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Skewed options market causes huge moves in US tech stocks
Peter Garnry
Chief Investment Strategist
Summary: In the last week we have observed how the VIX Index has increased despite new record highs which is an unusual behaviour. Part of this move is heavy volume in call options in several US technology stocks such as Apple and Tesla forcing market makers to aggressively buying the underlying stocks to hedge their short call option positions. In this research note we discuss the dynamics and how it can cause significant volatility in technology stocks over the coming week.
Several US technology stocks are down in US pre-market pushing Nasdaq 100 futures down 1.2% for the day while European equities are firmly in positive territory and S&P 500 is holding the line. Tesla is down 6.5%, Apple is down 2.5%, Zoom is down 4% and DocuSign is down 6% just to name a few of the technology stocks hit in pre-market. In this research note we lay out that volatility could rise dramatically under the right circumstances and that it is the US equity options market dynamics that are driving the behaviour this morning.
As we mentioned in our Quick Take this morning and on our morning Saxo Market Call podcast, there was evidence in yesterday’s session of fragility beyond what could be explained from news. Tesla shares were down as much as 15% intraday and Apple was at one point down 5% which is unusual for such large cap stocks on no important news or overall market decline. The US and global equity market were on a firm footing yesterday, so any statistical analysis would obviously point to something odd going on. What happened was a sharp reversal in call options to put options volume on US equities indicating significantly shift in options volume. We still do not have the numbers on outstanding options from Cboe from yesterday’s close, but our guess is that the number of outstanding call options to put options were dramatically reduced yesterday. Why is this important?
Since late last year US equity options trading has been commission free driven by Robinhood. Combined with the COVID-19 restrictions millions of new investors have opened accounts with online brokers in the US. Many of these are trading in equity options because it gives more upside through the implied leverage. What we have observed over the past couple of months is that retail investors are aggressively buying call options which means that market makers are short all these call options. To neutralize their exposure and get a loss if the underlying stock price soars they buy the underlying. If the outstanding notional of call options become big relative to the normal trading flow in the underlying the market makers’ delta hedging causes the underlying stock price to become more volatile.
What likely happened yesterday was that Tesla shares fell just enough to push the delta low enough on a lot of the outstanding call options so that market makers began unwinding a lot of Tesla shares. This caused a sharp sell-off in Tesla shares. The subsequent rebound could have happened because a lot of retail investors bought large quantities of call options forcing market makers to buy the underlying to hedge their options book. These options dynamics are causing massive intraday volatility in certain stocks, so we recommend traders and investors to prepare for large sudden intraday moves.
Tesla Sep 18 call options with strike at $450 (just above yesterday’s close) are trading at implied volatility of 120% indicating the huge uncertainty in Tesla’s share price. This means that investors buying call options really need big moves to the upside to get the calls in the money. At some point many investors buying these calls will learn it the hard way that these implied volatility levels are extremely elevated and expensive. Please also note on the chart below that the open interest in this particular option actually rose yesterday, indicating that retail investors aggressively added call options despite the sharp 15% intraday sell-off.
The chart below is a 5-year chart on the stocks mentioned in the research note. This is for regulatory purposes.
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