The OPEX Effect: October Expiration | S&P 500, Bond Volatility, MAG 7, Ozempic Trade

[00:00:00] Welcome to the OpEx Effect, a joint podcast from Excess Returns and 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 Carbono, 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. Securities discussed is a new initiative, a new sort of, I guess, podcast we're launching with you. We're calling it, as people can see on the screen, the Opex effect. And we're just, yeah, we're excited to kind of jump

[00:01:41] into this.

[00:01:41] I think this is gonna be pretty data intensive

[00:01:45] in the sense that there's gonna be a lot of slides here

[00:01:48] that Brent will show. The thing I think we're trying to do here is is tend to have a lot of the advisory, a little bit longer term investor audience. And I think the options market shows data and has impact for this type of investor or even a trader that has a little bit

[00:03:00] of a longer term time view.

[00:03:01] And the options expiration,

[00:03:03] which we're gonna talk about,

[00:03:04] we're doing this every month for options expiration

[00:03:06] because a lot of times those options positions, to just kind of let's start there like at that, why do you think long-term investors should be paying attention to some of the things in the office market? Yeah, thanks Justin. So for that, we'll dive into the old presentation here. And what I wanna start with is record overall options volume.

[00:04:20] And I think a lot of people probably are aware

[00:04:22] of this by now, but I wanna provide a chart

[00:04:24] just to reveal exactly how much this volume

[00:04:28] has grown over the last couple of years. affect you on different time frames. And we're gonna give you some of those examples here. So to give an example of the relationship between options positions and volatility, this kind of underlines the impact of options trading on market flows. And what you have here along the X-axis is our measurement of gamma, we call it a gamma index.

[00:05:42] And essentially what it's doing is it's measuring

[00:05:44] through our models the amount of gamma

[00:05:45] that's in the market for around options expiration. There's a lot of data and information in those slides, and I don't want to repeat that here. But if you go back and reference that presentation, we talk about some of those longer term effects. So this is just a very simple way to show you in very detailed form the correlation between options positioning and realized volatility

[00:07:05] in the S&P. training market as or traders in general have really come to understand options, I think, are learning to use them in intelligent ways. And, you know, I think that has really bred the growth here. So, you know, it starts with technology offering access. And then, you know, when you go through with, you know, the growth of products and understanding of how risk parity funds, whatever it may be, they're getting lower volatility that drives money into equities. It becomes this reinforcing reflexive feedback loop, so to speak. And it's a market regime, right? And it can last really years where you maybe have a few weeks here where puts expand because of a headline comes off,

[00:09:42] but in general, people buy that dip and things continue.

[00:09:45] After January of 2022, we the bottom of the market is based on how puts are acting. People don't wanna pay for insurance anymore, right? It's basically what that starts to reflect. And dealer positioning, I think it's so full on puts that market makers are required to offer a bid and offer,

[00:11:03] but they can charge prices that are so high

[00:11:06] that it disincentivizes trading. And so maybe you could use that as example or something else and talk about sort of this cycle and how all this works. We can just use Friday to have a chart of this. You know, unfortunately, last week, you know, tensions in the Middle East flared up and you know, it's a really bad situation and it's unfortunate. And you know, so, you know, my comments here don't reflect kind of that situation, but

[00:12:24] the VIX on Friday moves significantly higher relative You and I, the three of us could sit here and probably outline a few scenarios which Wall Street would be deeply concerned about the events in the Middle East or whatever it may be. And unfortunately, it would take a magnificent increase, just something that is

[00:13:44] magnificent, another great term for it, but just this jump in escalation, like Iran joins and event has to get over. So at a certain level of hedging, it doesn't really matter how bad the event is. Like we've hedged like the worst case scenario for some of these things. Yeah. And that's, that's 100% right. And so, you know, the VIX went to 20 on Friday's close right in that neighborhood. It was a significant move. People were getting very concerned about, you know, that rise in VIX and our point

[00:15:01] and we put it on Twitter, you know, just, but looking at slide eight, it's a good example I think of some of the impact. I mean I think on here into expiration and then in expiration all the positions expire or a big chunk of positions expire and that releases the market or releases the stock from its current position or from its current behavior. And again, we'll touch on this to examine this. So if you're a longer term investor, you want a bunch of calls or if you know a bunch of

[00:17:43] stock, you're worried that stock's going to go down, when can I hedge this?

[00:17:45] Ops' expiration is very interesting. is coming up on the horizon and people start buying a lot of puts. The initial reaction to that is dealers are going to have to sell the underlying, so it's going to drive that down. But as we get to expiration, if we don't get the major move, the value of those is going down so the dealers have to reverse what they're doing. Is that the general idea? Yeah, that's exactly right. So if you look at the flows here, what I've done is I've mapped out the size of the Delta

[00:19:03] for spiders, idaleum, cues, the big index one. volatility shifting in a rather violent way. And this is the Vanna trade we often talk about where the VIX doesn't understand its options exploration. The VIX doesn't price that in, but the VIX gets smacked as soon as the market starts to rally off of options exploration, right? And when the VIX goes down, that tends to push the market higher. And similarly, when the VIX starts to jump,

[00:20:20] the market gets sold off or pressured down.

[00:20:22] And so, all these ideas are intertwined,

[00:20:25] but they can be triggered by positional events

[00:20:27] like an options exploration. for single stocks as well, couple of these we're gonna talk about. Cause the other side of the equation is how much hedging flow is there, right? How big are these options positions? That could be tough to assess if you don't have the right tools. But yeah, you may look and say, oh, there's a ton of calls here, but maybe it's a hundred lot of calls. And so even though it's big and balanced, there's just not enough positions to actually matter, right? So you do have to weigh those positions a little bit

[00:21:40] to see how impactful they may be.

[00:21:42] And slide 10, you kind of,

[00:21:44] we're seeing evidence of what you alluded to before,

[00:21:46] this idea of 4, wall above 4,500, these call walls start to build above that, it's a sign that the options markets in belief or is giving weight to the fact that the market could rally through that. But right now, the 4,500 area is, I think something that out of October expiration,

[00:23:00] you wanna watch an into November as a possible high.

[00:23:03] 4,400 for Friday.

[00:23:06] And then if you break 4 really show on the data, and we see this on a daily basis, is that the positions in the market the point of this is that even though the market has been selling off the S&P, volatility has not been popping, right? It has not really gone crazy where the VIX has gone over 20 and there's been a lot of fear and panic in the market. And we haven't seen the options positioning ready to support that high level of volatility. And I would actually make the argument that I don't think we're gonna see it this year.

[00:25:43] I think we could see VIX test 20 a couple of times.

[00:25:45] I think the market could sell off 5%, right? in to be like a World War III scenario and be really bad for everybody. That could present that element. Okay, there is this war, not something yet, and how do I hedge that unknown? And the credit events are that type of situation. But one of the things we're talking about here are yields, yields coming down. There's just a lot of reasons to think that scenario is not yet on the tape.

[00:27:05] The next slide talks about skew, which is something I didn't totally... I understood the concept, If I want to get long volatility, I got to own out of money puts. And so when this S-DEX spikes, it's telling you that people are tail hedging, right? They're hedging precipitous drop or what they're worried about may be a precipitous drop in the market. So this is really just telling you that downside demand is there and it's real. Sometimes

[00:28:23] you see the VIX spike, for example, but up people get too crazy and they overpay for that downside protection and it becomes an opportunity in the upside. So is this at all predictive of like what happens in the future? I think you can take some of these major lows that you've seen over time here.

[00:29:41] And, you know, it appears there is kind of a lower bound in this metric, as you can see.

[00:29:45] And I think it's interesting or useful from that. Whereas volatility in theory could go to a million to the upside, right? So that's what makes it harder to use as a bottoming predictor, right? So you want to think about the skew index or this S-DEX at 50 as a top, as a signal that maybe volatility has hit its lows, right? And the market's kind of topping out. How about this next slide here? You're talking about the S&P SPX variance premium, and a lot of people probably

[00:31:02] won't know what that is, so can you talk about what that is and what we're seeing here?

[00:31:05] Yeah, absolutely.

[00:32:04] VIX was much lower compared to the S&P 500, then all of a sudden the VIX got bit up

[00:32:05] because everyone was worried about the war, right, on Friday.

[00:32:07] So the VIX went up four or five points,

[00:32:09] and that spread, you could see, widened out.

[00:32:11] When that spread widens out,

[00:32:12] that's telling you that people are paying up for options,

[00:32:14] and there's not a lot of realized volatility.

[00:32:16] So there's this extra amount of premium,

[00:32:18] which in theory makes it juicier

[00:32:20] for volatility sellers to come in and short, right?

[00:32:22] You know, sell VIX futures under that,

[00:32:23] or some people like to sell VXX,

[00:32:25] or those inverse spreads, right? percentile here and you're along a lot of equities, well, maybe you want to add some put protection to your portfolio because puts are cheap, but also there's not a whole lot of places for volatility to go. So that may benefit me as a timing indicator for my portfolio for adding hedges. And then conversely, if we're up around this top line and I own put protection, maybe I want to roll it out or maybe I want to adjust it or maybe this is a good time to add some

[00:33:43] equity exposure because maybe this premium is telling me that the market's due for a

[00:33:47] rally. I also want to talk about some other things you're seeing in areas outside of the S&P 500. And one of the most interesting things we've been seeing recently is, as much as there has not been a lot of that volatility S&P 500, there's been tons of volatility in rates, particularly in the long term rates. So you've got this chart of yields driving equity vol, the VIX versus the 10-year. So can you talk about that a little bit? I'm going to first preface all this by saying I stay out of the macro pool.

[00:35:03] I don't envy people who have to wade through that market right now.

[00:35:05] So, you know, I'm not rates traders in disguise at the moment. But where these things can decouple, I would say is that if rates just stop going up, they can stay flat or they can come down

[00:36:20] and either snare, vol likely to come down,

[00:36:22] the VIX is likely to decouple.

[00:36:24] And I think that would be a real risk on indicator

[00:36:26] for the market when this decoupling takes place. environment like this, right? This is all new to us. You can back test it all you want, but after 2008, rates have only gone one direction, right? And so rates rising at this rate and this level of inflation and all these things, a lot of people have never seen a little tough to show, but I want to show a very long-term chart. Call volume in TLT has really spiked. It's record call volume, it's record open interest in TLT calls and put volumes, they're elevated, but call volumes are in blue here,

[00:39:00] they're significantly higher.

[00:39:01] And so what's happened is as TLTs come down

[00:39:04] to this 87 to your point, the percentage of options flows in something like the long-term bond market is a lot lower than it is in something like the equity market. 100%. You can look at Nvidia, just as an example. We could have $300 million of deltas traded in Nvidia in a single day. And when you weigh that versus the market cap in Nvidia, it's huge.

[00:40:22] But the bond market is just unbelievably massive and TLTs. which is one thing to note, but below 85, there's hardly any put positions. So if you were going to try to bet that rates were going to go higher in the long end, you couldn't really trade bonds directly. You didn't want to. You buy TLT puts as a way to express that downside. People aren't doing it. They're not betting that we're going down below 85.

[00:41:42] Doesn't mean it's not going to happen.

[00:41:43] It's just there's no put positions out there.

[00:41:44] And you can see the calls in the orange bars

[00:41:46] are fairly stacked above.

[00:41:47] So I think that's extremely interesting

[00:41:49] from a sentiment perspective. which is suggesting that some of these calls that are layered in the market are getting sold rather than necessarily puts being bought. I think there's two different trades, right? I could sell a call and if the market goes down the call very quickly goes to zero and I collect my premium. It's also an expression I don't think that rates are set to pop a whole lot yet. So what you have here in summary, people aren't betting that TLT is about to go down

[00:43:02] below 85, right?

[00:43:04] They are starting to bet that rates are gonna rally

[00:43:07] or TLT, excuse me, rates are going to spike here, rates are going to spike here. I think we're done. Excuse me, TLT is going to spike here. I think rates are going to drop. And that's what the higher blue bars or blue lines was chart expressing. And so it's very interesting to me when TLT finally hit 85, it's like the actual call values have declined, even though call volumes are kind of increasing. It's sort of like the market

[00:44:23] is kind of exhausted here. People are trading a at the 55 level, but the put positioning, which you can really see by the curve of this blue line here, really dried up. And so, yes, people wanted to sell utilities

[00:45:40] and this kind of thing, but the bet,

[00:45:42] the explicit bet in the options land

[00:45:44] that this was gonna drive a lot has really dried up.

[00:45:46] And I think because this is the engine of the market and there's tons of studies about that. I'm sure one's aware. What I think is really interesting is this index here is the MGC, which is the Vanguard, I believe is the equally related Magnificent Seven Index. And it peaked in August. It made another attempt in September. So peaked in August at 162, this particular ETF. And it's currently at 155.

[00:47:00] And what I think is interesting from that, if you're looking at long term perspective,

[00:47:03] is there's a lot of options areas in here are red for near-term expirations, November expirations, et cetera, tells us that the implied volatilities of those strikes are coming down.

[00:48:20] That happens when people generally are selling calls.

[00:48:24] That means the implied volatility of these names dropped because investors are selling

[00:48:27] options. This option is getting a little bit dry, so here is your little tidbit for the day. The name Ozempic comes from the word Ozem, which is the fictional land in the Wizard of Oz. The idea is that Ozempic is meant to evoke sense and wonder and possibility. The possibility of you losing a lot of weight. That's what the name Ozempic means.

[00:49:40] I just thought that was kind of interesting.

[00:49:43] Novartis and Eli Lilly, I options market in a lot of these names have stopped betting sorry about that have stopped betting that these names are gonna go significantly lower

[00:51:03] and what's interesting from an options perspective is maybe you think these right, which is reflected in a lot of these consumer staple names. So, the spike in call activity is kind of a signal here that, hey, maybe we do have, maybe we can't make the case for a short term balance in the ozepic online trade. I'll just call it as a way to factorize. What's funny is, I don't know if it's been true of you guys, but if I was existing only in the forehand house, I'd be buying extreme call options on the sugary staples or whatever they're called,

[00:52:23] because my kids, that's pretty much all they're for. So you've been generous. And we'll do this in future episodes too, to highlight the content, highlight the trends and things that you're seeing in the options markets to help investors and also traders hopefully make better decisions and make more profitable