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J.P. Morgan's Marko Kolanovic told clients Friday before the bell that a combination of technical factors should lead to a market bounce during the session and into next week.
"Given the rapid selloff yesterday, the reverting feature of yesterday's option hedging impact should have a positive market impact today," said the bank's global quantitative and derivatives strategy analyst in the note. "The 3% rally in China stocks (FTSE China A50) overnight should improve overall risk sentiment."
Kolanovic has blamed the recent sell-off on so-called systematic strategies like risk parity funds and options hedging rather than fundamental forces. He said a week ago the sell-off was largely over and the S&P 500 is 0.5 percent higher since then.
"Next week might see a marginally positive impact and the same for the subsequent October month end rebalance given the significant drop in equities since September," he added in the note Friday.
U.S. stocks dove earlier in October as traders ditched equities over fears of rapidly rising interest rates, a possible global economic slowdown and frothy tech valuations. The Dow Jones Industrial Average is more than 1,000 points down from highs earlier in October; the is down 4.6 percent this month.
"Option hedging is a temporary impact (intraday momentum) that tends to revert," Kolanovic said. "Consistent with this, we saw Monday U.S. morning weakness, a large Tuesday rally and end of the day squeeze, a Wednesday U.S. morning reversal, and yesterday acceleration on the downside – all significantly driven by dynamic hedging of index options."
Those with significant equity positions, such as large institutional investors, often try to offset that risk through options on major stock indexes. These contracts are a sort of insurance that pay out when the indexes fall.
Weighing in on the effect technical factors and algorithmic trading have on markets, Goldman Sachs CEO David Solomon said Thursday that he believes part of the month's steep stock sell-off was the result of programmatic trading.
"There's no question when you look at last week, some of the selling is the result of programmatic selling because as volatility goes up, some of these algorithms force people to sell," Solomon said.
"Market structure can, at times, contribute to volatility and one of the things that we're spending a bunch of time thinking about at the firm is how changes in market structure over the course of the last 10 years will affect market activity," the Goldman chief added Thursday.