By Jeff Kearns
Oct. 17 (Bloomberg) — The U.S. stock market’s wildest swings since 1929 may get even bigger as almost 80 million options expire today.
Owners of the contracts on stocks, indexes and exchange- traded funds have until today’s close to take advantage of the rights granted by the calls and puts they own. Investors are preparing for the possibility that market makers will boost volatility by buying and selling stock to hedge the risk of the option trades they have facilitated, according to Scott Nations, president of Fortress Trading Inc.
“I’d expect some fireworks,” said Herb Kurlan, president of Vtrader Pro LLC, a San Francisco-based options and futures brokerage. “The unwinding of positions is going to be more pronounced because of the high volatility.”
About a quarter of the approximately 337 million existing options expire today, according to Chicago-based Options Clearing Corp., which settles all trading of exchange-listed contracts and is the world’s largest derivatives clearinghouse.
The Standard & Poor’s 500 Index moved more than 1 percent in 10 of the 12 trading sessions in October, or 83 percent of the time, amid concern the global economy will enter a recession. That puts the benchmark index for U.S. stocks on track for the biggest swings since November 1929, when gains or losses of at least 1 percent occurred 88 percent of the time, according to S&P analyst Howard Silverblatt.
The most widely owned S&P 500 options expiring this week are October 1,150 puts. The S&P 500’s 18 percent retreat from that strike price profited buyers of those contracts, which increased almost sixfold in value this month. Even after yesterday’s 4.3 percent surge, the index has slumped 22 percent in three weeks.
Market Makers Hedge Risk
“There could be significant volatility as market makers who are short the options try to hedge that risk,” said Nations, president of Fortress Trading, a Chicago-based firm that trades options and futures. “If you’re short puts as the market goes down, you have to sell more of the underlying, and if it goes up, you have to buy more back.”
The market already proved volatile yesterday. The S&P 500 jumped 9 percent from its low to its high, the ninth consecutive session that the trough and peak were more than 5 percent apart. The average difference this year is 2.2 percent, compared with 1.2 percent in 2007 and 0.8 percent in 2006.
The Chicago Board Options Exchange Volatility Index, a measure of expected share-price swings and option prices, surged to an intraday record 81.17 yesterday. It dropped 2.4 percent to 67.61 at the close of trading.
`All Hands on Deck’
“We’re going to have all hands on deck” for today’s trading, said Joseph Cusick, senior market analyst at OptionsXpress Holdings Inc., a Chicago-based online brokerage. “There’s a possibility it could be explosive, but it should be relatively orderly.”
Last week, the number of options traded in 2008 surpassed the full-year record of 2.86 billion contracts set last year, according to the OCC. U.S. trading of exchange-listed options began in 1973 at the CBOE.
October options on the S&P 500 and other stock indexes finished trading yesterday. The settlement price for those contracts will be determined by today’s first trade. For S&P 500 options, which are the most actively traded U.S. contracts, about 24 percent of the total open interest of 17.6 million expires today, according to the CBOE.
Contracts on stocks and ETFs continue trading through today’s close.
“We’re going to be in for a wild ride,” said Michael Nasto, the senior trader at U.S. Global Investors Inc., which manages $6 billion in San Antonio. “It’s going to be like going to Coney Island.”