Options mania to test resolve Options mania to test resolve Options mania to test resolve

Options mania to test resolve

Equities 4 minutes to read
Strats-Eleanor-88x88
Eleanor Creagh

Australian Market Strategist

Summary:  Following a lacklustre lead to start the week, with US markets out for Labor day, European traders stepped up to buy the dip. European equities registering robust gains. Although most Asia indices are trading off highs of the day, sentiment has followed Europes lead with last weeks vicious sell off and simmering geopolitical tensions brushed aside in favour of dip buying. US futures remain in the green, but we look to tonights cash session in the US, as traders return post the holiday weekend, for a real litmus on sentiment.


The risks we highlighted last week, excessive positioning, an almost parabolic extension in the Nasdaq 100 (NDX)and rising volatility, notably with the CBOE NDX Volatility Index (VXN) soaring and the VXN-VIX spread at historical extremes, reached boiling point in the last week. The extreme speculation within growth/momentum/tech stocks that has dominated the pandemic trading environment, most markedly within short term call option trades (dubbed the Robinhood effect), collided head on with a dose reality as two way price action returned to the market. Following the aggressive rebound off the March lows and the much-reported phenomenon of increased retail participation in financial markets, Goldman Sachs reported that for the first time in history the average daily volume of single stock options being traded exceeded volumes on the shares themselves, with the volume of calls traded more than triple the average in 2017-2019. This record call option buying prompted market makers to hedge their exposures, buying the underlying stock, which contributed to the upside acceleration we have seen in recent weeks and in turn sucked in more buyers along with the continued need for market makers to hedge their exposures. A virtuous buying, hedging, buying feedback loop. This effect coupled with increased demand for longer dated options to hedge exposures into the upcoming election contributed to the extraordinary magnitude of the simultaneous increases in the NDX and the VXN we and many others flagged. This virtuous loop came to an abrupt end last week as the NDX logged one of the largest 2-day declines in the last 30 years. The Robinhooders may have received an important reminder that just as momentum works on the upside, it also works on the downside. Moreover, typically much more quickly on the downside as crowded positions are unwound and everyone rushes for the same exit at once. In markets seldom do we travel in way forever, and a 2-day meltdown does not a trend make. However, these underlying speculative dynamics are important to understand the kind of trading environment that has persisted with the divergence of financial markets from the real economy and the financially engineered perpetual bid (rational or not) that comes from unconventional monetary policies coupled with the persistent low rate environment.

The week ahead could prove pivotal and deliver a key test of the resolve of this cohort of retail speculators. It might not take much to topple sentiment further given the rampant speculation we have seen, particularly as last week’s sell off highlighted another fragility of the present trading environment, with high cross asset correlations leaving very few places to “hide”. Global COVID cases topping 27mn and India’s mounting crisis, with an overwhelming surging caseload could see some headline angst. Any follow through of dollar strength, particularly with a dovish ECB meeting on the cards (the virus resurgence, and inflation disappearance reinforcing this view), may be crucial for potentially precarious sentiment amongst dip buyers and could well fuel another bout of risk aversion. Furthermore, with cryptocurrencies, another retail favourite, under pressure the recent euphoria across risky assets faces a timely test. Perhaps a precursor for the months ahead as the upcoming election and mounting geopolitical tensions leave plenty of room for increased volatility.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
Full disclaimer (https://www.home.saxo/legal/saxoselect-disclaimer/disclaimer)

Saxo Bank A/S (Headquarters)
Philip Heymans Alle 15
2900
Hellerup
Denmark

Contact Saxo

Select region

International
International

Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

This website can be accessed worldwide however the information on the website is related to Saxo Bank A/S and is not specific to any entity of Saxo Bank Group. All clients will directly engage with Saxo Bank A/S and all client agreements will be entered into with Saxo Bank A/S and thus governed by Danish Law.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.