Global financial giant Goldman Sachs is sounding the alarm on a potential correction in the stock markets, citing the looming expiration of $2.7 trillion in derivatives this Friday.
A potential correction in the stock markets is on the horizon, according to a note from Goldman Sachs. The warning comes as $2.7 trillion of US stock market derivatives are set to expire this Friday.
Stock market derivatives, such as options and futures contracts, have an expiration date.
This is the last day on which a buyer can exercise their rights under the contract or sell it to another party.
If the contract expires unexercised, it becomes worthless.
Derivatives expiration occurs at regular intervals, typically on the third Friday of each month for stock options and on various dates depending on the underlying asset for futures contracts.
Understanding 'derivatives expiration' is crucial for investors, as it can significantly impact their portfolio's value and risk exposure.
What’s Driving the Concern?
The expiration of these derivatives will put pressure on the stock markets and lead to increased volatility. This is because investors who have taken out options bets may not renew them, causing banks and intermediaries to unwind their hedges. These positions have previously acted as a dampener on volatility, supporting weakness and muting rallies.
Stock market derivatives are financial instruments that derive their value from an underlying asset, such as a stock, commodity, or currency.
They allow investors to bet on price movements without owning the underlying asset.
Options and futures contracts are common types of derivatives used in stock markets.
Options give the holder the right, but not the obligation, to buy or sell at a predetermined price.
Futures contracts obligate the buyer to purchase or sell an asset at a set price on a specific date.
Why Is This a Concern?
The S&P 500 and European stock markets hit record highs on Tuesday but have since declined due to concerns over trade wars. The latest tariff warning from Trump has exacerbated fears of a broad trade war, unnerving investors. Additionally, retail traders in the US are trading less as they prepare to pay their annual taxes, and average flows from retirement funds into mutual and exchange-traded funds typically taper in March.
The Numbers Are Staggering
$2.7 trillion is the amount of equity options that will expire this Friday. These derivatives include wagers on the S&P 500, US exchange-traded funds, and single stocks. Banks and intermediaries have over $9 billion of hedges against these trades, which have previously supported weakness and muted rallies.
The S&P 500, also known as the Standard & Poor's 500, is a stock market index that represents the market value of 500 large, publicly traded companies in the United States.
It is widely considered to be one of the best indicators of US equities performance and is often used as a benchmark for investment portfolios.
The S&P 500 is market-capitalization-weighted, meaning that larger companies have a greater influence on the index's performance.
The Potential Consequences
If investors do not return to renew their options bets, it could trigger a larger sell-off. Dan Izzo, founder of the hedge fund BLKBRD Asset Management and a former bank trader, explains that this would translate into a large momentary pressure on the markets. If there’s no one willing to buy the impact, we could see a larger sell-off.
