I always like to look at trading as a series of cycles and one of the cycles I have been studying lately is the OpEx cycle…
The monthly and quarterly expiration cycles make a lot of sense as a natural beginning and end to a cycle.
Expiration wipes the slate clean for investors where the options they purchased either expire worthless like a losing lottery ticket.
That is not the case for the dealing desks that are the counterpart on most of those trades …
Many dealing desks even pay the exchange for sending them order flow … then manage huge books of options positions hedged with underlying stocks in an attempt to capture their bid/ask spreads …
However, with some of the changes that have hit the options markets are dealing desks losing their enthusiasm to provide the liquidity they have in the past?
Today, we’ll look at these changes and what they mean for markets …
State of the Options Market
Option volumes with a little help from The Fed, stimmy checks, and meme stock mania have exploded in the past couple of years …
They have surpassed stock volumes and incented exchanges to launch new products such as 0 days-to-expire (DTE) options …
DTE options are the most recent craze in the markets with their share of overall volumes increasing from 5% to 50% in the past 10 years…
10x increase in volumes is incredible and in an environment where the Fed was injecting liquidity into the markets on a daily basis, there were no worries that anything could ever go wrong …
However, the Fed has done an about-face, due to inflation and now money is now wrong withdrawn from the markets …
The dealing desks are now being told to take on less risk as fears of recession and possible defaults i.e. FTX has become a legitimate concern.
Market Liquidity
In good times every dealing desk wants to be in their providing liquidity in size … in bad times many desks need to pull back and preserve capital.
That is what we are seeing now and just as volumes continue to surge, liquidity is drying up as you can see from the CME S&P 500 futures top-of-book (highest bid and lowest ask price) liquidity graph.
Notice that just a year ago the number of contracts that were offered at the best prices was 3x larger than they are today … This is with volumes up 10%!
This trend adds to increased volatility … This is a great thing for traders IF you have a process that can anticipate the inflection points in the market that may lead to outsized moves.
Well, I have been monitoring these developments and it is possible to identify air pockets in the market where trends can accelerate … This is especially true when liquidity has decreased.
Trading Different Time Frames
So what is the key to trading 0 day-to-expiry options? In my opinion, the key is playing off the time frames against each other …
For example, market participants trading the NOV8 DTE options were successful in forcing dealer desks to take large positions in the NOV8 3800 puts …
Once the option moved closer to in-the-money (ITM) the dealers had to sell stock in a declining market to hedge their option exposure risk …
This push caused an outsized move to the downside, which snapped back quickly as the initiators on the trade bought back their options for a massive profit …
However, the 3800 strike was a critical level for the 11/18 expiration and the trade gave you a chance to get into the market at what I would call a discounted price.
So, there are many ways to make money off the large swings of DTE options …
The safest and most consistent may be to let the flushes and rips happen and then lean on them to execute high-probability trades in the longer-term expirations.
Bring It Home
I am launching a complimentary product to Power Income Trader tonight at 7 pm and shorter time expiry options will be a focus of my Win the Week product …
I will be giving out a minimum of two trades per week that will be closed by happy hour on Friday so you can go celebrate your victories each week.
These will be very simple and easy-to-execute trades … One of the trades each week will be straightforward vertical spreads that can be executed right from your mobile phone …
You will be able to monitor all the vertical spread trades from the app and you’ll be amazed at how easy the app makes it to execute and manage the process.
The Win the Week process is a simple 4-step process that comes together to make a FIST
If you attend the event Tonight you will receive a special report on Gamma, which is becoming a most important indicator of option flow and is a game changer for trading options.
I’ll give you the 4-step process live and a trade to capitalize on a trend change I see coming on the heels of NOV18 expiration that Friday …
See you there and as always …
Live and TRade With passion My Friend,
Griff