Stocks rebounded slightly this morning, recovering from yesterday’s major plunge into the close. The S&P opened with a 0.8% increase, bouncing back from its largest single-day loss since October. The Dow rose by 0.7%, and the tech-heavy Nasdaq Composite saw a 1.2% gain, following a halt in their nine-day winning streaks.
Investors had been riding a wave of optimism, fueled by expectations that the Federal Reserve would shift towards cutting interest rates, potentially as early as March. Despite central bank officials trying to temper these expectations, the market had remained resilient until Wednesday’s downturn.
The cause of Wednesday’s sharp market decline wasn’t immediately clear, with various theories circulating. Some speculated it was due to FedEx’s gloomy revenue forecast, year-end profit-taking, or the impact of zero-day options trading.
The S&P had been in an overbought state, and with trading volumes reduced due to the approaching holidays, the market was ripe for a pullback. Observers pointed to significant volumes in put options expiring within 24 hours, known as 0DTE options, as a potential trigger for the market drop. These trades could have led market makers to hedge their exposure, contributing to the market’s decline.
Matthew Tym, head of equity derivatives trading at Cantor Fitzgerald LP, expressed concern about the impact of 0DTE options, suggesting they might have played a role in the late-day sell-off. Notably, put options in the 4,755-4,765 range on the S&P 500 drew attention, with significant notional values tracked by Bloomberg.
The S&P experienced a substantial drop from its intraday high of 4,778.01 to close at 4,698.35, marking its biggest decline since September 26. The VIX, Wall Street’s volatility index, also saw a sharp increase from near multi-year lows.
Strategists had been cautioning about the potential for a market pullback, given the almost uninterrupted rally since late October. Lori Calvasina from RBC Capital Markets had recently highlighted the risks of a pullback, and Fed officials had been trying to manage expectations regarding rate cuts.
“Long put 0DTE on the S&P 500 is likely one of the catalysts that triggered the significant bearish reversal seen across the benchmark US stock indexes yesterday, on top of short-term overbought conditions and thin trading environment ahead of the year-end holiday season,” said Kelvin Wong, senior markets analyst at Oanda.
The surge in trading of zero-day contracts has sparked debate about their broader market impact. While they offer institutional investors a way to hedge short-term risks and retail investors an opportunity for quick gains, concerns have been raised about their potential to destabilize the underlying market. SpotGamma, an options analysis firm, attributed the decline in the US equity benchmark to 0DTE options, and Rocky Fishman from Asym 500 pointed out the unusually high daily volume of these options.
Despite these concerns, Cboe Global Markets maintains that there is little evidence to suggest that the trading of these derivatives is causing instability in the market. And they’re right; it’s really the lack of liquidity that has made the indexes so susceptible to major moves.
In the end, though, it’s probably not a fluke that the market went sharply lower yesterday. Stocks are still extremely overbought after rallying for seven straight weeks. If anything, it may have been a glimpse of things to come rather than the result of a temporary hiccup in 0DTE put volumes.
