JPMorgan’s Kolanovic Warns of ‘Volmageddon 2.0’ Risk in Options

(Bloomberg) — The explosive rise of short-dated options is creating event risk on the scale of the stock market’s early-2018 volatility implosion, according to JPMorgan Chase & Co.’s Marko Kolanovic.

Most Read from Bloomberg

That episode, known as Volmageddon, sparked market chaos exactly five years ago and forced the shuttering of one major volatility-focused exchanged-traded product. The latest proliferation of options with zero days to expiry has similar potential to create market turmoil, the top-ranked strategist says.

By his team’s estimate, daily notional volumes in such short-term options — known as 0DTE in industry parlance — is around $1 trillion.

“While history doesn’t repeat, it often rhymes,” Kolanovic wrote in a note to clients. The selling of these “daily and weekly options is having a similar impact on markets.”

The February 2018 “Volmageddon” episode is one of the more famous instances of dynamics in derivatives markets bleeding into their underlying assets, in this case stocks. The main culprits were exchange-traded funds designed to pay investors the inverse of equity volatility.

When turbulence in stocks ramped up in the early part of that month, it triggered a snowballing effect that eventually sent many such strategies hurtling toward worthlessness, contributing to a 10% plunge in the S&P 500 over two weeks.

Now, Kolanovic is issuing what’s likely the loudest alarm on 0DTE options whose explosion since mid-2022 has been often blamed for amplifying moves in underlying assets. Their impact was on display Tuesday, when S&P 500 futures swung wildly following an inflation report, making any attempt to figure out the market’s collective thinking on the economy an especially futile exercise.

Read more: One-Day Options Binge Makes It Tough to Read Market’s Tea Leaves

In the eyes of Kolanovic, the risk involves options dealers, who take the other side of trades and must buy and sell stocks to keep a market-neutral stance. Since 0DTE options rarely get in the money, their market impact is now mostly felt through volatility suppression and an intraday buy-the-dip pattern that results from hedging, according to Kolanovic.

However, should the market stage a big move that put these contracts in the money, that would force options dealers to unwind a large amount of their positions, warns the strategist, who was ranked the best in equity-linked strategies in last year’s latest Institutional Investor survey. On a big down day such intraday selling would reach $30 billion, his model shows.

“These flows could particularly impact markets given the current low liquidity environment,” he wrote.

Taken up first by retail traders during the 2021 meme mania, 0DTE options have gained popularity among big money managers. During the second half of 2022, such options made up more than 40% of the S&P 500’s total trading volume, data compiled by Goldman Sachs Group Inc. show. That’s almost double from six months ago.

Most Read from Bloomberg Businessweek

©2023 Bloomberg L.P.

Source: https://finance.yahoo.com/news/jpmorgan-kolanovic-warns-volmageddon-2-202708851.html