Markets Becoming Predictable?

How Market Markers Hedge

From my point of view, it is. Much of the market's predictability is due to the options market. Options have become such a big part of everyday market movement that we can increase the probability of which direction the market is going just by understanding the mechanics.

An example of this is the last couple of Fridays then Monday opens. Due to the availability of Zero Days to Expiration Options, large institutions, as well as individuals can now hedge their portfolios over the weekends. This has become more obvious since the Israel / Hamas war has broken out. The last couple weeks we have seen an increase in Put Option buying as we get past Wednesday. Thursday, Friday the implied volatility rises into the weekend. On Monday those hedges are unwound and the “market” rises.

The Mechanics of Markets

When you buy or sell a stock or bond or whatever, there is a Market Maker who makes a market for you. They will match your stock or bond buy up with a seller. In the options world, they sell or buy your option purchase with the expectation that they will have to full fill that agreement. To reduce the risk, a market maker will buy or sell the underlying investment.

Example

Let's say you and I manage a portfolio worth $500 million of Large Cap Growth stocks. We are concerned that war is going to spread in the Middle East and possibly here in the United State this weekend causing the markets to open drastically lower on Monday. To hedge that risk we buy S&P 500 Puts or SPY Put contracts that will expire on Monday or Tuesday of the following week. Today, October 24, 2023 at 9:06am SPY Puts will cost us $3.52 for the October 30th Puts with a strike price of $423 (At the Money Puts). We decide to hedge 20% of our $500 million dollar portfolio, so we buy 10k contracts ( one contract represents 100 shares of the underlying investment) spending $3.52 million. Because the options have roughly a leverage ratio of 1:100 ratio, we are able to hedge more than just the 20% of our portfolio.

When we make this purchase of 10k SPY Put contracts at the $423 strike price, a Market Maker agrees to honor that contract, taking on the risk. The Market Maker is on the hook for a whole lot of money. Since we are not the only one they are doing this for, they are taking on a MASSIVE amount of liability if the market falls before expiration. To hedge this risk, the Market Maker will sell short $100 million worth of SPY stock, sell short Call contracts or sell short the underlying the top holdings of S&P 500 such as Apple or Microsoft, etc..

Once Monday rolls around and nothing has happened over the weekend. The Market Maker unwinds their short positions by buying SPY or the individual stocks that they shorted. This action then causes the “markets'' to go up on Monday and Tuesday. By Wednesday, depending on the Geo Political environment, this sicario rolls out again.

Understanding the mechanics of markets gives us better insight to how markets will perform in the future.

The state of QQQTrades.Club

As many of you probably noticed, I did not write anything last week. Ayear and a half ago I started working with the Best of US Investors. Friday, two weeks ago my role in the company escalated and has become the majority of my time spent. Due to this, I’ve decided to integrate my writings into the Best of US Investors Discord under the Everyone tab. When it comes to my paid subscriber program, I will be ending that. I’ll no longer be providing ideas on different allocations. I’ve decided to move all of that towards the Best of US Investors subscription programs, which you are welcome to subscribe to.

I do appreciate all the support since starting this and I hope to see you over at the Best of US Investors website andDiscord in the future. In the meantime, I will be periodically posting on the Discord under our Everyone tab, which is available for free, you’ll just have to subscribe to ourDiscord, which you can do by clicking the link below.

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