Will trading in option contracts known as zero days to expiration (ODTE) become the bane of the markets? Goldman wrote yesterday “a flurry of trading in ODTE caused the S & P 500 to slide about 0.4% in 20 minutes.” Goldman stated there is not enough liquidity to “handle the market delta hedging such a dramatic move over a short 20-minute period that could perhaps cascade into a major market calamity.”
Bloomberg writes that earlier in the week both Nomura and Citigroup stated that trading in ODTE contracts has exploded to record highs this month “and may have been contributing to intensified intraday swings that could perhaps at one point become uncontrollable.”
UBS expressed similar concerns stating, “the S & P 500 close below its 50-day moving average for the first time since late March was primarily the result of ODTE.”
Goldman further states “amplifying the influence of zero-day options is a market where it is getting harder to trade stocks without moving their prices as liquidity conditions have worsened over the past two weeks, with a measure plunging 56%.”
Market liquidity is already challenged. Moreover over 90% of equity volume is the result of algorithmic or technology-based trading, trading whose catalysts are momentum and headlines.
During the 1987 stock market crash, the Federal Reserve stated a major reason for the plunge was the result of portfolio insurance and behavior from options contracts that was not fully understood at the time.
Will history repeat itself, making the 2013 flash crash that was fueled by “high speed trading and options” as a walk in the park?
Commenting about the Minutes from the recent FOMC meeting, the Minutes stated “most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy.”
The Minutes further stated.
A number of participants judged that, with the stance of monetary policy in restrictive territory, risks to the achievement of the Committee’s goals had become more two sided, and it was important that the Committee’s decisions balance the risk of inadvertent overtightening of policy against the cost of insufficient tightening.
Finally, the Minutes said all future decisions will be entirely data dependent.
Markets were mixed on the hawkish sounding Minutes. Treasury yields increased nominally across the spectrum and equities were bifurcated as the NASDAQ closed lower by 1.15% and the Dow lower by 0.52%.
Last night the foreign markets were down. London was down 0.13%, Paris down 0.07% and Frankfurt down 0.08%. China was up 0.43%, Japan down 0.44% and Hang Seng down 0.01%.
Futures are nominally higher. The 10-year is off 12/32 to yield 4.30%. The 30-yeaar Treasury is at the highest level since 2011 yielding 4.42%. On July 31, this benchmark was yielding below 4%.
