Explains: How a massive options trade by a JP Morgan fund can move markets

NEW YORK, Sept 29 (Reuters) – A nearly $16 billion JP Morgan fund is expected to reset its options positions on Friday, potentially adding to stock volatility at the end of a dismal quarter for stocks.

Analysts have previously pointed to the JPMorgan Hedged Equity Fund̵[ads1]7;s quarterly reset of roiling markets as a source of potential volatility during Friday’s session. read more

WHAT IS JP MORGAN HEDGED EQUITY FUND?

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

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

The fund’s assets have surged in recent years as investors sought protection against the kind of wild swings that rocked markets in the wake of the March 2020 COVID-19 outbreak.

The holdings include some of the market’s biggest names, 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 benefit from any market gains in the average range of 3.5-5.5%. On June 30, the update of the fund’s options positions involved about 140,000 S&P 500 options contracts in total, including S&P 500 puts at strikes 3580 and 3020 and calls at 4005, all for the September 30 expiration.

HOW MIGHT THIS AFFECT THE WIDER MARKET?

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

To minimize their own risk, they usually buy or sell stock futures, depending on the direction of the market’s movement. Such trading related to dealer hedging has the potential to affect the broader market, especially if done in size, as is the case for the JPM trade.

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

However, it has worsened daily movements in the past, according to some analysts.

The S&P 500 (.SPX) fell 1.2% in the final hour of trading on March 31 on a lack of obvious news — a move some analysts pinned on options hedging flows. read more

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

“That’s because there’s a lot that needs to be adjusted and secured to roll the trade,” said Brent Kochuba, founder of analytics service SpotGamma.

“I think the position is increasing volatility this week,” Kochuba said.

All things being equal, once the option position is rolled forward three months out, their influence on current price swings should diminish, he said.

Reporting by Saqib Iqbal Ahmed in New York Editing by Ira Iosebashvili, Matthew Lewis and Nick Zieminski

Our standards: Thomson Reuters Trust Principles.