First Step: The Trade

Option trading has reached a fever pitch in U.S. markets. With zero-days-to-expiration (0DTE) options now becoming the most heavily traded option instrument of all, the amount of money moving in and around the option market is beginning to increase its weight and influence.

It may be time for technical analysts to consider just what kind of impact option purchasing is having on price action in the market place. The reason for this is not that options have any special predictive magic, but that the sheer size of options being traded may force larger commercial traders to do things they wouldn’t have done in the past. Things that move the market in substantial and predictable ways.

What I am about to offer as evidence is by no means conclusive. It is admittedly anecdotal and circumstantial. However it is an excellent illustration of the concept and hopefully a motivating narrative for further research.

The timeline begins on February 4th, 14 minutes and thirty seconds after the NYSE closing bell.

While stock trading officially closes at 4:00 Eastern time, two ETFs: SPY and QQQ, have option that continue to trade for 15 minutes longer as those ETFs settle out. It is within this window (the last 30 seconds of it) where 390 contracts of QQQ put options were purchased for a price of 4.32 per share ($432 per contract each, plus commissions). These options are set to expire less than 24 hours later, on Thursday’s close (the next day).

Why did someone wait until literally the last minute to make this large purchase, capable of providing a hedge to over $23 million worth of QQQ shares?

Second Step: The Market Maker’s Exposure

It isn’t hard to imagine a scenario where this kind of a purchase makes sense, but the purchase and the price give us little to no clue about the motivation behind it. However, what the trade conclusively does tell us is that someone else on the other side of the trade (a commercial floor trader acting as a market maker), now has a very significant exposure. If the price of QQQ should drop more than $4.32 cents lower during the upcoming trading session, this trader will begin to lose $40,000 for each dollar that QQQ falls.

By the time the market opens at 9:30 am Eastern time, this position is now running an unrealized loss for the market maker of around $160,000 dollars. Of course QQQ is very heavily traded and this amount of money barely qualifies as a drop in the bucket when compared to all the money moving in the ETF trading volume and the option trading swirling around it.

But to the individual trader, or to their small market-making firm, this loss is big enough to matter. If our hypothetical professional trader or the multi-million dollar firm behind him thought they could do something, anything, to stave off this loss, they surely would consider trying it, so long as they thought the weren’t going to lose even more money in the attempt.

Third Step: The Real-Time Reaction

At a minimum, such firms have egregiously large lines of credit at their disposal for intraday trading. For moments exactly like this when avoiding a six-figure loss, and even better, turning it into a six-figure gain, was a realistic possibility. Even if no other tools, skills, or relationship-based communication among traders were involved, the line of credit would be all that was required.

The mere fact that a commercial trader could apply a few million dollars worth of share purchase or sales to move prices back into a range where they could gracefully exit all positions, and maybe even get short themselves for the next few hours, is enough to imagine that if it could happen, it would happen.

This isn’t about a conspiracy, this is about using the tools available to you. Based on the way these prices moved on the next day, it creates an uncanny coincidence that prices were almost immediately pushed higher, and then once they hit a certain range and held there for 30 minutes or so, that they resumed their overnight trend of heavy selling.

The price moves on these five minute charts don’t look highly predictable until you factor in the late-hour purchase of the options on the previous session. And it isn’t even the purchase that creates the predictive move. It is the circumstance created by the seller of the options.

Once you realize the seller of the options has massive exposure, and if you could somehow assume that any such seller would have resources to potentially push prices around, even if it is for only a few minutes, then it is hard to look away from these charts. These charts represent the real possibility that Thursday’s early morning price moves weren’t random at all, and to some extent might even be–dare we say it–predictable.

---

Shared content and posted charts are intended to be used for informational and educational purposes only. CMT Association does not offer, and this information shall not be understood or construed as, financial advice or investment recommendations. The information provided is not a substitute for advice from an investment professional. CMT Association does not accept liability for any financial loss or damage our audience may incur.

---