US stocks welcome "Quadruple Witching Day" again! $4.5 trillion options expire, Goldman Sachs warns of "gamma flip"

On Friday, September 20th local time, it was the ninth options expiration date for the United States in 2024, and also the last "quadruple witching day" before the U.S. presidential election, with Goldman Sachs warning of severe market volatility.

"Quadruple witching day" refers to the simultaneous expiration and settlement of stock index futures, stock index options, stock options, and single stock futures on the same day. According to Goldman Sachs statistics, from September 18th to September 20th local time, approximately a nominal value of up to $4.5 trillion worth of options will expire, setting a record high for September in recent years.

It is worth noting that out of this $4.5 trillion worth of options, around $2.6 trillion are regular September options on the S&P 500 index, with the rest distributed among ETFs and individual stocks. This volume is enough to create significant waves in the U.S. stock market.

The continuous increase in market volatility in the U.S. stock market in recent years is remarkable. Brian Garrett, a trader at Goldman Sachs, pointed out in a recent research report that currently there are 50 million options traded daily in the U.S. stock market, far exceeding the 20 million daily volume in 2018. After these options expire, it is expected that stock market volatility will continue to decrease towards the end of the quarter.

Garrett believes that despite the S&P 500 index being at historical highs, investors do not seem to have fully positioned themselves in bullish options, and there has been no surge in buying bullish options under the "fear of missing out" sentiment in the market. He reminds investors that considering the "Black Monday" on August 5th and the 2008 global financial crisis, the seasonal volatility in October should not be ignored. Currently, hedging costs are very low, and if market makers are willing to build spreads, the costs could be even lower (for put options on the S&P 500 index).

With the surge in "volatility coverage" products, S&P 500 options market makers rarely find themselves in a negative gamma situation. Negative gamma is usually associated with selling options, where traders take on the risk of negative gamma when selling options, meaning that as the price of the underlying asset changes, their option Delta value (sensitivity of option price change relative to underlying asset price change, ranging from -1 to 1) will accelerate against them.

However, at the current spot price, the Goldman Sachs model shows that there is a negative gamma exposure of 50 million S&P index options in the market. This means that if the S&P index experiences significant volatility, the negative gamma exposure may lead market makers and option sellers to engage in a large number of trades to hedge risks, potentially further exacerbating market volatility.

This dynamic will change after expiration, with traders transitioning from a slightly negative gamma state to a significantly positive gamma state. Historically, when the market shifts to negative gamma, the likelihood of a short-term rise in the U.S. stock market increases.

Garrett also observed that as global markets gradually adapt to derivative trading, investor behavior has significantly changed after market fluctuations. In the past, market selling would trigger demand for upside Delta, achieved through buying call options. However, in recent years, some of the "upside Delta" demand has shifted from stocks to VIX put options.

This dynamic will shift after expiration, with traders' positions transitioning from slightly negative gamma to significantly positive gamma. Historically, when the market shifts to negative gamma, the likelihood of a short-term rise in the U.S. stock market increases The recent VIX SQs event witnessed the largest volume of VIX put options in history, most of which occurred after August 5th. In his view, this will lead to a structural increase in volatility of volatility during periods of market stress.

Based on the current level of volatility and previous asset trends, Garrett believes that the best "volatility adjustment" hedging tools include HYG (High Yield Corporate Bonds), XOP (SPDR S&P Oil & Gas Exploration & Production ETF), XLF (SPDR Financial Select Sector ETF), and XLE (SPDR Energy Select Sector ETF). With market implied volatility low enough to utilize Delta in either direction, Garrett tends to buy index put options here - low volatility, high catalysts, and overall light positioning