Thread by @TradingFloorWs

The JP Morgan Collar Trade Demystified - A🧵

As we near the end of the month/quarter, you might come across discussions about the JP Morgan collar trade. So, let's take a closer look at what it actually means.

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The JPMorgan Hedged Equity Fund (JHEQX) is a $15.5 billion fund that tracks the S&P and uses options to protect against market downturns.

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3/7 Every quarter, the fund sells a 3-5% out-of-the-money SPX call option and uses the proceeds to buy a 3-5% out-of-the-money put spread, expiring on the last trading day of the quarter (March, June, Sep, and Dec).

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These trades are massive, usually around 42,000 contracts, which makes them hard to miss on the option chain.

The current positions expiring on 6/30:

Short 4320 CALLS
Long 3885 PUTS
Short 3280 PUTS

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The significance of these trades lies in their size, as the associated hedging flows worth billions of dollars can influence the price of the underlying asset.

The tail wagging the dog...

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As the expiration approaches, strikes with large open interest tend to act as magnets, pulling the underlying asset toward them for expiration.

It's no coincidence that the SPX has been within 0.5% of a JPM collar strike at the last three quarterly expirations.

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That's because dealers' directional exposure (gamma) is highest when a strike is ATM nearing expiration, so they ramp up their hedging (buying and selling SPX) near big OI. These flows are the magnet...

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Don't worry if it seems complicated, here's a cheat sheet for the last two weeks of the quarter:

If the SPX approaches a JPM call, it may rise to the strike for expiration, resulting in lower volatility.

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And if the SPX is approaching a JPM put, it may be pulled down toward the strike for expiration, leading to higher volatility.

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At the end of the quarter, the trade is rolled forward for three months, and the Gamma's influence diminishes significantly... until the end of the next quarter, that is.

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