Market On Open, Friday 16 May
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Opex
by Alex King, CEO, Cestrian Capital Research, Inc
Today is May options expiration day. This matters even if, like me, you don’t care for options and prefer to stick to grandpa’s common stocks and ETFs. Why? Because the amount of capital in the options market dwarfs that in the equities market and because, crucially, option sellers are typically market-makers who are required to hedge their book at all times. (This is unlike common stocks where you could be buying from K. Griffin or you could be buying from Chad P. Yolo, you have no idea).
If you want some real brains to learn about opex I would suggest taking a look at SpotGamma or Jay’s Options. But I can give you the 101 right here.
After a very bullish market, as we have seen since the April 7 lows, investors have typically been buying up calls like there is no tomorrow. This is because, as everyone knows, when markets start going up, they only go up. It’s the same reason why when markets are falling, investors start buying puts as if the next Great Depression is going to happen next quarter. It’s almost as if nobody has any imagination that things can change!
Anyway, when investors have been loading up on calls it means that heading into an important options expiry date - monthly or quarterly - the dealer book has had to be hedged by the dealer buying long positions on the way up. Why? Because the dealer has been selling calls to the momentum bros. That’s a bearish thing to do as you know. So to hedge this bearish, short side of the book, said dealer has to take on long positions either in stocks, ETFs, or equity futures. This is why relentless call-buying actually drags the market up before expiry dates - it is a self-fulfilling prophecy if enough people load up on them.
Come options expiry day, the options, er, expire. If they were in the money then the owners will have sold them or, less often, exercised them. And then expiry hits. At that point the short side of the dealer book (remember the dealer sold the calls so this is the short side of their book) evaporates. Leaving the dealer with the long side of the book in the shape of futures, stocks and ETFs. Now obviously they don’t leave it till one minute to midnight to fix this but the fixing is rather concentrated around opex day. And the fixing involves selling those long positions to get the book re-balanced. So an all-bulled-up market heading into options expiry can often see a local high followed by a selloff.
Now you have the muppet’s guide to opex. Lob rocks at it if you want but that’s the basic arrangement right there. And what it means is that markets can be tricky around these dates. (The CBOE has the dates on their website by the way). So taking on new, large, one-way positions can be risky. You may prefer to hedge into opex, or take some gains to reduce exposure, or put some stops in place (not too close! as those self-same dealers will hunt you out just for fun).
So let’s get to work and look at how markets stand.
I would be remiss, of course, if I did not try to sell some subscriptions before doing so.
Quantitative, Unguilded
The big news around here is how well our quant services are doing, and I mean both the quality of ideas generated and the number of folks signing up for them. If you haven’t read up on our quant offerings, you can do so here.
Alex King
Bitcoin x AI
Do not miss the opportunity to sign up for Yimin Xu’s Bitcoin Signal Service at the low launch price. This is a special subset of his excellent YX Insights macro work. Read more here.
Alex King