JPMorgan fund's massive options trade contributed to S&P 500 slump

Traders work on the floor of the NYSE in New York.

NEW YORK - Traders point to a massive quarterly options trade from a JPMorgan fund as one reason why the stock market took a nose dive late in the day, as options flows linked to trade exacerbated market weakness.

The S&P 500 Index fell by 1.2% in the last hour of trading on Thursday, marking the largest hourly drop for the index in more than three weeks. It ended the day down 1.56%, with some attributing part of the weakness to the large options trade that went down earlier in the day.

According to Brent Kochuba, founder of the analytical service SpotGamma, "I think trade exacerbated volatility because the quarterly hedging activity does not move markets much," said Brent Kochuba, founder of SpotGamma.

The way the trade is structured means when the market starts to fall, options dealers - typically big financial institutions that facilitate trading but seek to remain market neutral - would have to sell an increasing number of stock futures, causing the selloff, SpotGamma's Kochuba said.

Markets have had a rollercoaster quarter due to Russia's invasion of Ukraine, volatile commodities prices and the U.S. Federal Reserve starting to hike interest rates. It was not clear what caused the initial market weakness on Thursday that triggered the cascade of stock futures selling.

The trade, which took place shortly before 11: 00 am, was a large collar options trade, involving the sale of about 44,000 June calls and the purchase of an identical number of June put spreads, which would pay up if the S&P 500 were to decline more than 5% from its current level. A collar is an options hedging strategy that involves a combination of puts and calls.

The sale of around 24,800 calls linked to the 4,300 level on the S&P 500 was intended to be a way to guard against any moves in the market during the trading session.

Traders pointed out the $19 billion JPMorgan Hedged Equity Fund as being behind the moves. The fund, which holds a basket of S&P 500 stocks along with options on the benchmark index, resets hedges once a quarter. As the fund is so large, traders know and anticipate its patterns.

The trade was initiated by the JPMorgan Hedged Equity FundJPMorgan Hedged Equity Fund based on past trading patterns and details of investment strategies laid out in the prospectus.

Joe Tigay, Portfolio Manager at Equity Armor Investments, said the trades had the hallmark of the JPMorgan fund's hedging program.

Asked about the trades, Kristen Chambers, a spokesman for JP Morgan Asset Management, confirmed that the fund has a scheduled quarterly hedging program, but did not confirm the exact details of the trade.

Systematic traders, often hedge funds, tend to take a rules-based approach to their investments and are often driven by fixed quarterly schedules rather than strong investment themes.

As such, other investors don't try to interpret signals from their choices of strike prices and expiration dates, as they would with a trade by a discretionary investor.

Chris Murphy, co-head of the derivatives strategy at Susquehanna International Group, said that this is a systematic trade that we see at the end of every quarter.

Thursday's trade, worth around $20 billion in notional terms based on the index level, replaces a similar position opened at the end of last quarter, according to Trade Alert data.