A boom in one corner of the options market could bring 'volmageddon' and jolt the stock market in a big way

• The rising popularity of short-term options poses a big threat to the stock market, according to JPMorgan's Marko Kolanovic.
• Zero-day-to-expiry options allow traders to hedge market positions over a very short period of time.
• According to Kolanovic, the rise of these option strategies could amplify any up or down move in the stock market.

Zero-day-to-expiry options have surged in popularity since the pandemic, with daily trading volumes soaring to as much as $1 trillion, according to JPMorgan.

But the rise in popularity of the short-term option vehicles, sometimes referred to as 0DTE, poses a threat to the stock market and could amplify volatility in such a way that it sparks "volmageddon," JPMorgan's Marko Kolanovic said in a recent note.

The zero-day-to-expiry options allow traders to hedge their market positions over a very short period of time. But the rapid selling and buying and covering of such option instruments can lead to a surge in notional selling or buying of stocks in the broader market.

"If there is a big move when these options get in the money, and sellers cannot support these positions, forced covering would result in very large directional flows," Kolanovic said. "These flows could particularly impact markets given the current low liquidity environment."

Kolanovic estimates that a large daily stock market move, whether to the upside or downside, could spark a cascade of trades that "could result in intraday selling on a large down move (or buying on a large up move) on the order of ~$30 billion."

Kolanovic's reference to "volmageddon" is rooted in the February 2018 stock market scare that saw a surge in market volatility and a massive drop in stock prices as investors grew concerned about the potential ramifications of former President Donald Trump's trade war with China.

But that downside move was amplified by a volatility implosion tied to the rising popularity of inverse VIX products, which represent bets against the future direction of market volatility.

"In February 2018, a sharp increase of market volatility was triggered by a collapse in inverse VIX products and fueled by further systematic selling... the rise of inverse volatility products prior to Volmageddon started as a virtuous feedback loop of volatility selling," Kolanovic explained.

"While history doesn't repeat, it often rhymes, and current selling of 0DTE, daily and weekly options is having a similar impact on markets."