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Options Hedging & Leveraged ETFs in Market Swings

June 1, 2022

GameStop stock soared in just a few hours in early 2021 with the effects of broker dealer options hedging spurred by retail investor buying pressure. And from February to March 2020, option trading activity was also pointed to as a contributor to stock swings in the COVID-19 selloff. (The market dropped 30%, and then recovered quickly over the following weeks). It has been documented that the need for market makers to hedge their positions with options (given rapid changes in stock prices) can contribute to market and stock price swings. However, might there be other factors also at play in these types of stock and market fluctuations?

Use of leveraged ETFs (exchange traded funds) has been on the rise over the past several decades. The chair of the Securities and Exchange Commission made a statement about how they could potentially contribute as a source of instability for financial markets.

In their most recent research, Heiner Beckmeyer, University of Munster; Andrea Buraschi, Imperial College; Mathis Moerke, University of St. Gallen, and Andrea Barbon, University of St. Gallen examine the combined effects of leveraged ETFs and options trading on stocks and the market. They are the first to compare these effects individually and together.

The researchers leverage OptionMetrics data in their analysis. “OptionMetrics offers open interest for every option broken down by integrities of investors. It also offers Greeks of options and breakdowns of global open interest, readily available out-of-the-box, which is a huge time-saver,” says Barbon in his article.

Barbon says their findings can be leveraged by regulators and investors to better understand the markets, and potentially provide insights into investing opportunities. Read the article on their research in Alpha Architect.