Explainer: How a massive options trade by a JP Morgan fund can move markets

NEW YORK, Sept 29 (Reuters) – A nearly $16 billion JP Morgan fund is expected to reset its option positions on Friday, potentially adding to stock volatility at the end of a dismal quarter for equities.

Analysts have historically pointed to the JPMorgan Hedged Equity Fund’s quarterly reset of markets, seeing it as a source of potential volatility during Friday’s session. Continue reading

WHAT IS THE JP MORGAN HEDED EQUITY FUND?

The JPMorgan Hedged Equity Fund holds a basket of S&P 500 (.SPX) stocks along with options on the benchmark index and resets hedges quarterly. The fund, which had approximately $15.59 billion in assets as of Sept. 28, aims to let investors benefit from stock market gains while limiting their risk of downsides.

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For the year to September 28, the fund was down 10.66%, compared to a 21% decline in the S&P 500 Total Return Index (.SPXTR).

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The fund’s fortunes have exploded in recent years as investors sought protection from the wild swings that rocked markets following the COVID-19 outbreak in March 2020.

Its holdings include some of the biggest names in the market, such as Apple Inc (AAPL.O), Microsoft Corp, and Amazon.com Inc.

HOW DOES THE FUND USE OPTIONS?

The fund uses an options strategy that aims to protect investors if the S&P 500 falls between 5% and 20% while allowing them to benefit from market gains in the average 3.5% to 5.5% range. As of June 30, the refresh of the Fund’s option positions totaled approximately 140,000 S&P 500 option contracts, including S&P 500 puts at strike prices 3580 and 3020 and calls at 4005, all for expiration on September 30.

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HOW CAN THIS IMPACT THE WIDER MARKET?

Options traders — typically large financial institutions that facilitate trading but try to remain market neutral — stand on the other side of the fund’s options trading.

To minimize their own risk, they typically buy or sell stock futures depending on the direction of market movement. Such trader hedging related trading has the potential to impact the broader market, especially when done at scale as is the case with JPM trading.

Trading is “well understood” and “largely digested by the market,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group.

However, according to some analysts, this has exacerbated daily movements in the past.

The S&P 500 Index (.SPX) fell 1.2% in the last hour of trading on March 31 in the absence of obvious news — a move some analysts pinned on option hedging streams. Continue reading

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Analysts say the update could exacerbate market volatility on Friday as the fund lengthens options positions and traders buy and sell futures to hedge their risk.

“That’s because a significant amount needs to be matched and hedged to roll the trade,” said Brent Kochuba, founder of analytics service SpotGamma.

“I think this week’s position adds volatility,” Kochuba said.

All other things being equal, after extending the option position to three months, their impact on current price volatility should lessen, he said.

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Reporting by Saqib Iqbal Ahmed in New York Editing by Ira Iosebashvili and Matthew Lewis

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