Why are US stocks sluggish? Some blame a looming USD5 trillion options expiration

NEW YORK, Dec 12  – Dealers squaring their books ahead of an options expiration that is set to be the largest on record for S&P 500-linked derivatives may be helping to tamp down swings in US stocks, market participants said.

Some USD 5 trillion in US stock options are set to expire on Friday, 80% in S&P 500-linked contracts – the largest such expiration in at least 20 years – according to Asym500 MRA Institutional, a unit of derivatives strategy and execution firm Macro Risk Advisors.

While such events can exacerbate volatility, strategists say market participants’ behavior ahead of the upcoming expiration has been muting stock gyrations and may be one reason equities have traded in a tight range over the last few weeks.

The S&P 500 is up 21% this year, following a nearly 13% rally from its October lows. More recently, however, market moves have been subdued.

The benchmark index has not logged a greater than 1% move in either direction for 19 straight sessions, the longest such streak since early August. At the same time, the Cboe Volatility Index stands at 12.07, a near 4-year low.

Another example of the market’s sluggish trading can be found in the 10-day realized volatility for the S&P 500, which is how much the index has swung over the last 10 sessions.

That measure stands at 6.8%, after touching a low of 4.5% in late November. By comparison, it stood as high as 22.5% in March, when a regional banking crisis rocked markets.

The positioning of options dealers who act as intermediaries between buyers and sellers of derivatives has been one factor in keeping stock swings in check.

Options trading volume is on pace for a record year with average daily volume of 44 million contracts, according to data from clearing house OCC.

That volume has been boosted in part by the popularity of exchange-traded funds (ETFs) that sell options to generate income that have doubled in size in 2023 and now control about USD 60 billion, according to a Nomura analysis.

Robust options selling activity by these ETFs has left dealers loaded with options contracts going into the last expiration of the year.

In market parlance, the dealers are net long “gamma,” and must continuously sell stock futures when equities rally and buy futures when markets sell off to keep their position neutral.

With the huge amount of options set to expire, that buying and selling has had a knock-on effect of keeping stocks in a tighter trading range, market participants said.

The dealers’ positioning “is more than likely to arrest any deeper selloff between now and year-end,” Nomura strategist Charlie McElligott said in a note on Tuesday.

Market participants have pinned the muted stock moves on other factors as well, including volatility targeting funds and commodity trading advisers, as well as the VIX’s historical tendency to stay subdued once it hits the bottom of its trading range.

The lull in volatility could extend to Wednesday’s Federal Reserve meeting. While the central bank is expected to leave rates unchanged, investors are keen for hints on whether policymakers are pivoting towards cutting rates sooner, an expectation that has fueled the rally in stocks this quarter.

Expiration is likely to loosen the options market’s vice-like grip on stocks, said Brent Kochuba, founder of options analytic service SpotGamma.

Markets faced a similar situation two years ago, when a similarly large options expiration reined in volatility for part of the fourth quarter, only to give way to a 3% rally in the last two weeks of the year following the December expiration, he said.

“All that positive gamma is really crunching the market,” Kochuba said. “The lid has been kept on volatility.”

(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili, Nick Zieminski and Jamie Freed)