The OPEX Effect: December Expiration | S&P 500 Update, Small-Cap Surge, JP Morgan Collar

[00:00:00] Welcome to the OPEX Effect, a joint podcast from excess returns in SPOT Gamma, where we take a deep dive into the world of options and the flows they generate in the markets.

[00:00:07] Join Brent Kachuba, Jack Forehand, and me, Justin Carboneau, every month on the Options Exploration Week as we look at the major developments in the options world and how they impact all of our portfolios.

[00:00:17] No information on this podcast should be construed as investment advice.

[00:00:21] Securities discussed in the podcast may be holdings of clients of the L.A. Kappa.

[00:00:25] So episode 3, Brent.

[00:00:27] We made it to three episodes. incredible catals coming up. You got the CPI, you got FOMC. Today we're talking, it is the 11th. So, CPI is tomorrow 12. There's a humongous treasury auction today, which seems to spark a little bit of movement and in equities. There's VIX expiration the week after that, and there's then all that falls into a really big January options

[00:01:40] expiration. So an option space and macro space, etc. There's there's hits, and all that open interest is wiped out, and the hedging flows associated with any open interest is also removed. And so that allows stocks sort of move more freely, or it implies at least that the options flows change or switch, right, because of all these positions expiring.

[00:03:02] So on Friday, we're going to have the options expiration. Many of them come at very significant turning points in the market. Some of them are sort of in the middle of a larger trend, and those are generally smaller

[00:04:21] expirations that don't fall on a quarterly expiration.

[00:04:24] So the quarterly expirations, like I justut position is as the market goes up, specifically the S&P goes up. They sell futures, they sell stock into those rallies.

[00:05:42] And then as the market comes buy or sell single stock options. And the idea is that you're betting that the two would move, the volatility of the two would move in a different way, right?

[00:07:00] So I could sell SPX, let's say calls or something

[00:07:04] and use that to buy MAG7 calls,

[00:07:07] Microsoft or Tesla or something like that. doesn't mean you necessarily have like lack of excitement. Like behind the scenes, you could still have some excited in the individual names behind the scenes, even though the market's going nowhere. Yeah, 100%. S&P's been very boring. We can show some charts of that, but you know, like I'm looking at AMD today, I think is up, was that three, four percent? Avgo up 10%, Macy's is up 20% today.

[00:08:20] So there's a lot of stuff that's moving.

[00:08:23] Everything is moving up,

[00:08:25] even though that, we know that, hey, the options game is about to change like it is on Friday because of the fact that all these calls are going to expire.

[00:09:40] So therein our game index would slide down and volatility should increase.

[00:09:46] And that's really what's coming up.

[00:09:47] That's what we're facing here. on payrolls number, for example, on Friday, everybody was super excited for that. Implied volatility, so the options market was pricing a little bit more movement, but ultimately just did nothing, right? We were just locked in the same levels we were. And I think that when we approach CPI tomorrow, it could be the same thing, right? CPI could move the market a little bit, but it's facing all of these hedging flows that

[00:11:02] are really going to lock in. and like it just completely inflated. So like that, maybe that was another example of like it was getting pinned for a while. And then once OpEx came, it was clear to go. Yeah, there was a, to your point, there was a tremendous amount of positive game of back then in February 2020. And the market really fell apart the Monday after that February options expiration. So it was like, Feb I mean, what are your thoughts on that? First of all, is that contributing to the muted volatility? And is there a danger on the other side of that? Yeah, you know, markets are reflexive in that the behavior or for the P&L of trades, when trades are working the size of assets

[00:13:40] or whatever that are tied to those trades,

[00:13:43] I think increases, right?

[00:13:44] So if you're short-fall and that's working,

[00:13:45] you continue to these levels where, you know, this isn't the VIXAT 20, you can go to 15, right? We're talking the VIXAT 12 and what's it gonna do? Go to like eight or nine, like historically kind of low levels. There's very little room for error here, right?

[00:15:01] And the error is that people are not only,

[00:15:05] so if you talk about, am I think it's a 4X, X, X, X, X, long S&P product, I think it is.

[00:16:20] I saw that.

[00:16:21] So, you know, these, these derivative ETFs cause a scramble to the upside because short volatrators have to cover, right? Volatility works both ways. Yeah, you actually had an interesting slide on this idea of this terminal volatility slide. On your next slide, you're talking about your estimated move versus the VIX. Can you just talk about what we see there? If we look at that gamma index, this one here, right, we take that gamma index and we forecast

[00:17:43] the daily move.

[00:17:44] So 55 basis points is our daily move.

[00:17:46] That's what you know, in volatility, it can't go much lower, right? Cause markets are going to open. The exchanges are going to turn on. Something is going to move around a little bit. Uh, you know, zero is not an option. Um, we could stay at very low levels, but I don't think that's realistic.

[00:19:03] Given end of year flows, expiration, FMC and all this other stuff.

[00:20:03] You can't, you know, banks are going bankrupt, right? You couldn't put a date, specific date on when the next bank would go bankrupt.

[00:20:07] So you had to buy a longer dated option, right?

[00:20:09] You couldn't buy the 0DTE because that only covers you for today.

[00:20:13] But obviously with the CPI or FMC, you can hedge that out arguably with a 0DTE option.

[00:20:17] And so some people think that that really has a dampening effect on longer-term volatility.

[00:20:22] But volatility across the spectrum, if you start to sell

[00:21:42] puts at this point, you're more betting that the, like there wasn't much time to get out the door basically, you know, if you weren't out ahead of it, like you were in huge trouble. Yeah, I mean, that's another saying not to not to glom on all the things, but risk happens fast, right? And I think that this is the challenge of trading in general is is okay, yeah, volatility is too low. I get it, but it may day low for a week, 10 days, two weeks a month.

[00:23:04] I mean, if 2017 for the whole year for right, imbalance here, right? Because orange is calls and that's 800 billion, let's call it and then blue is puts and there's only 130 billion of puts expiring on a relative base. So

[00:24:21] this is a huge call heavy expiration historically

[00:25:22] But given that volatility is pretty low, you got a factor in Powell here.

[00:25:25] I do think that this is a period where we could see

[00:25:28] a little bit of a pullback in markets,

[00:25:30] which could play still into a year in Raleigh.

[00:25:33] I just think right now that the market is very lean one way

[00:25:37] and generally needs to kind of consolidate a little here.

[00:25:41] So, to take away as our massive exploration,

[00:25:43] huge options of expiring that should lead to volatility,

[00:25:46] volatility could go either way, I also think that, you know, look, if guys like Citadel are extremely smart, I think they know what all the positioning is in the market and I think that they can, you know, position themselves to do what the market doesn't expect, right? Because if a crowded trade going against somebody, you know, they're going to continue to do the same thing. Kind of like JP Morgan Call,

[00:27:02] which I know we want to talk on, that doesn't seem to have traded, so to speak, or futures or stock being traded because you could just hedge it out with zero DTEs now, right? So maybe that's my favorite theory as to maybe why the impact is changing, son. You mentioned the JP Morgan trade. Can you explain what that is? Because you hear a lot of talk in the market about, I think there's like two strike prices associated with it.

[00:28:20] And people say it'll pin at one of the other.

[00:28:22] Like I guess you're saying it's not

[00:28:23] as much of an impact as it used to be.

[00:28:25] Yeah, so the JP Morgan collar trade is in this orange bar. It's a call position that's not deep in the money. So the theory was that as we get closer to that expiration, that position was like a magnet and these hedging flows will move us into that level. That used to be a very sticky level, I would say in 2021. And then in 2022, you can make some argument.

[00:29:41] And then in 2023, it seems like the market doesn't pay a whole lot of attention

[00:29:44] to it anymore.

[00:29:45] And it's ability the ability for the S that people watch. So looking for around 4,500, let's call it above 4,400, but under 4,600 in the week before expiration, this is 1229 expiration, then it could have some effects. But right now that position is very deep in the money. And the other thing is that the number of other ETFs

[00:31:03] and positions that sell options has increased significantly. volatility, one could argue. And the strategy is very popular. I think there's some that feel that on a total return basis, they're very bad strategies, you know, selling calls, but they provide this income and or security that a lot of people like and find attractive and, you know, so they so they're growing and gaining in assets and they'll be selling more options as a result,

[00:32:23] particularly calls. So we do what's moving segment every week, but where you find some things you've And you're listen you get more attention by making extreme so Extreme call yeah, did you see that by the way that guy like that uh that was going around Twitter like that guy who had for every YouTube Podcast he did like the cover was just something on fire And it was like hell coming like the world is gonna end like every video We did with the same exact cover just with fire burning and like some catastrophe that was about to come so

[00:33:41] I think it's like the rich dad Robert cut whatever his November IWM's are up five and a half percent As of yesterday today they are I think adding on another little smidge They're up. Yes, slightly There's some more to talk about the IWM space crypto we were saying hey

[00:35:01] This looks poised for a breakout based on call positions. Well crypto went bananas

[00:35:06] Bitcoin hit 45,000 if you look at Coinbase but you have Avgo, AMD, and some of these other some of these are really ripping and the SMH is up quite a bit. And so it's an interesting moment, I think, for catch up and some of these kind of second tier names. I'll touch on that in a second. Again, here's the chart of the small caps, just a huge move higher there. As you can see, we still like Ida Williams up to the 190ish area.

[00:36:23] And then lastly, here's a chart of coin base.

[00:36:27] And you can see tomorrow, FMC, obviously on Wednesday. You can see how tight this range is, right? I mean, really from the 22nd, specifically, even into today, the daily range has been extremely tight.

[00:37:41] It's been a really range-bound market over the last 17 or 18 sessions,

[00:37:44] as volatility has really just kind of collapsed.

[00:37:46] And so, you know, outpace the S&P year to year end. And that's my favorite trade, as long as I do videos and short spiders. I like doing that with calls. Because look at palops, that's the market. If you sold spider calls and bought IWM calls, then everything goes to expires worthless, no harm, no foul.

[00:39:00] But IWM should outperform the upside in my view.

[00:39:03] Is there a risk associated with the huge expiration there?

[00:39:06] Like that that chart was pretty scary.

[00:39:07] Like if you look at that, Arguably, if not longer. And so that tells me that there's people that are long calls. So deals are short calls in the eye of the U.M. What does that mean? Well, if the market starts to go up and your short calls, you have to buy stock to hedge yourself. And as the stock continues to go up, you have to buy more stock. And so that could create a relative chase. You are correct in that this expiration

[00:40:20] is going to ding this pretty good.

[00:40:21] But there's still enough open interest here

[00:40:24] that if we do rally kind of the call heavy period of June of this year or any period of 2021, right?

[00:42:46] that led to that. Not only was, we had the pandemic, someone was locked inside, everyone had the stimulus checks and was focused on the market because there wasn't anything else to do. And

[00:42:51] no one thought that retail in particular would come in and pay these crazy prices for options

[00:42:55] because institutions would have done that by and large. So now I think this is an

[00:43:00] effect that you see in the market is that when And that reaction function, how fast call prices are elevated, has increased in a lot of fast notes. It's kind of like to your point, you know, they're hip to the game at this point. It's hard to get a jump on these guys know. Yeah, it's interesting. Those types of things are got to be really tough, like for somebody to try to treat. And then if you think about it, like the people that were, there were probably

[00:44:22] people selling, you know, those calls like way, infinity, right? There's no upper bound that exists. Yeah, you can have valuations or this and that, but really, there's no theoretical limit to the price of something going to the upside, right? So that volatility could really go extra high in the face of a higher market. Yeah, sorry, I got this a little off track there, but I think that's really interesting.

[00:45:42] Like for people, it's a good way to. Um, if that SPX. So what do you see here? This is worth and he's get, I think particularly interesting for those with a little bit of a longer term view, where we're the argument I'm trying to make now or here is that we're, we're done pinning, right? We're hitting CPI. We're hitting FOMC. We're going to hit, uh, options expiration. So there's going to be a release of volatility.

[00:47:02] We're going to, we're going to rally, you know, a good, those calls go very deep in the money, and the value of those calls expands a lot, right? Obviously, because the stock is going higher, the calls are going deep in the money, the value of those calls increase. So, that's what's happening here. A lot of leaps are in place, the market rallied really sharply just as it did in 2021, and so you have this, you know, hundreds of billions of dollars worth of calls set to expire now

[00:48:23] in January.

[00:48:27] And very small on the put side. But this is where we are essentially in 2021 and so you could see that after FOMC and into optics We had some weakness which is arguably what I'd forecast here I think because of these expiration positions rolling away So, you know look we drift back to this 46 hundred level in 2021 and then we snap off this 200-handle S&P rally So it's a massive rally from call it a couple days before Christmas into end of year

[00:50:45] percent drop in the S&P 500. And I think that was largely exacerbated by these giant call positions that are set to expire. So if we rally here at a December expiration,

[00:50:53] into the end of the year, that increases the value of all these calls. And I think it makes

[00:50:57] the chances that we sell off hard into January. I think it significantly elevates the odds of a

[00:51:02] sell off in January, right? Because those calls is a big impact on the market and it kind of fights these flows, but also it's kind of a completely different thing like outside of what you can model with options.

[00:52:21] So like how do you think like as an options guy,

[00:52:23] how do you think about the macro stuff?

[00:52:25] I think of the options that in single stocks. For example, when we were talking about, why are call positions dying out in the MAG7s? Or why are call positions picking up in IWMs? That's an expression of people thinking rates are gonna stop. So I think you can look at,

[00:53:41] it's helpful to know the macro events

[00:53:43] that are coming up so you can say,

[00:53:44] okay, I know this is what's happening,

[00:53:47] but how are options. So, it's the reaction to the news, it's the positioning around the news that I think matters most and that's how I read it. Is it like a probabilities thing almost? So you can say, I can't predict what's gonna happen with CPI, but I can see in the options market,

[00:55:00] what might happen in either case

[00:55:02] based on how people are set up going into it?

[00:55:04] Yeah, that's exactly right.

[00:55:06] And so options at the end of the day, times where it gets a little bit too cheap obviously or it can be too expensive and there's some opportunity for, you know, I would argue alpha around those. But, you know, in general, you're getting a sense of what the market is pricing in in terms of risk. And if you think that's wrong, either too high or too low, well, then you have a trade, right? And you and you arguably should put a trade on, right? If you think the market's pricing something

[00:56:24] in incorrectly. But I think in general, same age we're in our 40s here.

[00:57:41] And so we've lived long enough to experience enough

[00:57:44] to be pretty humble around all this sort of help you in that position, regardless of what the macro setup is. So now the options market supporting volatility, Powell is going to trigger us and we should have a pretty nice move into the end of the year. Yeah, my 45 year old self has had to accept the fact that by 25 year old self thought I was going to be the next Warren Buffett and that's not going to work out for me. So it's been a humbling experience.

[00:59:02] I thought like after this first couple of years it of me. That's probably, that's probably a good thing to wrap up on. Compounding was a word I work for. I said convex, but a man compounding. I'm sorry. Well, thank you for everybody, everybody for joining us. Please, if you do, if you made it to the end here, I don't know how many people did, but like, everybody did. Well, like and subscribe on YouTube. Let's get this thing.

[01:00:22] If I want to be the next word buffet, I'm going to need a lot of views.

[01:00:24] So please, please help Brett and I out.