Traders Pile Into Boom-or-Bust Options to Play Stock Market Volatility

Activity in the stock options market is at a peak, with many rushing into trades that expire in a matter of hours or days to play the wild market swings.

Options contracts that expire in less than a week account for about half of all activity in the US-listed options market, according to derivatives analysis firm SpotGamma. That’s up from about 45% over the last year and about a third of all activity in 2019.

Options give traders the right to buy or sell shares at a specified price by a specified date. Buying short-term options allows traders to accelerate their bets in one of the most volatile years since the 2008 financial crisis.

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For some, the short-lived trades are a way to capitalize on the sharp one-day moves that have become a feature of the market this year and take advantage of the intraday momentum. Others have tapped into the trades to manage risk in their portfolios during a turbulent time.

“Speculators love them,” said Steve Sosnick, chief markets strategist at electronic broker Interactive Brokers, of options with the shortest expiry times. “When you’re speculating, you don’t necessarily want to be thinking about moving in three months — you want to be thinking about moving tomorrow.”

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The S&P 500 just posted its worst nine-month performance since 2002. And the dizzying stock moves have continued into the fourth quarter. The market index is up 5.5% to start the week, including the best two-day return since April 2020. It’s still down 21% in 2022.

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The sharp swings weren’t limited to the broader market. Twitter inc

Shares rose 22% on Tuesday after Elon Musk indicated he would go ahead with his deal to buy the company. More than 1.1 million options contracts were tied to the exchange’s hands on Wednesday, a more than six-fold increase from typical levels, according to Cboe Global Markets.

The most actively traded contracts were those that expired on Friday.

Markets are suggesting money managers are moving money in a way that suggests they see a recession coming. WSJ’s Dion Rabouin explains what to look out for. Illustration: David Fang

Options have grown in popularity in recent years and many institutional and retail investors have amassed since the start of the Covid-19 pandemic. Overall activity is on track for another record year, with more than 40 million contracts changing hands on an average day in 2022.

Shorter-dated options can be cheaper to trade while offering traders the opportunity for explosive returns if their bets prove right, Mr. Sosnick said.

An option’s price can change quickly as it nears its expiry date, allowing buyers to take advantage quickly when the market moves in their favor. Alternatively, the approaching expiration date may be attractive to sellers looking to secure income from selling an options contract if its value collapses. These approaches can be risky and leave traders with large losses.

Julien Stouff, founder of Geneva-based hedge fund firm Stouff Capital, said he bought S&P 500 options that expired on the same day to take advantage of the stocks rally earlier in the week. It started trading before the US stock market’s opening bell on Monday and completed a similar trade on Tuesday.

Mr Stouff said the trades allow him to manage his risk in a difficult market that is prone to wide swings in both directions and where rallies have so far been short-lived. While he said he believes this week’s recovery will eventually peter out, the options have allowed him to take advantage of the higher momentum.

“This market is very dangerous,” Mr. Stouff said. “Every day is a new day, it’s a new market.”

Cboe Global Markets introduced additional weekly options expirations this year, fueling more activity and helping push the S&P 500 index’s options volume for intraday contracts to a high in September.

Of course, many traders have also tried to profit from market declines or to hedge their portfolios. The recent surge in volatility has been punctuated with heavy activity in put option trading, which has surged to its highest level since 2008. This suggests that many traders are turning to bearish trades to take advantage of market declines or to protect themselves from further losses.

Facing one of the most uncertain times for the economy in years, traders have turned to index options rather than options on individual stocks to place broad bets on the market. This is a departure from the meme stock mania and excitement surrounding individual company stocks that dominated markets in early 2021.

According to data provider OptionMetrics, more than 60% of index-linked options trades expire in nine days or less, up from around 40% in January 2021. Overall, options linked to stock indices and exchange-traded funds are worth about $1.6 trillion are, every day, nearly eight times the $204 billion of individual stocks, according to an analysis of OptionMetrics data by Goldman Sachs.

It’s not all speculation. Another reason short-term options have become so popular is risk management, said Benn Eifert, chief investment officer at hedge fund firm QVR Advisors, which uses complex derivative strategies.

“Every market maker, every major Wall Street bank, and every hedge fund like us uses short-term options every day to more accurately manage risk,” Mr. Eifert said.

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Write to Eric Wallerstein at [email protected] and Gunjan Banerji at [email protected]

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