What does the recent volatility in tech stocks say about their future performance?
of the summer often brings about a dose of realism. Children bemoan the end of their leisurely holidays and trudge back to the classroom. Summer-lovers return from the beach. This time of the year often brings stockmarket investors back to Earth, too. On average, since the 1950s, September has been the worst month for American shares.
Derivatives have been called weapons of mass destruction. In this case the masses have weaponised themselves with call options, a type of derivative that gives the buyer the right, but not the obligation, to buy a stock at a given “strike” price on a specific date in the future. Options can have an outsized impact on prices because they leverage investments—a buyer might spend just $1,000 to purchase an option that could give him a position worth $10,000 or $20,000.
The second is the rapid growth in purchases of call options by small traders , dubbed the “Robinhood effect” after the popular platform on which many retail investors punt. Historically, large orders of options—in bundles of more than ten contracts, or around $10,000-worth—were the dominant source of options-buying. But through 2020 small buyers, who acquire fewer than ten contracts at a time, have taken a bigger share of the market.
This is different to the type of option that retail investors typically buy, which is a call option purchased “naked”, ie without a hedge. Significant volumes of unhedged call options will force the marketmakers to buy up shares in the underlying stocks, creating a positive—and potentially euphoric—feedback loop. Adding to this dynamic is the short-dated nature of the derivatives. The value of an option that is short-lived moves rapidly as the share price moves.
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