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

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

Analysts have in the past pointed to the JPMorgan Hedged Equity Fund’s quarterly market reset and see it as a source of potential volatility in Friday’s session. Read more

WHAT IS THE JP MORGAN HEDGED EQUITY FUND?

The JPMorgan Hedged Equity Fund holds a basket of S&P 500 (.SPX) stocks as well as options on the benchmark and resets the hedges quarterly. The fund, which held 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 was down 10.66% through September 28, compared to a 21% decline for the S&P 500 Total Return Index (.SPXTR).

The fund’s assets have exploded in recent years as investors sought protection from the kind of wild swings 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 aims to protect investors if the S&P 500 falls between 5% and 20%, while allowing them to take advantage of any market gains within an average range of 3.5 to 5.5%. . On June 30, the refresh of the fund’s options positions involved approximately 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 expires September 30.

HOW CAN THIS AFFECT THE WIDER MARKET?

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

To minimize their own risk, they usually buy or sell stock futures, depending on the direction of the market move. Such trading related to dealer coverage has the potential to influence the broader market, especially if done in size, as is the case with 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.

It has, however, exacerbated daily movements in the past, according to some analysts.

The S&P 500 Index (.SPX) fell 1.2% in the last hour of trading on March 31 amid no obvious news – a move some analysts have pinned on options hedging flows. Read more

Analysts say the discount could exacerbate market swings on Friday, as the fund rolls over options positions and dealers buy and sell futures to hedge their exposure.

“That’s because there’s a fair amount that needs to be adjusted and covered to keep the trade rolling,” said Brent Kochuba, founder of analytics service SpotGamma.

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

All other things being equal, once the options position is rolled over three months, their influence on current price movements should diminish, he said.

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

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