In 2015, options expirations mattered – stocks would tear higher into the event and like clockwork sink back lower after.
2016 was not so obvious but the all-important 'quad-witch' expirations still had some bias.
However, if JPMorgan's equity derivative strategists are right, today's 'quad-witch' – with $1.4 trillion worth of S&P 500 notional set to expire – could lead to a vicious cycle higher in volatility going forward. It is notable that VIX has been entirely decoupled from stocks for over 6 weeks now.
Right as Catalsyt Fund liquidation chatter began (forced buying due to the gamma in their options strategy – which is likely heavily used across many funds).
VIX Call volume relative to put volume has collapsed to pre-December op-ex.
Which brings us to tomorrow's 'quad-witch' options expiration. As JPMorgan's equity derivatives group warns, on Friday, ~$1.4Tr notional of S&P 500 options expires.
As the market drifted lower over the past roughly two weeks and option positions were rolled higher into/following Feb expiry, the gamma imbalance fell significantly and is now only moderately tilted toward calls (~$15Bn per 1% now vs. ~$50Bn into last month’s expiry).
[NOTE – there is a huge pin around 2250 – puts and calls – which just happens to be around the level at which Catalyst's strategy started to implode]
The gamma imbalance remained tilted toward calls throughout the past two weeks, and thus dealer hedging activity likely continued to depress market volatility.
However, the majority (~70%) of the imbalance expires on Friday, likely leaving dealers close to flat post expiry (assuming spot roughly unchanged), and the gamma imbalance remains highly sensitive to spot moves near current levels and would be flat if the S&P 500 fell just ~1% (Figure 3).
This suggests dealers could be taken short gamma relatively quickly on a selloff (particularly if it comes ahead of March expiry).
In english, Friday's expiration could change options dealers' positions in a manner that could leave them more likely to feed into any uptick in stock market volatility going forward, and after tomorrow, dealers' positions in S&P 500 options will change so that any stock market selloff could quickly see dealers boosting volatility as they hedge their positions.
Or even more simply put, the foot on the throat of volatility could well be lifted tomorrow… and positioning suggests any pain will quickly feed on itself.