How the Options Market Influences the Stock Market

The U.S. options market influences the stock market in complex ways, with both direct and indirect impacts. Below, we explain how this occurs in a clear and concise manner:

1. Direct Relationship via Delta Hedging

• What it is: Many options market participants, such as market makers, use delta hedging strategies to manage the risk of their positions. This involves buying or selling stocks in the spot market to neutralize the risk of the options they have sold or bought.
• Impact: When there is significant trading volume in options (especially around expiration dates), the adjustment of these positions can generate substantial buy or sell orders for stocks, influencing their prices. For example:
  • If many call options are exercised, market makers may need to buy stocks to cover their positions, pushing the stock price upward.
  • The opposite occurs with put options, potentially pressuring the stock price downward.

2. Gamma Effect and Volatility

• What it is: "Gamma" measures the rate of change of an option's "delta." Near expiration or when prices are close to the strike price, gamma increases, requiring more frequent hedging adjustments.
• Impact: This can amplify price movements in the stock market, especially for stocks with high options volume. Phenomena like the "gamma squeeze" occur when large adjustments in options positions force sharp price movements in the underlying stocks. A classic example is the case of stocks like GameStop in 2021, where high demand for calls led to a combined short squeeze and gamma squeeze.

3. Market Sentiment

• What it is: The volume and type of options traded (calls or puts) reflect investor sentiment. An increase in calls may indicate optimism, while an increase in puts may signal pessimism.
• Impact: This sentiment can influence investor behavior in the stock market, particularly for stocks with high options activity. For example, a large volume of calls can attract more buyers to the stock, driving its price higher.

4. Expiration Events (OPEX - Options Expiration)

• What it is: On options expiration days (typically the third Friday of the month in the U.S.), there is a massive adjustment of positions, known as OPEX.
• Impact: These events can cause volatility in the stock market, especially for stocks with significant open interest in options. Phenomena like "pinning" occur when a stock’s price tends to stabilize near a strike price with high options volume.

5. Liquidity and Arbitrage

• What it is: The options market can increase liquidity in the stock market, as traders seek arbitrage opportunities between the price of options and the underlying stock.
• Impact: This can stabilize or amplify price movements, depending on the direction of orders in the spot market.

6. Impact on Specific Stocks

• Stocks with high options volume (such as "meme stocks" or tech companies like Apple and Tesla) are more susceptible to the influence of the options market. Stocks with low options trading experience less impact.

7. Practical Example

• GameStop (2021): Massive buying of call options by retail investors forced market makers to buy large quantities of stocks for hedging, contributing to the stock’s price surge.
• Indices: Options on indices like the S&P 500 (SPX) also influence the stock market, as adjustments in index options positions affect the stocks that make up the index.