When the Tail Wags the Dog: How Options Trading Is Steering U.S. Stock Prices
- Gustaf Rounick, CFP®, ChFC®
- Aug 27
- 10 min read
Understanding the “Tail Wags the Dog” Dynamic
In traditional markets, the stock market was considered the “dog” and the options market its “tail” – meaning options were a smaller sideshow reacting to moves in stocks. Recently, however, many market observers say the roles have flipped. The options market has grown so influential that it can actually steer stock prices, essentially becoming the “dog” itself (castfirm.com). In simple terms, heavy trading in stock options (especially very short-term options) can push the underlying stock up or down, sometimes regardless of fundamental news. This phenomenon is often called “the tail wagging the dog,” and it’s increasingly evident in U.S. markets.
Why Options Influence Stocks More Than Before
Several trends in U.S. markets have made options a bigger driver of stock movements. One major factor is the rise of ultra-short-term options, such as 0DTE (“zero days to expiration”) options that expire the same day. Along with the growth of complex trading algorithms and leveraged funds, these short-dated options have reshaped daily market behavior (castfirm.com). It’s now common to see options trading volumes exceed the volume of the stocks or ETFs themselves, an astonishing reversal of the past. Roughly half of all S&P 500 index options expiring in a recent month were 0DTE contracts (envestnet.com) – a sign of how popular these same-day bets have become. With so much money chasing quick, leveraged trades, stock prices are increasingly driven by trading flows (who is buying or selling right now) rather than long-term fundamentals. In other words, options activity can set the tone for stock price moves instead of just reflecting them.
0DTE Options and High-Speed Trading
Zero-days-to-expiration (0DTE) options have surged in use, turning the market into a high-speed casino for some traders. These are option contracts that expire by the end of the trading day, leaving virtually no time for anything but speculation. The appeal is that traders can make very short-term bets on intraday market moves without tying up money for long – essentially aiming to profit from price swings within hours. Because they expire so quickly, 0DTE options are cheap in price (low premiums) and can offer huge percentage gains if the stock or index moves in the predicted direction that day. This has fueled a fear of missing out (FOMO) among some retail players, especially when stories spread of 0DTE trades yielding massive one-day gains (envestnet.com). As a result, trading of 0DTE contracts has skyrocketed. By late 2023, average daily options volume in the U.S. hit record levels (over 45 million contracts a day), and about one-third of the same-day S&P 500 options trades were being done by individual retail investors (nyujlb.org). This new breed of fast-expiring options is attracting everyone from small traders on Reddit to large institutions, and it’s changing how the market behaves on a day-to-day basis.
How Options Can Move Stock Prices
To understand how the “tail” can wag the “dog,” let’s break down the basics of options and market makers in plain English. An option is a contract that gives the buyer the right to buy or sell a stock at a set price (the strike price) before a certain date (expiration). Investors buy call options if they think a stock will rise, or put options if they think it will fall. On the other side of many of these trades are market makers – professional trading firms that continually buy and sell options to provide liquidity. When you buy an option, chances are a market maker sold it to you. Their goal is to earn a small spread and hedge away the risk of the trade by using the underlying stock.
Here’s the key: when a lot of traders buy call options for a stock, the market makers who sold those calls will hedge by buying shares of the stock. They do this because they might have to deliver shares if those call options are exercised. By buying the stock, they offset the risk of a rising price. However, that very hedging can push the stock price up even more – which is the opposite of what the market maker might want, but it’s necessary to manage risk (bankrate.com). This can set off a feedback loop: as the stock rises due to this buying, the calls become more likely to end up “in the money” (profitable), forcing market makers to buy even more stock to stay hedged. The result is a self-reinforcing cycle of buying. In options lingo, this is related to “gamma” – a measure of how much more of the stock a dealer needs to buy or sell as the stock moves. When a lot of short-dated options are in play, gamma can be high, meaning even small stock moves compel significant hedging adjustments. The outcome can be a sudden surge in the stock price fueled largely by these mechanics, commonly referred to as a “gamma squeeze.” It’s essentially an advanced term for when derivatives (options) drive the stock itself to soar or plunge rapidly.
Gamma Squeezes in Action: Tesla, Nvidia, and GameStop
This tail-wagging-the-dog effect isn’t just theoretical – we’ve seen it play out dramatically in real stocks. A well-known example is the GameStop saga of January 2021, when the video-game retailer’s stock exploded in price far beyond what fundamentals would suggest. Part of that story was a gamma squeeze: armies of traders bought call options on GameStop, forcing option dealers to buy millions of shares to hedge, which in turn drove the price even higher in a vicious cycle. In fact, gamma squeezes were a key factor in the massive run-ups not only of GameStop but also of tech high-flyer Nvidia during certain rallies (bankrate.com). Nvidia’s stock, for instance, saw huge gains that were at least partly fueled by heavy call option activity as excited investors bet on the company’s prospects in AI chips. As those calls piled up, market makers continued to buy Nvidia shares to hedge, adding fuel to the rally.
Another striking case is Tesla. In late 2024, Tesla’s stock surged over 100% in just a couple of months. While Tesla had some positive news (like earnings and optimism around a new administration), analysts noted that the options market appeared to be a major driver of the stock’s climb (investing.com). After a certain point, the buying frenzy in Tesla call options – especially weekly and 0DTE calls – reached a level where it dominated trading. Market makers selling those bullish options had to buy huge quantities of Tesla shares as a hedge, contributing to the stock’s rapid rise (investing.com). One report highlighted that around December 2024, Tesla’s most-traded options were calls expiring in just days with very high strike prices (for example, $500 strike calls when the stock was much lower) (investing.com). Those speculative bets implied traders were expecting big short-term jumps. Importantly, if the stock failed to reach those high strike prices by expiration, the options would expire worthless, and then all the temporary buying pressure could suddenly reverse. In Tesla’s case, experts warned that if the call-buying spree fizzled out or those options expired unprofitable, market makers would unwind their stock hedges (selling the shares they had bought), potentially causing Tesla’s price to drop sharply (investing.com). In other words, the surge was built on a fragile options-driven foundation that could quickly crack once the “gamma squeeze” phase passed. Tesla’s rally and many meme stock episodes have shown how intense options activity can lead to big swings in stock prices, even if nothing major has changed about the company’s actual business in the short term.
The Impact on Market Volatility
One might wonder, does all this options-driven trading make the market more or less volatile? The answer is both – it can calm the market at times, and make it more explosive at others. When there is a large open interest in options at certain strike prices and dealers are well-hedged, stock prices can get “pinned” around those strikes. For example, if many call options are written at a particular price, market makers will buy on dips and sell on rallies to stay hedged (because they are effectively long gamma in that range). This activity can dampen volatility in the short term, keeping the stock trading in a tight range – until those positions expire or a big piece of news hits (castfirm.com). Many traders have noticed that indices like the S&P 500 sometimes hover around key option strike levels (say, 4,500 on the S&P) because of this effect. It’s as if the market is stuck in a feedback loop created by the option hedging.
However, this stability can flip quickly if the position of dealers shifts to “short gamma,” meaning their hedging actions start to amplify moves instead of buffering them. When something unexpected happens or when a lot of option contracts roll off, volatility can spike suddenly. The same feedback loops that kept things calm can turn into accelerants for a sell-off or rally. For instance, analysts at Goldman Sachs pointed to the explosion of 0DTE activity as a factor that intensified a market selloff in August 2023 (nyujlb.org). The concern is that with so much leverage and rapid-fire trading tied to options, a sharp move in stocks could be exaggerated by all the hedging and potentially lead to a cascade (some observers even worry about mini “flash crashes”). In extreme cases, if many traders are caught on the wrong side of very short-term bets, the unwind can create air pockets in liquidity. In summary, heavy options trading sometimes mutes day-to-day volatility (when dealers are long gamma and keeping prices in check). Still, it also raises the risk of abrupt swings if conditions change and those same dealers have to adjust their positions suddenly. It’s a bit like a pressure cooker: tightly sealed most of the time, but prone to burst if the steam builds too much.
Regulatory Concerns and the Debate
The rise of options-driven market moves has caught the attention of regulators and market participants alike. Are these new trading dynamics good or bad for the market? Opinions differ. On one hand, there’s growing concern that products like 0DTE options are encouraging a gambling-like atmosphere in markets. Even a former SEC Chairman, Jay Clayton, suggested that ultra-short-term options trading is essentially gambling and perhaps should not be permitted (envestnet.com). Critics argue that inexperienced retail investors may be taking on significant risks without understanding that 0DTE options can lose value extremely rapidly. The U.S. Securities and Exchange Commission (SEC) has been looking into whether the “gamification” of trading – for example, broker apps with game-like features that entice frequent trading – is harming investors. In fact, the SEC has floated the idea of new rules to curb overly gamified, speculative trading in order to protect retail investors drawn into risky bets (nyujlb.org). This could indirectly affect how 0DTE options are marketed or used, given their popularity among day traders.
On the other hand, defenders of the current market structure point out that options (even short-dated ones) also serve useful purposes, like allowing investors to hedge positions or express views on events with limited risk. Industry experts note that large institutional players have begun using 0DTE options for hedging around events and that the market has so far handled these volumes without major incident (tradersmagazine.com). Some, like a quantitative analyst at a major asset manager, argue that 0DTE options don’t introduce fundamentally new risks but rather shift existing risk into a shorter timeframe (tradersmagazine.com). From this perspective, the “tail wagging the dog” effect is an evolution in market structure that participants are adapting to. Exchanges and firms are even providing more data and analytics around options flows so that everyone can better understand the impacts. Still, regulators remain watchful. The consensus is that transparency and education are key – traders need to know what they’re doing, and the market’s plumbing needs to be robust enough to handle these feedback loops. No major regulatory actions had been implemented as of 2025, but the debate continues on whether rules should change if option-induced volatility threatens overall market stability.
What It All Means for Investors
For everyday investors and clients with limited stock market experience, the idea that “the tail wags the dog” can be both intriguing and intimidating. The main takeaway is that short-term trading activity in options can significantly influence stock prices in the near term. A stock might swing or stall not just because of earnings or news, but because of the mechanics of options trading around it. Knowing this, investors should be cautious about chasing sudden stock moves that might be fueled by options market dynamics. Those sharp jumps or drops could reverse once the flurry of options activity subsides (as seen in some of the examples like Tesla).
It’s also a reminder that volatility can be deceptive. Sometimes a stock that’s barely moving is being held in place by option hedging, which can break down quickly. Conversely, a wild price surge might have more to do with traders’ bets than the company’s value. Long-term investors might take comfort that, eventually, a company’s fundamentals do matter more than short-term trading quirks. Over longer periods, stock prices tend to reflect a company’s real performance – earnings, growth prospects, etc. – once the short-term options-driven noise fades (castfirm.com). However, in the short run, being aware of this “tail wagging the dog” dynamic can help investors understand why markets behave oddly at times.
The bottom line: The U.S. options market has grown vast and fast-paced, and it can sway the stock market’s direction day by day. Retail investors don’t necessarily need to trade options to benefit or suffer from their effects – even a stock-only portfolio can be impacted by these flows. Staying informed and maintaining a level head during sudden changes is crucial. If you’re investing for the long term, it may be wise not to get swept up in the euphoria or panic that options whirlwinds can create. And if you do choose to trade options, make sure you fully grasp the risks, because as we’ve seen, big rewards often come with big risks attached.
Important Disclosures
This article is for informational purposes only and is not investment advice. Trading in options carries significant risk and is not suitable for all investors. Any examples of specific securities (such as Tesla, Nvidia, or GameStop) are illustrative only and not endorsements to buy or sell. Past performance or market activity, including instances of options-driven price moves, does not guarantee future results. Investors should consider their financial situation and, if needed, consult with a licensed financial advisor before making any investment decisions. The views expressed here are based on current market observations and sources cited, and are subject to change over time. All investments involve risk, including the potential loss of principal.
Gustaf Rounick, CFP®
