Why Friday’s options expiration could send this historic stock-market rally skidding to a halt

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Why Friday’s options expiration could send this historic stock-market rally skidding to a halt

Friday’s options expiration is one of the most heavily tilted toward calls that SpotGamma’s Brent Kochuba has ever seen. – MarketWatch photo illustration/iStockphoto

After a wild month for the market, investors are sitting on a heap of bullish call options that will expire on Friday as monthly contracts for May come due.

Options dealers’ hedging of these long positions has helped push stocks higher over the past couple of weeks, according to Brent Kochuba, founder of SpotGamma, an options data and analytics company.

But once they are no longer active, the market’s torrid rebound could stall out.

“I argue that the unwinding of the call values both lead to bearish hedging flows, but also a stalling in momentum. This is more skewed towards calls than I’ve ever seen it,” Kochuba said in response to questions from MarketWatch via email.

Just how skewed toward calls can be seen in the table below, courtesy of SpotGamma. SpotGamma’s calculations adjust each contract for how close it is to being profitable at expiration, based on current market prices.

Another popular methodology used by investment banks like Goldman Sachs puts the total value of contracts expiring on Friday at $3.4 trillion, a fairly average amount for a monthly expiration, Kochuba said.

– SPOTGAMMA

Investors’ shift toward call buying has become more pronounced over the past couple of weeks as stocks continued to climb. As of Wednesday’s close, the Cboe total put-call ratio has fallen back to 0.7, its lowest level since Feb. 14, according to Dow Jones Market Data. Back then, stocks were trading just shy of record highs.

When investors’ buying is more heavily slanted toward calls, options market makers typically need to hedge their exposure by buying more stocks or stock futures.

– DOW JONES MARKET DATA

Following a burst of volatility in April provoked by President Trump’s aggressive tariff agenda, the Cboe Volatility Index VIX has retreated at the fastest pace on record. Meanwhile, the S&P 500 SPX has risen by more than 18% since its April 8 closing low, FactSet data showed.

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Danny Kirsch, head of options at Piper Sandler, offered up a similar interpretation to Kochuba.

Kirsch said he expected to see more volatility seep back into stocks starting next week once options dealers no longer needed to hedge so much long exposure.

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“Next week should open back up,” he told MarketWatch via email.

After seeing modest weakness earlier in the session, U.S. stocks had bounced back in afternoon trading Thursday. The S&P 500 was up by 21 points, or 0.4%, at 5,914, while the Dow Jones Industrial Average DJIA was up by 166 points, or 0.4%, at 42,218. The Nasdaq Composite COMP was up by 20 points, or 0.1%, at 19,167.

Call options give the holder the right, but not the obligation, to buy an underlying asset at an agreed-upon price, known as the strike price, before an agreed-upon time, known as the expiration date.

Similarly, a bearish put option gives the holder the right to sell an asset at an agreed-upon strike price before a given date.

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