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.