‘This is a no-rules market’. Goldman strategist explains why recent stock moves have confounded traders.

The company reported profits that were $2 billion above the Wall Street consensus, and forecast revenue for the third-quarter that was more than $3 billion above expectations.

This kind of volatility has left many professionals scratching their heads.

“I was pinged more times during [Thursday’s] market trading than any other trading day in my 20-year career on Wall Street,” said Scott Rubner, a managing director and a derivatives strategist at Goldman Sachs.

But according to Rubner, there’s a simple explanation: systematic funds and option traders are pushing the market around as liquidity has dried up during the typically slow month of August, which is also typically a weak month for U.S. equity returns, Dow Jones data show.

Meanwhile, option market makers have helped to amplify intraday swings instead of acting as a stabilizing force due to their growing exposure to customers buying contracts on the verge of expiration.

As a result, traders are operating in a “no rules” market, he said.

More recently, markets have been struggling to absorb a flood of selling from a class of systematic trend-following funds known as commodity trading advisers, or CTAs, he explained in the note.

And the CTAs are not alone: other systematic funds pursuing strategies like volatility control and risk-parity have been curtailing their exposure as Treasury yields have climbed higher and U.S. stocks have sunk. The end result is that stocks have been sliding over the past month, although the S&P 500 and Nasdaq Composite snapped a three-week streak of losses on Friday.

Against this backdrop, traders of zero-day to expiration, or “0DTE,” options have exerted more of an influence on the market, with the tape often swinging around popular strike prices, like the 4,440 S&P 500 put options that were blamed for exacerbating a late-day selloff on Aug. 15.

See: Wall Street blamed zero-day option traders for a sudden stock-market selloff. But a BofA team says they got it wrong

Heavy short-dated option volume has left option dealers with a lot of exposure to hedge every day as a relatively small move in markets can cause a wave of 0DTE options on the brink of expiration to suddenly see their values surge as they move “into the money.” According to Rubner, dealers’ “short gamma” exposure is the largest he has seen since Goldman began tracking it a few years ago.

And underscoring all of this is the fact that what Rubner calls “top of book” liquidity in S&P 500 e-mini futures
ES00,
+0.62%
has fallen by about 56% from about $25 million to $11 million.

When dealers are short gamma, it typically means their customers have been buying put options and selling calls, option-market analysts told MarketWatch. A put option gives the holder the right, but not the obligation, to sell the underlying security at an agreed-upon price before a set expiration date. A call gives the holder the option to buy.

A large short-gamma position means dealers have to hedge their exposure by selling equity index futures or another instrument when the S&P 500 index is falling and buying when it rises, contributing to larger intraday swings.

“This is a market exacerbator, not a muting factor,” Rubner said about dealers positioning.

Stocks finished lower on Thursday, with the S&P 500
SPX
and Nasdaq Composite
COMP
seeing their biggest daily percentage declines since Aug. 2, while the Dow Jones Industrial Average’s
DJIA
nearly 375-point drop was its largest since March 22, according to Dow Jones Market Data.

But all three indexes bounced back on Friday, with the S&P 500 rising 0.7%, the Nasdaq gaining 0.9% and the Dow gaining roughly 250 points, according to closing data from FactSet. Both the S&P 500 and Nasdaq finished higher on the week, their first such gain after three weeks of losses.