Inflation, valuations, rising rates – all are suggested as the causes of this week’s tech implosion, but a less publicized catalyst could be the stock option market.
This alternative theory is that Wall Street derivatives brokers exacerbate market fluctuations by hedging their books to offset the high demand for protection against a sell-off, through so-called gamma coverage. This is when option market makers buy or sell an underlying stock to manage their risk as the stock price moves.
A university study from last year showed that options brokers do contribute to intraday volatility by balancing their exposures in this way. Volatility has been on full display lately, with the Nasdaq 100 falling as much as 2% on Tuesday before erasing most of the loss. It ended lower for a second day after Monday’s rout, sending a measure of the gauge’s implied volatility to the highest since March.
A rush is believed to put them on the biggest tech ETF, known as the QQQ, left dealers with an imbalanced number of short positions. In order to balance their books, these option market makers buy futures on the Nasdaq when they rise and sell them when they fall, a practice that intensifies volatility known as “negative gamma”.
With negative gamma currently affecting the QQQ fund, “the high volatility will remain this week,” said Brent Kochuba of options analysis service SpotGamma.
It wouldn’t be the first time that the options market blamed for bypassing stocks. The meteoric rise in retail call activity last year, alongside institutional purchases by companies like Softbank Group Corp., has fueled theories that the derivatives market has started to whip stocks like never before.
Read more: Wall Street dealers in a hedging frenzy are blamed for their volatility
Open interest in puts on the $ 155 billion Invesco QQQ Trust Series ETF has grown at a much faster rate than the same metric for calls, suggesting dealers have indeed been caught off guard . It also suggests that investors prepare for declines in the technological benchmark.
Charlie McElligott of Nomura Securities also pointed to the imbalance, noting Tuesday that brokerage hedge flows act as an “accelerator” and QQQ registers an extremely negative gamma reading.
However, not everyone primarily blames the options market. Susquehanna’s Chris Murphy acknowledges the existence of these positioning dynamics, but attributes most of the blame for this week’s volatility to more traditional culprits.
“I think it’s all about reducing risk in the hottest tech stocks and focusing on the potential for inflation and higher rates (the simple, boring answer),” the derivatives strategist said. .
For those who buy the primacy of the options market as an explanation for this week’s moves, the good news is that the storm may soon pass. About a third of the put options exposure that fuels the fluctuations is in contracts that expire on May 21, according to SpotGamma’s Kochuba.
As that date approaches, “these put options disintegrate, prompting dealers to cover their short covers, which may lead the Nasdaq to rebel,” he said.