Monday, October 19, 2020

How tech options started juicing the stock market

Sep 10. 2020
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By Syndication Washington Post, Bloomberg · Yakob Peterseil · BUSINESS 

The precipitous rise of U.S. technology stocks in 2020 left even seasoned veterans on Wall Street struggling for explanations.

Sure, many of the companies were among the select few that had prospered during the pandemic, as online shopping and working from home proliferated. But the stock gains were so stratospheric -- Apple Inc. shares doubled in five months -- that some market watchers began to speculate that a traditional hedging trade might be fanning the flames. Options trading -- so the theory goes -- had evolved from a way for investors to protect against losses to a key driver of market frenzy.

1. Why are options under the spotlight?

The options market in the U.S. has exploded this year. Trading volumes of single-stock options exceeded those of regular shares for the first time during July, according to Goldman Sachs Group Inc. strategists. Options became hugely popular with retail investors seeking to ride the technology share rally. That's had some peculiar effects on markets, such as reversing the usual relationship between options and stock prices, which typically move in opposite directions but have been rising together. An unusually volatile Nasdaq 100 Index -- it fell 4.9% or more in three straight trading sessions in early September -- also hinted at the outsize influence of options.

2. How do options work?

An option is a financial contract that gives the holder the right to buy (a call option) or sell (a put option) an underlying security at a predetermined price. A contract typically references 100 shares, meaning that for a relatively small sum an investor gets exposure to a lot of stock. For example, to buy an option on Apple stock rising over the next week might cost a few hundred dollars compared to more than $10,000 to purchase 100 shares. Given how Apple shares rose for 19 of the 23 weeks from the final week of March, it's easy to see why options became a favored trade.

3. How exactly are options moving markets?

One theory is that the explosion in demand for options fed into gains in the stocks. That's because the people offering the contracts (options dealers) typically offset losses or gains on their positions by trading in the underlying stock. When the price of the share moves, they're forced to adjust their hedges. For example, if a dealer sold call options to clients, they'd usually buy the underlying stock when it rises and sell when it falls. Taken together, these hedging trades can influence equity prices but by exactly how much is a matter of speculation. Some analysts say hedging by options dealers had more impact this year because of the fierce demand for short-term options in single stocks. When there's not much time before expiration and a contract is likely to be profitable, dealers have to be more active in adjusting their positions, which can fuel volatility. Some analysts disagree and contend that the influence of such hedging trades has been overstated.

4. Who has been buying options?

Retail investors using trading apps such as Robinhood piled into bullish bets on tech shares, lured by the appeal of supersized gains from leveraged trading of popular stocks. Larger investors eventually joined the fray, too. The Financial Times reported that SoftBank Group Inc. poured billions into bets on Amazon.com Inc. and Microsoft Inc. using a trade known as a call spread, earning itself the moniker the "Nasdaq whale." The trade involved simultaneously buying and selling a call option -- a technique that caps possible winnings but also lowers costs. According to the FT, the Japanese investment group spent $4 billion on options focused on tech stocks. That compares with the $40 billion in call premiums paid by retail investors in a single month, according to data compiled by Sundial Capital. Whether the enthusiasm for options continues after the big tech shares tumbled in early September remains to be seen.

# Tech rallies most since April in stock rebound (Bloomberg · Katherine Greifeld, Claire Ballentine)

U.S. stocks rebounded from a three-day rout, as dip buyers poured into beaten-down tech shares to send the Nasdaq 100 to its best day since April. The dollar fell vs. major peers.

The S&P 500 Index rose the most since June, though finished well off its session highs. The Nasdaq gains followed an 11% rout took it down to the average price over the past 50 days. Tesla also bounced off that closely watched level after suffering its biggest sell-off. Computer chip and hardware makers rose, led by Advanced Micro Devices Inc. and Apple Inc. Shares climbed broadly in Europe.

"Dip buyers have been handsomely reward for the last 12 years," said Randy Frederick, vice president of trading and derivatives at Charles Schwab & Co. "There's substantial amounts of capital on the sidelines still available to come into the market."

Treasurys retreated and Bloomberg's dollar index turned lower. The pound headed for its longest declining streak since March on worries that talks could collapse over changes to the Brexit withdrawal deal.

Volatility remains a feature on U.S. equity markets, where a three-day rout plunged the Nasdsaq 100 into correction before the Wednesday bounce. Investors will be on guard for any signs the selling may resume. Thursday brings the European Central Bank's latest policy decision and weekly jobless claims data in the U.S..

"The market was sprinting so fast and it just seemed very reasonable for it to pause and catch its breath and decide what it wants to do next -- and that's where we are today," said Lawrence Creatura, a portfolio manager at PRSPCTV Capital LLC.

Elsewhere, crude oil climbed just above $40 a barrel in London. Yields on New Zealand's three-year bonds dropped into negative territory for the first time.

These are the main moves in markets:

Stocks

- The S&P 500 increased 2% as of 4 p.m. EDT.

- The Nasdaq 100 jumped 3%.

- The Stoxx Europe 600 Index climbed 1.6%.

- Germany's DAX Index rose 2.1%.

- The MSCI Asia Pacific Index declined 0.8%.

Currencies

- The Bloomberg Dollar Spot Index fell 0.4%.

- The euro was gained 0.3% to $1.1809.

- The Japanese yen weakened 0.1% to 106.18 per dollar.

- The British pound rose 0.2% to $1.3008.

Bonds

- The yield on 10-year Treasurys climbed two basis points to 0.695%.

- The two-year rate was little changed at 0.14%

- Germany's 10-year yield gained three basis points to -0.46%.

- Britain's 10-year yield gained five basis points to 0.237%.

Commodities

- West Texas Intermediate crude climbed 3.5% to $38.06 a barrel.

- Gold futures rose 0.7% to $1,958 an ounce.

 

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