The US The derivatives regulator is investigating the impact of extremely short-term options contracts on markets, as analysts warned that the bullish trend could contribute to wild swings in share prices.
Commodity Futures Trading Commission Chairman Rostin Behnum said Wednesday that the agency is assessing potential risks or systemic problems that could arise from the so-called zero-day trading strategy, which has grown in popularity since the start of the coronavirus pandemic.
Zero-day options refer to contracts that expire on the day they are purchased and are primarily linked to the S&P 500 index. About 45 percent of S&P 500 option volume on a typical day comes from single-day options, according to Bank of America.
Proponents say daily expirations allow investors to make more targeted bets or hedge risk around specific events such as economic data releases or central bank meetings, but analysts have warned that the increased number of contracts could exacerbate violent market swings. Equity options contracts in the US are regulated by the CFTC’s sister regulator, the Securities and Exchange Commission.
Speaking to reporters at the annual Futures Industry Association conference in Boca Raton, Behnum said: “We’re talking internally about who the participants are in that market, what that potentially means from a risk standpoint, what are the obvious — if any — systemic issues. . I don’t want to prejudge it, but it’s clearly on our radar.
He added that greater transparency around who uses options is “key to a successful market”.
The flexibility of short-term options has been particularly popular with investors during the market volatility of the past year, with trading volumes frequently setting new records.
However, the trend has drawn regulatory attention after a series of reports by analysts at JPMorgan compared the surge to a 2018 blow-up in the options market dubbed “Volmageddon.”
A build-up of one-way bets on products tied to the Wix volatility gauge ended with the closure of two major investment funds in early 2018 when stock markets fell, sparking a sharp reversal in Wix.
In its worst-case scenario, the bank suggested that the cost of unwinding zero-day options bets could effectively turn a 5 percent S&P 500 decline into a 25 percent market decline.
Most zero-day trading focuses on contracts and is offered by Cboe Global Markets, the world’s largest options exchange. At a separate event at the FIA conference on Tuesday, Cboe head of derivatives Ariane Adams dismissed comparisons to Volmageddon or early pandemic meme stock trading.
She said the exchange’s S&P 500 contracts were being traded by a broad spectrum of investors and spread between buy and sell orders, which reduced the risk of sharp moves in one direction.
She added that many trades were closed before expiration and said more than half of investors used complex spread trades that included inbuilt hedges.
A senior executive at a major market maker that trades S&P 500 options said that much of the concern was based on a misunderstanding of how the trades were being made, saying that “if anything the added volume is just more liquidity, which [make markets] less dangerous.”
The trader said he had discussed the matter with regulators, and he believed they were “pretty on what the story is and want to understand. [the issue]Not just a knee jerk reaction”.
