JPMorgan Says Big Options Bets Swing Stocks in Thin Markets

(Bloomberg) -- Market liquidity remains thin and this can leave stocks vulnerable to exaggerated moves around big options trades, according to JPMorgan Chase & Co.

“While we are not concerned about a dominant ‘whale’-type investor, exceptionally large trades in thin markets,” especially in sectors or investment styles considered overbought or oversold, increase the “potential for exacerbated stock moves as dealers hedge exposure,” Shawn Quigg, a derivatives strategist at JPMorgan, said in emailed comments.

Big trades under such conditions open the door “for larger swings in dealer gamma positioning,” Quigg said. Gamma refers to the option price drift that dealers seek to offset by buying or selling the underlying stock.

Large options volume attracted investor attention in recent days -- first as volatility started to rise along with equities, and then on reports that SoftBank Group Corp. and others plowed billions into derivatives. Some analysts argue that dealers hedging the other side of options trades from day traders and institutions contributed to recent gyrations in the shares of U.S. tech giants.

The Nasdaq 100 index has dropped about 8% this month, paring its climb from a low in March to 59%. Quigg said retail investors had a role but that institutions were the main drivers of September’s equity correction as “tech/momentum stocks decoupled and reached extreme overbought levels.”

In the wake of the recent multi-day selloff, investors can take advantage of rich implied volatility -- particularly in technology and momentum stocks -- by selling put options, he said.

Quigg and colleague Peng Cheng recommended tail protection in a note Thursday: selling 1x three-month at-the-money puts on the Invesco QQQ Trust Series 1 while buying three-month 90% puts for zero cost up front, they said.

A debate has been raging about who is behind the surge in options trading and what it means for investors. Hordes of retail traders buying short-dated call options had the bigger impact on the bullish feedback loop that drove tech stocks higher, according to Benn Eifert, chief investment officer at QVR Advisors LLC.

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