A large slug of option contracts tied to the Cboe Volatility Index are set to expire on Wednesday, which could potentially amplify stock-market volatility after the Federal Reserve releases its latest decision on interest rates, several analysts said.
Better known as “the Vix,” or Wall Street’s “fear gauge,” the Vix VIX, -2.06% attempts to reflect how volatile option traders expect the S&P 500 index to be over the coming month.
So-called “open interest” in option contracts tied to the Vix rose to 13.3 million as of Tuesday’s close, according to data published online by the Cboe, meaning more than 13 million contracts were circulating among traders, with buying heavily skewed toward calls — that is, bets that the Vix will rise.
Brent Kochuba, founder of SpotGamma, said roughly 45% of outstanding VIX-linked options expired when the market opened on Wednesday. These options are cash-settled based on the opening value of the special opening quotation for the VIX. Settlement typically occurs the following day.
A bullish bet on the Vix typically pays off when the S&P 500 SPX, -0.14% falls. A rebound in U.S. stock prices over the past week drove the Vix back to 21.38 on Tuesday, its lowest end-of-day level since stress in the U.S. banking sector began earlier this month.
Marios Hadjikyriacos, senior investment officer at XM, warned clients in emailed commentary that Wednesday’s “gigantic Vix-piration” could amplify volatility following the Fed’s policy-rate decision, which is due at 2 p.m. Eastern Time.
“Such expirations have the capacity to amplify market moves, so equities could be even more sensitive than usual to what the Fed says,” he said.
The last time a Wednesday Vix option expiration coincided with a Fed rate-hike decision was Sept. 21, when the central bank hiked its policy rate by 75 basis points, its third “jumbo” rate hike in a row. The S&P 500 fell 1.7% that day, according to FactSet data.
Heavy buying of Vix calls on the verge of expiration has left option dealers net short, said Charlie McElligott, managing director of cross-asset strategy and global equity derivatives at Nomura, meaning that they may need to buy or sell futures contracts tied to the S&P 500 in order to hedge their positions, depending on how the market moves.
Heavy Vix option buying helped send the Cboe VVIX to its highest level in roughly a year earlier this month, according to FactSet data. The VVIX reflects demand for option contracts tied to the Vix.
Trading in Vix calls has surged in recent weeks as the volatility gauge climbed to its highest level of the year amid the fallout from the collapse of Silicon Valley Bank and two other U.S. lenders, according to data from SpotGamma.
The Vix briefly broke above 30 on March 13, its highest intraday level since October, according to FactSet data.
However, the index has seen a substantial pullback since then. It finished Tuesday below 21.50, the lowest end-of-day level since March 8, the day Silicon Valley Bank announced plans for a capital raise that ultimately triggered the bank run that brought it down.
The level of the Vix is largely based on trading volume in option contracts tied to the S&P 500. Typically, only option contracts with roughly one month left until expiration are used in the calculation.
Over the past year, a surge in trading in S&P 500 option contracts on the verge of expiration — better known as “zero days to expiration” or “0DTEs” — has caused the Vix to trade at subdued levels relative to history, several sources told MarketWatch during interviews conducted late last year.