Investing in a Flows Driven World | Cem Karsan
Excess Returns
Understanding Reflexivity in Options Trading and Market Volatility
The use of options and market positioning plays a critical role in shaping market volatility, rather than the mere increase in options trading itself. Current positioning, especially in short volatility scenarios, can exacerbate market declines during acute events, as evidenced by historical examples like COVID-19. The reflexivity involved means that when there's significant short tail positioning, an unexpected event can lead to a magnified market movement. Conversely, periods of good hedging, like in 2022, can dampen volatility and lead to more gradual market corrections. The dynamics of option trading reflect a cycle influenced by prevailing trends; successful strategies attract more participants, which can create an imbalance. Therefore, positioning can lead to heightened outcomes when it becomes excessive on either the buy or sell sides. Understanding who is positioned where in the current market is essential, as excessive short volatility positions can lead to market instability when sentiment shifts.
