Heavy option trading creates a feedback loop that forces market makers to buy high and sell low, turning stable markets unstable.
April 1, 2026
Original Paper
Market Instability from Option Flows
SSRN · 6447643
The Takeaway
While we think of derivatives as following the stock market, this paper shows they can actually take the wheel. It identifies a 'Stability Gap' where speculative option flows force the middle-men of the market to amplify price swings rather than dampening them, explaining how meme-stock style spikes happen endogenously.
From the abstract
We develop a theoretical and simulation-based framework to show how speculative option trading can generate price instability in the market for the underlying asset. The model features fully funded investors with downward-sloping demand, option traders who continually reinvest their gains in leveraged call positions, and a rule-based market maker who clears both asset and option markets while remaining deltahedged. When volatility is underpriced or speculative flows are large relative to the und