The OPEX Effect: November Expiration | 0DTE Options, S&P 500 Update, MAG 7 Positioning

[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. Camera.

[00:00:25] Brent, welcome back. That's by far. That's all. I was proud of the little joke was going to be I'm surprised I was in France, which is the formula of the derivative, you know, as opposed to Italy. Oh, that is true. Yeah. Well, maybe anybody who's out there in France this time, you know, maybe we'll get it on the charts this time. So yeah, so in general, our goal with this for anybody who's new to us is, you know,

[00:01:41] we wanted to do this for longer term investors.

[00:01:44] You know, obviously there's a lot in the stuff that we write on a daily basis is focused in the short-term time for a bit more of the day-to-day typically we'll see 30 days on a cycle is typically what I see. I also like doing this because it gives me the opportunity to zoom out just a little bit. Like I said, speak to people who have a little bit of a longer-term lens and let people know

[00:03:00] what the options market may be telling them or how the options market is informing them

[00:03:04] of future price moves. launched in September of last year, 2022. And before that, we had expirations three days a week. So Monday, Wednesday, Friday, and then before that, they had Mondays. And so it's been sort of this evolution over the last couple of years of an increase in the number of days expiration options or the number of expirations listed each week. Historically, the third Friday expiration

[00:04:20] was the biggest expiration.

[00:04:22] That's where a lot of people traded.

[00:04:24] But now we sort of split that up with these daily expirations.

[00:04:27] And then the single stocksTE trading and what tail risks might be embedded in this. And that's why there's so much attention associated with it. I'll tell you just sort of the high level view is,

[00:05:41] there's this idea that there's a tail risk embedded in here.

[00:05:46] JP Morgan got a lot of attention around this note. What does it look like on the single stock side in white here is the zero dt flow now? This is a real sawtooth pattern on this chart because obviously, you know when you get to expiration contracts roll and that's kind of what causes the salt sawtooth sort of Pattern in the chart, but if you look at the general, you know If you're to imagine a moving average on this chart you would see that you know roughly 35 ish to call it a third

[00:07:04] Essentially of stock individual stocks like Apple Tesla Amazon etc In the past, you would have people buy futures to hedge portfolio. So institutional investors or even some high frequency trading shops, you trade the future as a way, the E-minis as a way to express that the market was going to go up or down or hedge your risk up or down. And I think that what has happened now is that people have substituted the zero DTE contracts for those underlying futures hedges.

[00:08:21] And the reason you do that is because there's a fixed cost with these contracts.

[00:08:25] They trade in cash. I think that's where the bulk of this volume is being traded. In this, in this, there was recently last week, there was a presentation on the options market at Bloomberg and New York. And I went down to that and a couple of interesting tidbits that I want to clue it onto your question. The Cebo says that 25, that's just a 30% excuse me, I'll type over there.

[00:09:40] 25 to 30% of zero DTS retail.

[00:09:42] That's what their estimate is.

[00:09:44] Um, but retail can mean different things.

[00:09:47] Like, you know, I think a lot of options and that there's risk associated with that. But they basically said, look, there's been an uptick in 0DT flow. It's minor.

[00:11:00] They don't see any risk to themselves as an entity.

[00:11:02] And they didn't really feel like there was a lot of market

[00:11:04] risk thereging. And so, as long of a term investors, like a lot of you are likely are here, you say, okay, just give me the payload, the TLVR of this. Well, on one side, you have the JP Morgan Volmageddon, which essentially said that, look, these options could cause a major crash in stock markets.

[00:13:40] If throughout numbers that were hundreds of billions

[00:13:42] of dollars of hedging flows that are required,

[00:13:44] if the market goes limit down.

[00:13:45] And if you played out you know, four or five percent in your day. So again, I think there's this impetus to want to have these positions closed by the end of the day. Um, and that brings up this other interesting point. I believe that zero dt causes mean reversion by large and equities. And I have an example that I'll show you, but, but basically what you see is

[00:15:01] positions get put on at the start of the day in zero dt space.

[00:15:05] And then those positions are closed towards the end of the day.

[00:16:05] 5, 6, 7% moved down over a couple of days because essentially the VIX moves so much that these short volatility products blew up, right? And that caused a couple of days of shock in the market.

[00:16:10] And the reason I think that was a lasting shock is because those positions in that sort of sell-off

[00:16:16] cascaded for a few days over time. And I don't think you'd have the same situation with a zero

[00:16:21] DT flash crash because there's not a product think it was 10,000 features or they meant to put in 100 features, I forget exactly what it was. And that led to this really sharp precipitous sell-off in the middle of the day. And everyone was freaked out because they didn't know what's going up. But then as soon as someone found out or soon as they figured out, hey, this was a fat finger trade, that's all it was,

[00:17:42] people started buying the dip like wildfire, right?

[00:17:44] And then what happened was,

[00:17:46] I think it was night capital was the entity. off of a low because people are buying zero DT calls and that really serves to ramp people up. So to your question on volatility, these things do have the potential to drive a lot of volatility. Intraday. I don't think they have the, the, uh, the payload to deliver multi-day kind of volatility. Um,

[00:19:02] yeah, cause the idea would be once they, once they're aspiring that day,

[00:19:06] so unless they had impact on options flows to other options that did not expire that day,

[00:19:07] then you'd expect it to be largely contained.

[00:20:03] example, today again, Monday, November 13th. Today we saw the market rally rather sharply from,

[00:20:07] call it 4,400 up to 44.20.

[00:20:09] So, you know, not quite a 1% move.

[00:20:11] But what you can see here, this is the example

[00:20:13] of meaner version, the zero DTE.

[00:20:16] So let me take one step back.

[00:20:17] This flow monitors that Delta's being traded

[00:20:20] from options in real time.

[00:20:21] And the idea is that by monitoring the Delta's

[00:20:23] that are being accrued, we can estimate what

[00:20:26] dealer hedging flows from all the options

[00:20:28] that are being traded. our indicators start to go down. And what that tells us is that at that point, people started selling calls and buying puts in zero DTE space. And what that does is it pressures the market and you can see the options, the equity markets, excuse me, the S&P index, then sells back off, right? And these are, you know, look, 10, 15, 20-handle moves. You know, in this case, they're not massive moves on this day,

[00:21:42] but you know, it's just today's data.

[00:21:44] And so this is the kind of idea of mean reversion that we see.

[00:21:47] And if you think about indicator, it trends higher the whole day and meaningfully higher, which tells us that people are buying zero DTE calls, you know, all day long. And every time they do that, with every bout that they buy the zero DTE calls, that the market pushes higher, right?

[00:23:04] And so what's interesting about this day is that, you know, we had an outside kind of sneaky 1% move up.

[00:24:05] volatility. And, you know, if you were to run this sort of Friday, Friday, we play on steroids, right? Because a bunch of people got together and bought zero DT calls on Reddit

[00:24:10] or whatever it may be, then you could maybe start to envision the scenario where, hey,

[00:24:14] we just went up 5% today. Why? Well, it's because all these zero DT call buyers came

[00:24:18] out. But then I would think that that that move would unwind or mean revert very quickly,

[00:24:23] particularly people go, Oh, look, 70% of out and the zero DTE is just another part of that cycle, right? It's just a, it's a one day cycle as opposed to a 30 day cycle. Yeah, and that was probably a good time to switch to that because we talked about this last time. Maybe we should cover briefly again. Your first slide you got in here is this OpEx cycle.

[00:25:41] So before we talk about what's going on with the current exploration, maybe we should talk a little bit about the cycle first.

[00:26:43] and hedges start to build up around those positions. And then as we get closer to December exploration,

[00:26:46] the Greeks sort of embedded with these options trades change.

[00:26:50] It changes hedges flow or hedging flows around those positions.

[00:26:53] And then we generally start to pin in these options

[00:26:55] as expirations around where the biggest options open interest is, right?

[00:27:00] And this is kind of a, we call it the OpEx pinning effect.

[00:27:02] So again, you have after options, expiration positions are cleared out.

[00:27:06] The market starts to move to a new area, a little bit of a credit repo crisis. March of 2020, the low is the Monday after. Also, the market really started to fall apart for the February 20 expiration. You can see June of last year, for example, and then August of last year. So you can see a lot of these are turning points, and this is where positions build up. We did a podcast on excess returns where we really dug

[00:28:20] into the data around this. So please check out that on the Access Returns YouTube channel.

[00:28:25] So in this case here, we had Optobra expiration, and, three to five percent. And if you look back at the data, it was the morning of VIXx braces when the market fell apart. And then you had FOMC in here as well, and the market just careed, right? And we went down to 4,100. And so you could really see how this VIXx expiration kind of pulled the plug a little bit

[00:29:40] on this equity market rally that was going into October,

[00:29:42] we sold off really hard.

[00:29:44] What's interesting about that is we have,

[00:29:46] it's more magnitude here that you look at single stock side, single stocks in this case are purple, single stock, and then teal in the puts. You can see there's a massive imbalance here between equity calls like the size of Tesla Apple

[00:31:01] and video calls set to expire in puts.

[00:31:04] And so this is really where the imbalance is

[00:31:06] for November. Well, the market rallied 5% through that. So you spent $10 on this call, but now that call's worth $200, $200, right? So the value of that call's grown massively, right? It's essentially a synthetic stock position at this point.

[00:32:20] So that's what you really see embedded in this data here is that all the calls that

[00:32:24] have been positioned have grown tremendously in value because of the equity market rallies is call values get built up and the hedges associated with these call positions should in theory also grow as well. Well, as we get into that expiration and those call positions are closed, you know, they're rolled out in time. People are monetizing, but great, my calls are, you know, but if you own Nvidia calls and you're up 500%, you don't want to take delivery

[00:33:42] of that stock, you just want to take your gains and go. You're going to sell those call positions,

[00:33:46] you're going to roll those call positions or whatever you had. Does it matter? One of the things I noticed is sometimes the VIX expiration is before the regular options expiration, which I think it has been in October and November, but I think it's September is maybe reversed. Does that matter at all like the interplay between those two? So there's two things here, which I've had a hard time pulling out of the data.

[00:35:02] I've found recently the VIX expiration being before

[00:35:05] has been more impactful. equity options, expiration. And I think when you talk about, hey, could we get a pullback here? Because these calls are set to expire. I think the fact that the VIX expiration is before, uh, op X means starting Wednesday, we could get a little bit of market weakness here. Can you talk a little bit about the, when the VIX goes down, the idea that when the VIX goes down, it can like unleash flows to some degree

[00:36:20] that makes the market go up.

[00:36:21] Can you talk about the relationship at a high level between those?

[00:36:24] Yeah, I would look to.

[00:37:25] SPX the implied volatility or the value of put options in particular were start to go up and

[00:37:32] When those put values start to go up the VIX index which is calculated from those S&P puts goes up as well

[00:37:36] Right and so that means the VIX is reflecting is it is is?

[00:37:41] Reflecting the fact that there's more demand for puts and there's more pressure on the market going down

[00:37:43] and When put values increase

[00:38:44] not going to go up anytime soon. Powell didn't sort of upset anybody. And then also in the VIX collapse rates dropped and all those puts got smoked, right? Dealers were short puts

[00:38:50] like I am in this scenario had to buy futures back in the market rally. So that's sort of

[00:38:55] the feedback mechanism right between why the value puts feed into the VIX index and how

[00:39:01] that links to equity volatility. Essentially, you know, the second month fixed future becomes the front one. So what I think happens in these scenarios and it becomes more obvious when VIX is really high, you end up with the scenario that there are these forces that are pressuring VIX lower, the index lower and VIX futures are getting sold because as we march towards expiration, which is Wednesday at 9.30 in the morning, the two need to meet, right?

[00:40:23] And there's a lot of VIX index positions, then the selling of those, the un-winding of those hedges should lead to a little bit of equity market weakness over the coming week. Just for people who ever look at those VIX

[00:41:42] ETPs, what you explained is why those lose 99. that, I don't think, I think it's the not a vent net equity ball. You know, you remove some event ball and maybe we chump a little bit lower.

[00:43:00] Um, but it's been a good month to be short those VIX CTPs and, you know, you know,

[00:43:05] a squeeze the last dime out.

[00:43:06] Go ahead. because I think we may have seen some rehearsals in some of this stuff that was moving last month, you know, out of the expiration. So can you just talk a little bit about that? Yeah, you know, we're doing this monthly and so I thought it'd be interesting to say, what did we think last time and how did that play out? So, you know, kind of a report card, so to speak. The big thing, you know, last month was the link between yield and equity volatility.

[00:44:22] So as interest rates were going up,

[00:44:25] the VIX and equity volatility was also going up

[00:44:27] and a lot of the names that were rate sensitive the market slid down pretty sharply, right? Rate as that Dix expiration went off. What was interesting to me about this basket of trades that you can see here is that I morphed October expiration in a red line. You have XLP and dark blue, you have TLTs in yellow,

[00:45:40] and then you have Coca-Cola's one of those stocks we mentioned in particular is in Lightblen.

[00:45:44] You can see that even though the broader market was trading down,

[00:46:44] for several of these names, including TOT, where we said, look, the flows in TOT are not enough to move the actual bond market, but from a sentiment perspective, the fact that people weren't really

[00:46:49] betting on long yields going lower than this was a very interesting sentiment indicator to us.

[00:46:58] Yeah, so on your next slide, you've touched on this idea that rates and equity

[00:47:02] vol have become unlinked. They were surprising looking at the beginning of this chart. I mean,

[00:47:05] they were very, very linked for a long period come down in kind. Now, that has a lot of implications for how markets trade, but it's this other interesting idea that I think warrants attention in that. We were just talking before about

[00:48:20] how it was a bad jobs number that served

[00:48:23] for the equity market rally,

[00:48:24] because the bad jobs number,

[00:48:27] showing that people had lost jobs, This is sort of the narrative I think that's driving options markets. So I think we could stage for a nice equity market rally here into that December timeframe because these two become on the link. Equity vol is not likely to come and sneak up on us because rates suddenly jump. If it's jumped, then vol is going to go up in the marketing to pressure down.

[00:49:41] So I put in this kind of Q meme about And then recently, it's now these treasury funding announcements, like these quarterly funding announcements. And if they issue longer duration, the market goes down. And if they issue shorter duration, the market goes up. So I got to figure out how those work.

[00:51:00] So it seems like there's always something choices. Yeah. So there's a real synergy there between bad jobs, number by stocks, and anybody but this person. So anyways. Yeah. So on the what's moving segment this time, you've brought up the MAG7 stuff again here in the chart, which we looked at last time is that last time I showed this chart, I know it looks like the matrix here, these relative shaded areas here that I'm highlighting with my cursor, which is the five strikes, these are option strikes buy those dips or use that dip to get long some of these names. And I think you want to continue to own these leaders based on the call positioning that we're seeing here. Here on this next slide, you got to hit anywhere it hurts here because we're small cap value investors.

[00:55:01] And you had to point out here

[00:55:03] that things in the small cap space

[00:55:04] have not been going that well.

[00:55:05] Like I was looking the other day But small caps and IDMMs are starting to show up on our radar as downside is kind of overbit at this point. And so I think it's an interesting place to sell put spreads and possibly buy calls for a year in rally based on the fact that there's still a decent put position here. And that's enough fuel to help IWMs rally as we clear out some of these puts with November expiration.

[00:56:22] I think we could get a decent rally here into the market versus call gamma. And so when you get to the bottom of this chart, the blue line is at the bottom, that's telling us there's way more puts in the IWMs relative to calls, right? So to put heavy put dominated market. And you can see with the rally that we had, how sharply that change, right? Put value's got eviscerated,

[00:57:40] and that caused this spike up, right, in this metric,

[00:57:43] and that coincide with the really big stock rally.

[00:57:46] Well, what happened then is there was no follow-through there,

[00:57:48] right?

[00:57:48] People didn't continue to buy calls, crypto related names. So Bitcoin has moved up, and this chart's a little bit longer dated, but I think Bitcoin was up something like 10%. It went from what did it do? 35,000 to 38,000, sorry. In very short order. And that's sort of the bit up these crypto names a little bit. And if it shows up on our squeeze scanner,

[00:59:00] what that's reflecting is call positions

[00:59:03] are being built up overhead.

[00:59:05] And so what I this came up. And if you're a fundamental investor, or a longer term investor looking at this stuff, I wanted to flag that these names are continuously now showing up on our radar as heavy call activity, which means that if the market overall, if this sector of the market starts to rally,

[01:00:22] it could have a lot more upside volatility

[01:00:25] because of the way that these calls are positioned.

[01:00:27] So, for example, vanning and charm, essentially lifting the market up as he puts kind of decay. But the December options explorations work in reverse. Sometimes we have weakness as put values increase because the market's crashing. And then those put values are kind of erased with December options expiration. And we kind of rally. I think in this play, in this case, you know So if you talk about that option cycle, where we rally, positions start to build, and positions build up around where open interest is forming, and then we kind of pin into a certain area, well that 4,500 or 4,550 is that area that can really become a pinning area based on this cycle that we were talking about at the top of the discussion.

[01:03:00] And then, you know, that'll be for the S&B 100,

[01:03:02] and then in single stocks,

[01:03:03] the fact that people are buying calls,

[01:03:05] to me tells me that if we got a little bit of a window of clear sharing here. If CPI doesn't come in at some ridiculous number or some random data point, doesn't come in at some just really hot number that makes rates pop, then, you know, that there should be a nice tail and here. And look, that's, you know, 3% rally, which is great for a month.

[01:04:22] You know, but I think a pretty reasonable, you know, expectation that

[01:04:25] it's not like we're looking for a 10% rally here over some very short time period.

[01:05:22] can break down for our next call about this.

[01:05:25] Well, I hope Brent we've produced top 100 content here.

[01:05:31] Hopefully we've produced the content we need to vault ourselves into the top 100 this time.

[01:05:34] Well, you destroyed our chances to our big top 100.

[01:05:36] Yeah, that's true. Our Italian listeners to doubt immediately when I go at the beginning.

[01:05:41] But but yeah, anybody who wants to help in that in our pursuit of that, any any