Nomura Warns S&P 500 Options-Driven "Vol Killer" Looms Into Year-End... Then Brace

Despite the much-anticipated 'dovish soft-CPI', equity markets sold off last week and continue to do so (ignoring the Santa Claus rally). However, VIX remains notably low although uncertainty feels significantly higher and liquidity into year-end remains dismal as the quarterly roll-over of a massive put-spread collar that the $15 billion JPMorgan Hedged Equity Fund (JHEQX) owns as a protection for its portfolio remains the elephant in the room.

While the position consists of protective puts funded with the sale of bullish calls and even more-bearish puts, it’s the calls part of the trade that has Wall Street’s attention right now, in part because these contracts have a strike price near where the S&P 500 is trading: 3,835.

The 44,500 call contracts matter for the market because of the process that dealers usually must execute to maintain a market-neutral position. At the other side of JPMorgan’s trade, dealers who sold the options will have to either buy or sell stocks to avoid unwanted market risk.