Nervy stock markets spark records in derivatives trading

Investors are racing to protect their portfolios from damage as volatility spreads across Wall Street, sending stocks higher and lower as traders brace for more hawkish policy from the Federal Reserve.

Put options, which can protect against losses from declines in stock prices, were in great demand at the start of the week, when the benchmark S&P 500 index of US stocks posted a 10 percent drop from recent highs.

Traders bought 31.3 million stock put options contracts that day, according to Bloomberg data, just shy of an all-time high on Friday, when 32.3 million of the contracts were bought. Both days surpassed the previous record of 26.7 million contracts set in February 2020 when the coronavirus pandemic began to rock US financial markets.

The rapid recovery in hedging activity reflects the notably jittery mood among investors of all sizes at the start of 2022 as the Federal Reserve prepares to cut the stimulus it has pumped into the financial system since the pandemic hit.

“One of the main themes that emerged in the first few weeks of the year was the re-emergence of hedging activity,” said Amy Wu Silverman, options strategist at RBC. “Outside of the general uncertainty that we see when the Fed starts to act, I think there is more [tail risks] existing this year.

Line chart of the number of stock put options contracts traded in the US each day (AD) showing investors turning to derivatives as a hedge like the US stock market's bearish leaflets

On Monday, the S&P 500 index briefly fell more than 10 percent from its record, known as a correction, and ended up closing the day higher, marking the biggest intraday move since March 2020 as the market turned violently. However, it was back again on Tuesday morning, with the Nasdaq down about 2 percent. Markets, which have suffered for months from a looming shift in Fed policy, are beginning to grapple with geopolitical tensions in Russia and Ukraine, as well as the impact that the Omicron coronavirus variant will have on global growth.

Data from Cboe Global Markets indicated that $53.7 billion of options traded in the United States on Monday compared to the daily monthly average of $25.3 billion.

This partly shows how much the options market – formerly the preserve of professional traders – has changed in recent months. Trading in these contracts has skyrocketed over the past year as new retail investors flock to contracts in the wake of the free-for-all stocks that have drawn millions of people to the US financial markets. But while many of these new traders have been drawn to stock options — bets that the stock will go up — since late last year, they have become increasingly involved in selling.

This activity has ballooned since tech stocks peaked in November when Federal Reserve officials signaled their intention to tighten monetary policy. The Nasdaq Composite is down 15 percent from its all-time high, with thousands of stocks in the index down more than 20 percent.

Traders said they were watching to see how many newly bought IPO contracts remained pending after Monday, as some investors previously bought and sold contracts quickly on the same day in an effort to profit from the change in the derivatives price. .

Jason Hedberg, global head of equity derivatives sales at UBS, estimated that the pending interest in put options tied to one popular trading fund — the $187 billion Invesco QQQ Fund, which tracks the Nasdaq 100 stock index — has been roughly in line with the average over the past few years. past even with higher trading volumes.

“What it tells me is that there’s not a lot of protection in place,” he said. This “leaves everyone more exposed as the selling continues,” he added.

One measure of stock volatility, the Cboe’s Vix Index, briefly hit its highest level since October 2020 on Monday and options activity on the index is booming. Cboe, the largest US options exchange, said a total of 61.4 million contracts were traded in US markets on Monday, more than 60 percent above recent averages. She added that the purchases and contracts were in similar volumes.

Brian Post, co-head of equity derivatives Americas at Barclays, said that “for the first time in a long time,” some institutional investors have sought to reduce their exposure to equities rather than rotate between sectors due to the recent market decline.

“There is an element when volatility becomes unhealthy, when risk shifting becomes very difficult, and withdrawals from some of that money will eventually lead to less activity, and we stick to those reversal points,” he said. “I sleep a little at night.”

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