September 25, 2020

Breakingviews: Free retail tech-stock bets pile on risk

by Breakingviews.

Flashy U.S. technology stocks have been acting fishy. Unprecedented volume in derivatives linked to names like Tesla and Apple may be behind some of the recent volatility in the sector. Some platforms offering low or no-cost trades, like Robinhood, allow retail investors to take cheap leveraged bets using stock options. No-fee trading could have unintended costs.

August saw head-scratching share price jumps – like Tesla’s over 70% spike – even as volatility was increasing. Then September brought sharp selloffs, including a more than 15% slide for Apple.

Call options might be partly to blame. These bestow the right to buy an asset at a specific price. The average daily volume of options linked to single U.S. equities hit a record in August, according to Cboe Global Markets. And small investors’ call purchases represented about $500 billion in notional value last month, according to Options Clearing Corporation data.

This probably exacerbated price moves because of what’s called delta hedging. Delta is an estimate of how an option’s price changes as the underlying stock’s price moves. If a Wall Street market maker sells calls, the delta indicates how many shares to buy to be hedged. If investors purchase short-term calls, the option writers’ share purchases could push up the relevant stock price.

SoftBank Group’s widely reported $4 billion derivatives bets on tech stocks were far from the whole story. In fact, these were probably longer-term delta-neutral trades, according to Bloomberg, which would have damped the market impact.

The difficulty of making money with commissions so low recently led Citigroup to exit the retail options market-making business, according to the Financial Times. If the ease of placing bets is stoking day traders’ appetite for options, remaining middlemen like Citadel Securities may well react and make it less profitable for punters.

Unless that happens, the downsides remain real. It’s a recipe for market surges and slides, with the risk that retail investors then lose everything they’ve spent on premiums. Also, much of this is of questionable value to market function – it’s more like playing slots than allocating capital.

Higher fees might have previously deterred small-time options trading. As with other activity viewed as speculative, one way for regulators to limit it might be to introduce a tax on certain transactions. Sometimes, markets work best with some sand in the gears.

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