The SPX traded 650,000 option contracts early Monday morning.
Just to give you a feel, the SPX is a $7,700 product, and Meta is a $700 product. So every SPX contract is 10 times the size of a Meta contract, and it’s doing 650,000 of them. The SPDRs (SPY), which are basically the same thing, had already done 1.5 million.
When I left TD Ameritrade, I remember having conversations about this in 2014. The biggest days we ever saw back then were like 25, 30 million option contracts. We knew options could move certain products on certain days, but I never thought we’d see a day where the options became the market.
That changes how you should read every trading day, starting with the premarket.
Wipe That Slate Clean
For 20-plus years of my career, I looked at the S&P’s in the premarket, and whatever the futures did, so goes the market during the day. Now you can’t justify a trading day based on the premarket almost at all.
The options order flow is so large and so deep that it’s the driving factor. Zero DTE, options that expire the same day, definitely changed things, but something deeper changed over the last six to eight months.
So whatever you think in the premarket, the bell goes off, and you almost have to wipe that slate clean.
Dicing Through What The Order Flow Really Is
Take Meta this morning. People were smashing calls at the bid, trying to get out at any price, and they were doing it at almost double the rate anybody was trying to buy. That’s definitely going to generate some negative order flow.
The put/call ratio is insightful if you don’t look at the product as much as I do. I want to see where the options are trading, because that tells you who’s panicking.
A Gamma Squeeze To The Downside
Let’s say you’re a retail trader sitting at home on your Robinhood platform. You start buying puts (bets that a stock goes down), and buying puts, and buying puts.
For each put, a market maker has to sell it to you, then short the underlying stock to neutralize their delta, meaning they offset the bet you made against them. Even in hard-to-borrow names, market makers can short as much stock as they need as what’s termed a bona fide hedger.
So you, at home, buying puts are, in effect, almost forcing the market maker to short stock. We get caught in this negative feedback loop, and we start to go down. That is a gamma squeeze, where the hedging feeds on itself, but it’s a gamma squeeze to the downside.
For years, we’ve seen positive squeeze after positive squeeze, with stock buybacks and people adding money to their 401(k) fueling it to the upside. The same mechanism will eventually flip, and when you get negative squeezes, they’re far more violent.
So when the bell goes off, let the session evolve before you put money on it. You can’t sit there and handicap what you think will happen, because there is no thought.
It’s order flow piling in.
To your success,
Don Kaufman
