Since most of 2023, the US stock market has been on an upward trend with low volatility. Even after the recent gains, the VIX volatility index, which measures the cost of S&amp;P 500 index options, remains below its long-term average, making it potentially the calmest year since 2019.
However, there is a threat lurking beneath the calmness of the stock market in the options market.
Despite a slight 0.6% decline in the S&amp;P 500 this week, one of the smallest declines since 2023, the intraday movements tell a different story. According to Bloomberg data, the average intraday volatility of the S&amp;P 500 index during the five trading days ending Thursday was 1.1%, nearly twice the average daily volatility two weeks ago and the largest since June.
In the past six trading days, S&amp;P 500 index futures have erased their previous 0.9% gains twice, marking the first occurrence since February this year.
Goldman Sachs and Morgan Stanley analysts suggest that while uncertainty surrounding the US economy and Federal Reserve policy is one factor, other factors may also contribute to the volatility: market makers adjusting their positions.
<h2>Goldman Sachs and Morgan Stanley: Options traders are abandoning &#34;long Gamma&#34; positions</h2>
Currently, two prominent trading desks on Wall Street are warning of potential upcoming turbulence: options traders are abandoning their &#34;long Gamma&#34; positions.
Gamma trading refers to a trading strategy that involves buying options and simultaneously hedging the delta with the underlying asset to achieve a delta-neutral portfolio. Profits are made through buying low and selling high on the underlying stocks during the dynamic adjustment process.
According to Goldman Sachs' model, options traders' exposure to S&amp;P 500 index options has turned negative for the first time this week, and their short exposure to all index contracts is the highest since October last year.
A team led by Christopher Metli at Morgan Stanley has also observed this shift, noting that traders' risk exposure has decreased by over 80% compared to a few weeks ago. The team observed that this decline is increasingly driven by the selling of call options by ETF funds.
The Morgan Stanley team stated that, coupled with the current level of leveraged ETF activity, this indicates that the market is susceptible to greater volatility.
They wrote:
<blockquote>
&#34;Wall Street sells when it falls and buys when it rises. This may be temporary, but for now, it amplifies market volatility.&#34;
</blockquote>
<h2>Increased volatility could trigger a flight to safety, ultimately weighing on the economy</h2>
While the turbulence may be temporary, betting on price fluctuations is a common trading practice. However, according to Scott Rubner, Managing Director at Goldman Sachs, the change in market makers' attitudes is different from the first seven months of this year when this group played a crucial role in suppressing price volatility.
Since August, the S&amp;P 500 index has fallen nearly 3%, marking the worst monthly start since March. Rubner suggests that if this decline continues, it may prompt systematic fund management companies to withdraw in large numbers, as these companies allocate assets based on volatility and momentum signals.
Due to the steady rise in the stock market this year, these rule-based funds have been buying stocks, with their volatility target strategy hovering near a 10-year high.
Rubner, who has been studying fund flows for 20 years, wrote in a report on Thursday:
<blockquote>
&#34;Market volatility is intensifying and no longer calm.&#34; &#34;This is a new change.&#34;
</blockquote>
Commodity Trading Advisors (CTAs) grasp asset price trends by going long or short in the futures market. They hold too many stocks, to the point that even a slight pullback would trigger severe liquidation, according to Rubner.
He said that one indicator worth noting is the 50-day moving average of the S&amp;P 500 index. This trend line is currently approaching 4438 and has not been broken since the banking crisis in March.
His model shows that falling below 4278 (close to the index's 100-day average level) could turn the mid-term momentum indicator for CTAs negative.
Rubner wrote:
<blockquote>
&#34;The theme here is that if the stock market starts to decline, it will create a catalyst for positioning and rule-based trading.&#34;
</blockquote>
Bob Elliott, Chief Investment Officer of asset management firm Unlimited, suggests that further intensification of volatility could trigger a flight to safety, similar to what happened during the banking turmoil in March.
Elliott said:
<blockquote>
&#34;One important factor driving the stock market rebound is the overall low volatility, which makes people willing to take on more risk in the financial system. However, if we transition to a period of higher volatility, as we have seen in the past few weeks, it may limit investors' willingness to leverage and weigh down asset prices, ultimately dragging down the economy.&#34;
</blockquote>

Goldman Sachs and Morgan Stanley both issued warnings: options traders are abandoning "long gamma" positions. Market analysis suggests that this will amplify market volatility, and increased volatility could trigger a flight to safety, ultimately dragging down the economy.

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