Explained: How massive options trading by the JP Morgan Fund can move the markets

NEW YORK (Reuters) – JPMorgan’s $16 billion fund is expected to reset options positions on Friday, which could add to volatility at the end of a dismal quarter for stocks.

Analysts have in the past pointed to a reset in distressed markets for the JPMorgan Hedged Equity Fund, and view it as a source of potential volatility during Friday’s session. Read more

What is a JPMorgan Equity Hedge Fund?

The JPMorgan Hedged Equity Fund holds a basket of S&P 500 (.SPX) stocks along with benchmark index options and resets the hedge once every quarter. The fund, which had about $15.59 billion in assets as of Sept. 28, aims to allow investors to take advantage of stock market gains while limiting their exposure to declines.

For the year, the fund is down 10.66% through Sept. 28, compared to a decline of 21% for the S&P 500 Total Return Index (.SPXTR).

The fund’s assets have swelled in recent years, as investors sought protection from the kind of extreme volatility that rocked markets in the wake of the COVID-19 outbreak in March 2020.

Its holdings include some of the biggest names in the market, such as Apple Inc (AAPL.O), Microsoft Corp, and Amazon.com Inc.

How does the fund use options?

The fund uses an options strategy that seeks to protect investors if the S&P 500 falls between 5% and 20%, while allowing them to take advantage of any market gains in the middle 3.5-5.5% range. On June 30, the fund’s options positions update included about 140,000 S&P 500 options contracts in total, including S&P 500 strike puts 3580 and 3020 and calls at 4005, all expiring September 30.

How could this affect the broad market?

Options traders – usually large financial institutions that facilitate trading but seek to remain market neutral – take the other side of fund options trades.

To reduce their risk, they usually buy or sell stock futures contracts, depending on the direction of the market movement. Such trading associated with hedging dealers has the potential to influence the broader market, especially if it is done with volume, as is the case for JPM trading.

The trade is “well understood” and “mostly digested by the market,” said Chris Murphy, co-head of derivatives strategy at Susquehanna International Group.

However, this has exacerbated daily moves in the past, according to some analysts.

The S&P 500 (.SPX) fell 1.2% in the final hour of trading on March 31 amid no clear news — a move some analysts have pinned on options-hedding flows. Read more

Analysts say the update could exacerbate market volatility on Friday, as the fund rolls out options positions and traders buy and sell futures contracts to hedge their exposure.

“This is because there is a reasonable amount that needs to be adjusted and hedged to start trading,” said Brent Kochuba, founder of SpotGamma analytics service.

“I think the situation is expanding in volatility this week,” Kochuba said.

All else being equal, once an options position is rolled forward three months, its impact on current price volatility should diminish.

(Covering) By Saqib Iqbal Ahmed in New York; Editing by Ira Yosbashvili, Matthew Lewis, and Nick Siemensky

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