Traders Brace for Chaos on Friday as $5 Trillion in Options Expire and Index Rebalancing Ramps Up

Options contracts tied to over $5 trillion worth of stocks, ETFs, and indexes are set to expire in the latest "triple witching" event, coinciding with the S&P 500 and Nasdaq-100 rebalancing. This convergence may result in a potentially highly volatile session where tens of billions of contracts and shares could change hands, according to market strategists.

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Rocky Fishman, founder of Asym500, reports that options with a notional value of $5.3 trillion are set to expire, with a significant portion expiring ahead of the market open. Traders cashing in bullish bets deep in the money and rolling their positions may force market-makers to continue hedging their exposure. Simultaneously, index-tracking fund managers must complete adjustments before the announced index changes take effect.

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Trading volume has been increasing throughout the week, with 17 billion shares changing hands on Thursday, up from 10.6 billion on Tuesday. The upcoming expiration is anticipated to be the largest of the year, with the potential to become the largest SPX option expiration in over a decade.

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Brent Kochuba, founder of Spotgamma, an options-market analytics provider, suggests that this could be the biggest options expiration ever. As markets rallied, traders aggressively acquired bullish options contracts at a record pace. For S&P 500-linked options, a new record of 4.8 million contracts changed hands on Thursday.

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The surge in call-buying has contributed to the S&P 500's impressive performance, gaining 8.9% in November, its best month of 2023. It has continued to climb in December, rising 3.3% through Thursday's close. Despite warnings about a potential market slowdown around the 4,600 level, the call wall was surpassed, and the S&P 500 closed at 4,719.55 on Thursday, its highest close since January 12, 2022.

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Options tied to the iShares Russell 2000 ETF, tracking the small-cap Russell 2000, also experienced explosive volume. This heightened activity, especially in small-cap stock indexes, reflects investors' bullish sentiment.

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The put-call skew for S&P 500 options has reached its lowest level in a year, indicating a rush to buy bullish contracts while avoiding bearish ones. Market analysts describe Friday as "the last major liquidity event of the year."

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"Triple Witching" days, occurring once a quarter, involve the expiration of options tied to single stocks, ETFs, and indexes, along with index-tracking futures contracts. They are known for increased intraday swings and higher trading volume.

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This quarter's rebalancing of the S&P 500 and Nasdaq-100 is receiving additional attention following a rare ad hoc rebalancing over the summer. Standard & Poor's rebalancing plans include adjusting the weightings of key stocks like Apple and Alphabet.

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Brent Kochuba suggests that Friday's expiration could remove the last barrier holding stocks back from reaching record highs before the end of the year, allowing markets to move more freely. However, some caution that investors should not place too much weight on options-market activity and other technical factors, emphasizing the significance of macroeconomic trends.