2023.09.28 04:17
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"Option Whales" emerge! The unsettled S&P 500 may plunge to 4200 points.

Morgan Stanley's stock fund's large number of options positions could potentially exacerbate a widespread sell-off in the US stock market.

According to Dolphin Research APP, for those concerned about Wall Street, the large number of options positions held by JHEQX, a $16 billion hedge stock fund managed by Morgan Stanley, could exacerbate a widespread sell-off in the US stock market.

JHEQX is a long stock product that uses derivatives to protect its portfolio from declines and volatility. The fund holds tens of thousands of protective put options contracts expiring on Friday, with strike prices well below the current level of the S&P 500 index.

This is significant because as the expiration date approaches and the S&P index potentially falls below the strike price, the counterparty traders face risks. If this happens, they would effectively end up holding long positions in stocks. To hedge against this risk, they would engage in short-selling to return to a neutral position.

This is part of the delta hedging process, and some market observers are concerned that it could act as an accelerator and amplifier of the stock index's volatility. As of Wednesday's close, the S&P 500 index rose 0.02% to 4,274.51 points. The strike price for JHEQX put options is 4,210.

S&P 500 index faces a test at 4,200 points

JHEQX is known as the "options whale" in the stock market derivatives field due to its significant influence. The fund's concentrated options positions are relatively large by market standards, and its mechanical trading strategy is well-known, allowing other participants to profit from it.

As the fund's assets continue to expand, Morgan Stanley Asset Management created two sister funds in 2021 that follow the same strategy but have different option expiration dates. Since then, new funds have flowed into these two funds, and their total assets currently amount to approximately $7 billion.

A Morgan Stanley spokesperson declined to comment on the potential impact of JHEQX on the overall market.

The fund's derivative positions consist of put-spread collars, involving the purchase of put options and the sale of call options. These positions are typically rolled over smoothly at the end of each quarter. However, the market is particularly susceptible to impact when the trading level of the S&P 500 index approaches the strike price of any contract at expiration.

Large-scale options hedging is imminent

The potential impact of this fund is not just causing volatility. For example, during the stock market rebound in December last year, when the execution price of its bullish contracts was triggered, it was accused of suppressing the performance of the S&P 500 index.

Data compiled by Bloomberg shows that as of Monday's close, there were 55,000 outstanding put option contracts with a strike price of 4210, expiring on Friday. Their nominal value is $24 billion. The data shows that as of the end of July, JHEQX held nearly 37,000 such contracts.

Before the fund reset its options at the end of June, the total number of outstanding contracts for these specific put options was only 26, with a face value of $11 million.

After concerns about the Federal Reserve maintaining higher interest rates for a longer period of time triggered a new round of risk aversion, the fund's position once again put pressure on the S&P 500 index. Last week, investors withdrew from stock funds, while hedge funds increased their short positions.

The stock market has been in a downtrend since the end of July. During this process, the S&P 500 index fell below both the 50-day and 100-day moving averages, which some technical analysts consider as support levels.

Another important support level is the 200-day moving average, close to 4190 points, not far from the JHEQX put option strike price.

Breaking below the 200-day moving average would signal a deterioration in the long-term trend and could force trend-following traders and rule-based traders to reduce their stock exposure.

J.P. Morgan's equity derivatives trading team said that after the S&P 500 index fell below its 100-day moving average, commodity trading advisors who took advantage of the upward momentum in asset prices sold $15 billion worth of stocks. J.P. Morgan's equity derivatives trading team does not directly manage JHEQX.