JPMorgan Blames Pace of Friday’s Stock Selloff on Levered ETFs

(Bloomberg) — A run for the exits by investors in levered exchange-traded funds on Friday exacerbated the largest single-day stock market selloff since April, according to strategists at JPMorgan Chase & Co.

The S&P 500 Index fell 2.7% in the rout, while the Nasdaq 100 plunged as much as 3.6%, after a social media post by US President Donald Trump threatened fresh tariffs on China.

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Bram Kaplan and colleagues at JPMorgan pinned the blame for the speed at which the selloffunfolded on a set of funds that offer double or triple the performance of their underlying indexes. Specifically, a dash by traders to sell positions in levered ETFs, meant dealers in turn had to offload stock to remain hedged, amplifying market volatility, and accelerating the selloff as the day unfolded.

The drop pushed derivatives market makers into a state known as negative gamma, short hand for a market where dealers must sell stock into a rout or buy into a rally, adding momentum in either direction.

“Levered ETFs sold ~$26 billion in equities into the close on Friday to rebalance, driving markets to close at the day’s lows, according to our estimates,” Kaplan wrote in a research note Monday. The outflows “likely caused option dealers to turn short gamma, and will likely trigger further systematic selling flows this week, leaving markets fragile.”

The rapid growth of derivatives trading, especially as its popularity spreads with the retail trading set, has been fingered for other violent spikes in stock volatility. Unexpected geopolitical developments are sometimes a trigger for the big market swings that often drive dealers to sell large options position intensifying moves.

If the S&P 500 can recover to around the 6,663-level, the positive gamma conditions that have largely prevailed since April should return, making Friday’s selloff little more than a blip, according to data from SpotGamma. In a positive gamma environment, dealers tend to hedge by buying stocks during a selloff, adding stability.

Stocks appeared to rebound to just under SpotGamma’s positive gamma threshold on Monday, with the S&P 500 up 1.5% to 6,652 and the Nasdaq 100 at 24,708.

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