ECONOMY

People Are Talking About Options Roiling Tech Stocks Again

One theory behind the recent selloff in tech stocks is that with inflationary pressures building, the cycle that propelled tech and other growth companies to higher valuations than pretty much anything else will now come to an end. The thinking here is that higher interest rates will make such stocks look less appealing,  destroying lofty P/E ratios  and generally boosting value stocks instead.

Another theory behind the tech selloff is much more technical in nature. This one focuses on the dynamic between options and  the big market-makers of Wall Street. As the declines intensify, dealers who sold options need to balance their own exposure and they end up doing that in a way that moves the underlying stocks. We’ve seen that dynamic before, both with the GameStop drama (which resulted in a “gamma squeeze”) earlier in the year as well a similar tech selloff last September.

As my Bloomberg colleagues Yakob Peterseil and Katie Greifeld report: ” … a rush for puts on the biggest tech ETF, known as QQQ, has left dealers with a lopsided number of short positions. In order to balance their books, these options market makers buy Nasdaq futures when they rise, and sell when they fall, a volatility-intensifying practice known as ‘negative gamma.'”

We checked in with Benn Eifert, chief investment officer of QVR Advisors and one of our favorite Odd Lots guests, to see what’s happening.

Tracy:
We’ve seen a sizable selloff in tech stocks in recent days. And today Taiwanese stocks fell by almost 9%. Some of that was supposed to be because of concerns over a fresh Covid-19 outbreak, as well as the impact of higher inflation on tech generally. But a few people are also pointing to the fact that this all happened on the same day a bunch of options expired. Are options playing a role in the sell-off?

Benn:
Taiwanese stock markets are heavily retail-dominated and retail investors trade a lot of short-term options. Option volumes were very high today. It sounds like very large, client-selling flows were really driving the move, though option expiration likely accelerated the move with dealers net short expiring lines to the downside.

Tracy:
What about in the U.S.? The thinking there is that a bunch of people have been buying puts on QQQ and dealers have been hedging and exacerbating the recent moves? 

Benn: 
QQQ option volumes are elevated, especially the shorter dates (Friday’s expiring contract), but there’s nothing wildly out of line. I don’t think it’s a case of very unusual concentration of dealer short-gamma in QQQ. Just lots of good old-fashioned selling.

Tracy:
If it’s mostly fundamentals, what will it take to stop the slide? I should mention we’re doing this right as CPI comes in and it’s much higher than expected…

Benn:
For what it’s worth, leveraged and inverse ETFs like TQQQ play a role here too, the rebalance effect is around $1 billion per 1%. The idea that short-term market movements are mostly about something called fundamentals is fairly difficult to support on an ex-ante empirical basis, versus an ex-post “trying to explain the move that already happened” basis. 

There’s a very plausible sounding argument that tech should be very duration sensitive, especially high-growth tech. But then the late 1990s was the last case of a huge ramp in speculative tech, and interest rates were 4-5%.

Tracy:
It kind of makes sense that tech might look through rates after such a weird/unusual business cycle? That’s more of a comment than a question I guess.

Benn:
Yeah, agreed. 

Tracy:
O.k., I’m going to leave it there. Thank you so much Benn.

You can follow Benn Eifert on Twitter, and also check out previous Odd Lots episodes with him at the links below:



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