A slew of option contracts tied to the Cboe Volatility Index are about to expire on Wednesday, which could cause stock market volatility to increase after the Federal ReserveFederal Reserve releases its latest decision on interest rates, according to several analysts.
The Vix, or Wall Street's fear gauge, the VIX VIX, attempts to reflect how volatile option traders expect the S&P 500 index to be over the coming month.
More than 13 million contracts were circulating among traders as of Tuesday's close, according to the data released by the Cboe, meaning that more than 13 million contracts were circulating among traders, with bets that the Vix will rise.
Brent Kochuba, founder of SpotGamma, said around 45% of outstanding VIX-linked options expired when the market opened on Wednesday. The cash-settled options are based on the opening value of the special opening quotation for the VIX. Settlement typically occurs the following day.
A bullish bet on the Vix pays off when the S&P 500 SPX falls. The Vix went back to 21.38 on Tuesday, its lowest end-of-day level since stress in the U.S. banking sector began earlier this month, due to a rebound in U.S. stock prices over the past week.
Marios Hadjikyriacos, senior investment officer at XM, warned clients in emailed commentary that Wednesday s gigantic Vix-piration could cause more volatility following the Fed's policy-rate decision, which is due at 2 p.m. Eastern Time.
Since such expirations can amplify market moves, equities could be more sensitive than usual, he said.
The last time a Wednesday Vix option expiration coincided with a Fed rate-hike decision was Sept. 21, when the central bank hiked its policy rate by 75 basis points, its third jumbo rate hike in a row. According to FactSet, the S&P 500 fell by 1.7% that day.
Charlie McElligott, the managing director of cross-asset strategy and global equity derivatives at Nomura, said that heavy buying of Vix calls on the verge of expiration has left option dealers net short.
According to FactSet data, Heavy Vix option buying helped push the Cboe VVIX to its highest level in nearly a year earlier this month. In recent weeks, trading in Vix calls has risen as the volatility gauge climbed to its highest level of the year amid the collapse of Silicon Valley Bank and two other U.S. lenders, according to SpotGamma.
The Vix broke above 30 on March 13, its highest intraday level since October, according to FactSet data.
The index has seen a significant pullback since then. It finished Tuesday below 21.50, the lowest end-of-day level since March 8, the day Silicon Valley Bank announced plans for a capital raise that ultimately led to the bank run that brought it down.
The volume in option contracts tied to the S&P 500 is a factor that determines the level of the Vix. Only option contracts with roughly one month left until the end of the month are used in the calculation.
Over the past year, a surge in trading in S&P 500 option contracts on the verge of expiration has caused the Vix to trade at subdued levels relative to history, according to several sources told MarketWatch.