The Blubber

This blog post was supposed to be a quiet and informative piece about a somewhat special, recurring SPX options trade and it’s effect on the market. But somehow the media managed to turn that innocent trade into the harbinger of impending market doom. Yikes! So in addition to the informative part there will be a short run-down of what went wrong in reporting and why context and background information are so damn important when reading option flow.

But first things first, let’s look at the trade in question:

On the last day of each quarter JPMorgan resets the flagship product of their Hedged Equity Fund series: JHEQX. It’s a fund with 18.8 billion USD in assets holding a basket of S&P 500 stocks in combination with SPX options. The goal of the options is to smoothen the returns of the fund during volatile market periods while still allowing for decent upside. To achieve this goal JPMorgan is using a strategy called collar.

A collar is constructed by selling otm calls and buying otm vertical put spreads. The premium collected from the calls is used to pay all or most of the premium for the put spreads making this a very cost-effective strategy.
In an ideal world the underlying would end up just below the strike of the call options on expiration day. This would provide maximum gains on the stock portion of the position while not having to cover for the (now in the money) calls. Even if the underlying moves past the strike of the calls this position doesn’t actively loose money, the gains are just capped at the strike price until the position is rolled or re-established with new options.
On the opposite side, if the underlying moves down the vertical put spreads will provide protection until the strike of the short leg (so the put sold in the creation of the spread) gets passed. The width of the collar will have strong impact on the hedging ability as well as the maximum gains for the time until expiration – finding the right balance will mostly depend on the objective of the position as it’s basically a trade-off between yield and volatility.

Back to JPMorgan, they describe their collar on the fund as following:

'This downside hedge is in place from the S&P 500 Index falling down -5% to -20%, while allowing for upside participation in the average range of 3.5-5.5%.'

The time window for their calculation is a time period of 3 months – and this is how we finally arrive at the quarterly reset again. As mentioned in the beginning JHEQX is carrying 18.8 billion USD in assets, so JPMorgan needs a boatload of collars every time which they conveniently buy and sell on the last day of each quarter.
Yesterday (September 30th) this trade happened twice. It was originally opened at 10:26 am and then re-adjusted at 4:13 pm (so after regular market close). This is highly unusual for this particular trade and most likely happened due to the strong move down in which SPX covered roughly 50 points.

The blue vertical lines mark the timestamps of first entry and the re-positioning. This chart is showing ES instead of SPX as it has no extended trading session beyond 4pm.

The afterhour trade left JPMorgan with a position of 45,300 contracts - each for the 31Dec2021 expiration:
Sell to open: 4450 call for 78.53$ per contract,
Buy to open: 4080 put for 102.88$ per contract,
Sell to open: 3440 put for 25.51$ per contract,
Including the re-positioning and the intraday market move JPMorgan opened their overall position for a net credit of 134.4 million USD.
The details of the double trade will be covered further down, but first we will take a look at another anomaly yesterday – the media coverage of this trade.'

'Giant S&P 500 Options Trade Made to Guard Against 20% Swoon'

Oh yes, that headline will get clicks for sure.
The S&P 500 has been on a decline since September 3rd and just yesterday revisited it’s recent low of 4306. A remarkable 5% down from the recent all-time highs. Remarkable in the sense, that this seems to be the first dip since September 2020 that didn’t get bought up in a matter of a few days. This (somewhat) bearish climate seems to get people itchy and hungry for more bad news making it even more important for journalists to research before drawing and spreading conclusions.

Yesterday at 2:39 pm Bloomberg.com published an article discussing the original JPMorgan trade that was opened in the morning. At this point you probably already guessed the headline. The article was quickly distributed by Yahoo! finance and popular fintwitt news-providers @Deltaone and @Fxhedgers. Those two already have 600k followers, most likely the headline was caught by more algo-based news services as well to be spread further.

The article is picking up the protective nature of the option position correctly and even mentions some technical details like another, smaller leg with a different expiration to keep the trade delta neutral at opening (will be discussed in the in-depth part). The points made in the article get supported by comments from financial experts barring heavy titles like 'Oppenheimer’s head of institutional equity derivatives' or 'Susquehanna’s co-head of derivatives strategy'.

The only thing really missing in the article is any mentioning of the JPMorgan JHEQX fund and it’s cyclical option trade.
They failed to mention, that this wasn’t a multimillion USD bet on a market decline, but a trade that had to happen in this form on this exact day.
They provided no further information aboout how this option position actually has stabilising effects on the market due to option dealer flows providing much needed liquidity during declines.
They also didn't update on the re-positioning of JPMorgan in the afternoon nor spoke about the implications that trade has.

After the nightly update on OI(open interest) of the SPX options the picture becomes even clearer. The three strikes mentioned in the article show trading volumes of over 91,000 contracts, but the OI increased just by a fraction of that – I honestly hope those weren’t traders blindly following the ‘news' yesterday.

The 'head of options at Cornerstone Macro LLC' got pretty close to the truth with noting:

'…that a similar put-spread collar was often initiated at the end of a quarter in the past few years.'

Just scratch often for every quarter and we finally arrive at our destination.

This is in no way meant to mock the experts mentioned in the article, but to highlight that it’s more important than ever to do your own research or at least fact-check news that seem biased towards a certain market narrative. This giant trade is happening every quarter. Solely looking at the flow it seems like a huge bearish bet every single time. But I guess this time around it fit the story they wanted to tell. Please don’t confuse story telling with actual journalism and critical views when doing research for your own trades.
We won’t know for sure if the experts in the article just didn’t know about the JPMorgan trade or those details were excluded on purpose, but I will try to shine some light on the position in the following analysis.

Geek mode on! Diving into the JPMorgan collar position!

I will try to keep this section as light on math and deep market mechanics as possible – we won’t be able to avoid every technicality, but I will mainly focus on the resulting implications and provide additional reading at the end for those interested in climbing down the rabbit hole.

Part 1 - Deconstructing the double trade that took place

In the following table you can see an overview of the JPMorgan related trades that took place yesterday. Noteworthy is that they ended up collecting 134.4 million USD in premium after the re-positioning. The original morning trade costed them 20 million USD in premium instead. While this sounds like a awesome daytrade we need to remember the underlying stock basket was bleeding much more from that 50 point move down in SPX. Overall the fund ended up -1.22% yesterday.

If you want to check out the trades for yourself you can follow this link to the Flow tool with my filters on Unusual Whales to see all the involved trades with as little noise as possible.
The position also consisted of transactions from their old position from Jun 30th as well as additional trades on 4150 0dte calls to stay delta neutral. As those options already expired, they won’t have any effect on the market in the future, and I won’t get into more detail here. For future research check out the Flow tool again.

Part 2 – Quick introduction into dealer hedging flows

I will keep this very brief, for more details check out the links provided for further reading at the end.
Every time options get bought or sold there is someone else at the other end of the trade, in most cases that’s one of the designated market makers for the instrument. The market makers need to keep their directional risk to a minimum so they will try to match option trades against each other and (if that’s not possible) purchase or sell the underlying stock to stay delta neutral.
As SPX is an Index and has no underlying stock, E-mini futures (ES) are traded instead for hedging directional exposure.
Delta is one of the Greeks of an option that describes how the price of the option will react to changes in the price of the underlying and can take values between (-)1.0 and 0. As the market makers take the opposite end of most trades it also important to note, that their positions and therefor their delta act as a mirror image for your trade. If you buy a call with 0.3 delta the market maker will be short the same call and have -0.3 delta to deal with.
Based on this basic definition delta neutral simply means that movements in the price won’t affect the value of your position – the directional risk is therefor gone for the moment.

Sadly, the world isn’t as easy as that and delta is not a constant. It in fact has 3 mean cousins pushing it around – also known as 2nd order Greeks:

· Gamma – describing how delta changes in respect to changes in the price of the underlying

· Vanna – describing how delta reacts to changes in the IV (implied volatility) of the option

· Charm – describing how delta changes over the course of time to expiration

Seeing how delta is constantly changing while market makers need to stay delta neutral, we are now arriving at the core of dealer hedging flows. As it’s not predictable when and how many options get traded, the main instrument for hedging becomes trading the underlying, be it buying, selling or even shorting stocks (or ES futures in respect to SPX).

On any liquid ticker a market maker will be holding a huge range of option positions with different strikes, expirations and OI. While this leads to a lot of them cancelling each other out there will be a few strikes needing special attention, mainly those with very big open interest. This is where our JPMorgan trade finally comes back into play, as 45,000 option contracts is quite the number. Even for SPX.  The attached diagram displays all monthly expirations on SPX until the end of this year as well as the 31Dec2021 expiration – the JPMorgan trade is clearly visible here as well.

Part 3 – The actual dealer hedging flows tied to the JPMorgan trade

As established in Part 1 the trade was opened in a delta neutral state so we will solely focus on possible hedging flows down the road until expiration.
To be able to quantify the impact of delta changes on this position we need to establish how many ES futures need to be traded to hedge a certain change in delta. Any option with 1.0 delta tracks price movements like 100 shares of the underlying, at the same time a single ES contract tracks the price like 50 (hypothetical) shares of SPX. From here some basic math leads us to the following overview:

So even a minimal change in delta of 0.01 will force the market maker to buy or sell 906 contracts of ES – to put this into some perspective, most retail brokers expect roughly 12,000$ initial margin per ES contract.
All following graphs and conclusions will assume, that the whole JPMorgan position will be hold until expiration and is solely hedged by ES futures. While this will for sure introduce some inaccuracies it will help to keep this easily followable while still being a close enough resemblance of the real world.

The graph below is a visualisation of the net delta per collar on the market maker side (so the inverse position of JPMorgan) in relation to days until expiration and the price of the underlying SPX index. The shape might seem a bit weird at first glance, but that’s mainly due to the 3 legged setup which doesn’t produce a symmetrical outcome. Even without looking at detailed calculations this graph already gives us a lot of information about the position:

Delta is moving in a range between 0 and 1. Even though puts are involved in the trade the market maker will always be long delta and will need to hedge this exposure by selling (shorting) ES futures with increasing delta und buying ES futures with decreasing delta.
The sentence above is the single most important point about the whole position.

Overall, the uneven shape basically splits the graph into 2 zones – nearly flat ones and (very) steep ones. In the flat zones delta hardly changes across a wide range of SPX price levels and days indicating that the option position will have little to no impact on the underlying as there is only little hedging to do.

In the steep zones delta is changing very fast inducing a lot of hedging activity, we will take a closer look on that by dividing the graph in 4 zones based on the SPX price levels.

· 1 – SPX below 3440: Sadness valley
Below the lower put strike of the JPMorgan trade the delta hedging is acting as support against a further decline in price.
A decreasing price of SPX decreases delta, inducing buying of ES futures providing much sought after liquidity in market declines. Delta is also slowly decreasing with time, accelerating into the last days before expiration which as well induces buying of ES futures – you might have heard of this effect as Charm flows if you spent some time on fintwitt.

· 2 – SPX between 3440 and 4080: Mt. put spread
The behaviour in this zone is mainly influenced by the put spread component of the trade.
On the left flank of the plateau this area acts like zone 1. On the right side on the other hard the tables turn into increased volatility instead as the delta now increases with a price move lower and decreases with a move higher in price. The hedging induced happens in the same direction as the market is going.

· 3 – SPX between 4080 and 4450: The hole
While this zone has tendencies from 2 and 4, it will act as a price magnet getting closer to expiration.
The positive hedging flows from the rapidly decreasing delta heading into expiration are constantly battling with counterflows from the steep delta increase towards higher SPX prices while providing some protection to the downside (this is also helped by IV declining into close to expiration and therefor reducing delta furthermore).

· 4 – SPX above 4450: Call peak
Above the call strike the delta hedging is acting as resistance against a further increase in price.
A increasing price of SPX increases delta, inducing selling of ES futures. This is basically the opposite of zone 1.

Warning before jumping into trades based on this:
While the JPMorgan collar is a big trade, it’s by far not the only one that matters for SPX and the overall hedging flows in the real market will vastly differ from our thought experiment. We also took IV as constant over the time until expiration as accounting for it’s dynamic reaction to price and time would make things a lot more complicated. Diving into this topic is a project for another blog post down the road.

So… does size actually matter?

Yes, in the trading game it most definitively does. A huge trade like the JPMorgan SPX collar has strong effects on the market flows until it expires –months longer than it gets attention in the flow or in the media.

But we also saw that size might not matter, that even the big sharks swimming in the hedge fund pools can totally mess up their due diligence. From my perspective this is a big chance for us. The market is getting more complex and connected everyday from the massive uprise in option trading since 2020 but in the same time retail traders get more and more access to sophisticated tools like Unusual Whales to even out the information disadvantage as much as possible.
Do your research, ask questions, don’t trust someone just because he is carrying a hefty title!

Outro:

I hope I didn’t lose to many of our dear readers in the last two sections – but as promised I tried to keep it as easy as possible without deferring to much from market reality. As this post is my first one for the Unusual Whales blog I sincerely want to thank you for reading it and invite you to discuss the contents with me or just reach out for questions.
You can contact me on the Unusual Whales discord-server: mezzee | kevin
or via Twitter: https://twitter.com/m3zzee

With that said, I wish you all good luck with your future trades and projects.
May the flow be with you.

Further reading and media I can highly recommend:

Media page of Kai volatiltiy advisors - home of the infamous Cem Karsan

The implied orderbook by Squeezemetrics

Volatilty smile and delta Hedging by Harel Jacobsen