the idea, the floor is not tight to where meta is right now. That's exactly right. If this kind of feedback loop happens. There could be times where I say, hey, look, the floor is at like 370 and the stock's trading

[00:52:23] at 375.

[00:52:24] So this risk just you about it. And as we start out, we've been talking on all the episodes about the idea that zero DTE is very high right now. It's like at all time highs and it seems like you're echoing this with the first slide. Yeah.

[00:53:40] And people are, it's been interesting because. Now if you think about zero DTE because they expire today, they have lower premium values,

[00:55:00] meaning it costs less to buy zero DTE contract than a six month out option contract.

[00:56:05] system which measures the Delta is being traded in real time of the S&P 500. Now in this case we're looking at the S&P 500 flow. So this is SPX, SPY, and ESME any future. So every single time

[00:56:11] a trade takes place, we estimate how much hedging flow or the dollar value of hedging that's associated

[00:56:17] with that. On Monday, this past Monday the 8th, we hit our largest ever most positive hero value

[00:56:23] ever. So that's 12 billion of dollar Delta notional.. So every time that the market comes down a little bit, you see these zero DTE contracts come in and the markets get bid back up. I understand that people say, hey, zero DTE contracts could be hedged out with other zero DTE contracts. And I think on an average, you know, daily basis or on normal trading flows that can work.

[00:58:43] which is the next available expiration for like Tesla or a single stock, then we consider that a zero DT or next expiration for single stock.

[00:58:46] But let's just talk about the S&P.

[00:58:48] You know, if it expires today, that's a zero DT contract.

[00:58:51] And then the right access here is dollar delta notional.

[00:58:54] So in theory, delta, when you look at the delta of a contract that's traded,

[00:58:58] it's telling you the dollar value of what you need to hedge out,

[00:59:03] you know, the contract that's just traded.

[00:59:04] So, you know all this evidence that suggests

[01:00:22] that this is a leading indicator.

[01:00:23] And I also believe that it is bringing mean

[01:00:26] reversion into the stock market.

[01:00:27] Meaning that when the market goes down. We could crash up just as easily we'd crash down because there's arguably, you know, like I just showed, there's a huge amount of zero dt call buyers. So, and then there's not really the, you know, the volatility halts and things like that when the market goes up in a crazy amount, right? But the risk here is that, you know, everybody piles

[01:01:40] into call long calls or long puts, right, it didn't, there wasn't that much overall macro movement to the market, right? So, you know, XIV, it blew up, it broke the market

[01:03:00] for a couple of days, right?

[01:03:02] And it caused a little bit of a draw down,

[01:03:04] but we eventually recovered from that pretty quickly.

[01:03:06] So, you know, those are the scenarios,

[01:03:07] and seriously, look, is this gonna bring the market