Market ups and downs can be stressful, especially if you're saving for retirement or planning for the future. Personal finance expert Christopher Liew shares practical advice on staying calm and making smart decisions during a market downturn—whether you're new to investing or have years of experience. (Getty Images / Caroline Purser)
The recent decline in the S&P 500 has been strikingly steady, avoiding the dramatic spikes in volatility often seen during market downturns. As investors look for signs of a rebound or further decline, a key factor to watch is market liquidity—how easily assets can be bought or sold without affecting prices.
Historically, market crashes like the 1987 crash and the COVID-19 selloff have been worsened by liquidity drying up. With the increasing role of derivatives in today’s market, investors are closely monitoring how options trading influences stock prices. The fear stems from past incidents where derivatives collapses triggered extended market instability.
Despite the recent selloff, volatility levels remain relatively contained. The Cboe Volatility Index (VIX) rose to nearly 30 before declining, even as stock prices continued to slide. Day traders have been active during intraday swings, yet some indicators suggest that the drop in stocks may be partly due to investors cashing out of both equities and their option hedges.
Dealer hedging has played a role in market moves, as traders adjust positions in response to negative gamma exposure from short options. However, options haven’t been the dominant force driving the decline. Liquidity, measured by market depth from the Chicago Fed and CME Group, has remained mostly stable.
Liquidity is crucial for ensuring smooth market transactions, especially when options trading generates large shifts in buying and selling pressure. According to Benedicte Lowe and Georges Debbas from BNP Paribas, the real risk arises when liquidity dries up while dealers hold significant short gamma positions, which can lead to extreme market swings.
(via Bloomberg)
The S&P 500’s recent drops have mostly occurred during regular trading hours when liquidity is higher. Rather than a single major event triggering panic, a steady stream of trade-related news and policy changes has kept the market on edge. While some focus on the positioning of S&P 500 options—trading over $2 trillion daily—there are also significant reserves in futures, exchange-traded funds (ETFs), and cash markets that help absorb trading activity under normal conditions.
Joe Tigay, a portfolio manager, emphasized that dealer positioning is only one of many factors affecting the market. On some days, its influence is minimal, while on others, it can accelerate downturns. The biggest risks arise when liquidity is low, as seen recently when market makers withdrew bids and offers, making price swings more severe even with relatively small orders.
Options trading tends to have a greater impact on individual stocks than on broad indexes. The 2021 GameStop rally was a prime example of how options positioning can trigger sharp price movements. In some cases, market makers handling large, illiquid trades have found themselves forced to adjust stock prices based on options activity.
A significant focus in the options market is the quarterly "triple witching" event when trillions of dollars in options and futures expire. While this period can bring short bursts of volatility, it rarely causes long-term market disruptions. Even experts analyzing dealer positioning often have differing opinions on its true market impact.
That said, options trading has grown large enough to be a market-moving force. In February, zero-day options contracts accounted for a record 56% of S&P 500 option volume. Fund manager Stefano Amato believes these options now influence the movement of major stock indexes and act as a sentiment indicator that can amplify short-term market swings.
