(Bloomberg) – Like a slot machine that pays off with every move, the most reliable bets on the stock market of late have often been the riskiest.
Long walk a company that sounds like something Elon Musk mentioned in a tweet (but didn’t)? Signal Advance Inc. is just up 12x. Borrow money to a software company to buy Bitcoin? A convertible from Microstrategy Inc. is up 50% in four weeks (your option is in the money). Are you hedging the truck on bullish options after the Nasdaq 100 doubles in 24 months? Wednesday was the fourth biggest day for call trading in the US (the other three were last year).
Throw an arrow, hit a winner, or so it seemed lately. Encouraged by Federal Reserve incentives, vaccines, and the psychological conditioning that arises when a bad spot doesn’t last, everyone from retail novices to institutional managers is rushing to capitalize on the 10-month-old meltdown. Of course, it is possible for all of this to go on for weeks, if not months, without a slight reversal. It is nearly impossible to predict exactly when such fevers will break out. But bubble warnings are starting to boom from every corner.
“It’s a full blown mania, and the bull’s relative youth doesn’t make it ‘safer’ to climb aboard,” wrote Doug Ramsey, Leuthold Group’s chief investment officer, in a Jan. 8 customer report. that his company was also among the buyers. “We are just as guilty as the others if we chase that momentum.”
The hunt works. Four days into the year-end, at almost 40 times the gain, the Nasdaq 100 index saw its biggest rally in two months. Hedging against stocks, on the other hand, was expensive. A basket of preferred manager short positions rose 10% against them last week and rebounded the most in seven months. The hope that the mania will go away also turns out to be pointless. The frenzy of acquisition companies for special purposes continued. A new dozen submitted IPO registrations on Friday, including one with the ticker “LMAO”.
“Too much foam, too much complacency,” said Matt Maley, chief marketing strategist at Miller Tobacco + Co., who thought last week’s spectacle in Washington had at least slowed the frenzy down. “After a rally of 16% in just two months and a rally of 70% since March, this news should have upset the market. A correction of 10 to 15% would be normal and healthy. “
Tesla Inc.’s ability to add 25% in five days to a market value of nearly $ 700 billion hit the headlines last week, but for real foam, the options market was the place to be. Calls that expire on January 15 with a strike price of $ 1,000, the most traded Tesla option on Friday, quintupled on Friday, ending the week at $ 9.15 after starting at 53 cents each.
Individuals appear to be driving the action, according to JPMorgan Chase & Co., who cited a proxy for NYSE margin account data pointing to a potentially strong pickup in December from the previous months. Buying call options for small traders has retreated sharply after a seasonal decline in the last week of December, as has retail-focused over-the-counter trading, the bank said.
“In a repetition of the second quarter of last year, the strength of liquidity seems to be reflected again in an intensive way via private investors,” wrote strategists under the leadership of Nikolaos Panigirtzoglou in a note on Friday. “Given the expectation of further tax support, this force should continue in the coming weeks.”
The industry has taken note of it. Cboe Global Markets Inc. has tailored products for smaller investors. The Mini-S&P Index options have been updated to improve liquidity and provide retail customers with better execution after it was announced in June that it would revive a Mini-VIX product that is at least partially aimed at smaller traders.
The company sought “to make some products that accommodate these changes in investor demand that we believe will stay here,” said Arianne Criqui, Cboe’s director of derivatives and global customer care, in a November interview. It found that Robinhood Markets Inc. only gives about a fifth of the trading options its clients have. “We’re seeing great benefits,” so more people can get started, she said.
Jason Goepfert of Sundial Capital Research has been showing how strong retailers are in the options market since late December. He cited data on the number of call purchases and the money spent on them – with the smallest participants accounting for 54% versus 28% for the largest.
“It looks like it’s gotten worse,” Goepfert wrote in a note on Tuesday. “The most reliable sentiment measures tend to be those that focus on real money and leveraged instruments. Then emotion has the greatest influence. When we look at some of the most heavily indebted vehicles available to investors, there is widespread evidence of extreme speculation. “
The market is prepared for a rush for riskier stocks as many assets such as cash and bonds offer historically depressed returns. Some investors have turned to stocks – and options – for the income that is lacking in almost everything else. Chris Murphy, a derivatives strategist at Susquehanna, noted in November that given the combination of increased volatility and high valuations, overwriting “can be a great way to increase returns”.
Andy Nybo of Burton-Taylor International Consulting LLC also sees the chase for returns that adds to the option frenzy.
“With bond yields of zero or very low interest rates, quite a number of investors are looking for a return improvement,” he said in an interview in October. “Options are not only a powerful tool for generating engagement, they are also a tool for generating income for existing owners. Overwriting strategies and call writing strategies are therefore helpful tools for investors to generate returns and steer their risk either up or down. “
Saying that there is froth is not the same as saying that everything is doomed to fail. In a press release last week, Bank of America strategists tried to translate any bear market signals into broader stock measures and found 63% of them met. These include dwindling cash in fund holdings, a surge in the Cboe Volatility Index and buoyant consumer sentiment. While the reading reached a three-month high, it is below the high of 79% in September 2018.
“Our bear market signpost checklist (signals typically triggered prior to an S&P 500 market peak) has become increasingly bearish,” wrote strategists, led by Savita Subramanian. “Our forecast for 2021 is subdued S&P 500 returns.”
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