By Sarah Ponczek and Katherine Greifeld
Neither stalled stimulus, booming valuations nor even a congressional report implying they should be broken up is proving any impediment to megacap technology stocks, which jumped the most in almost six months with help from newbie traders.
The Nasdaq 100’s best day since late April came alongside an increasingly familiar sight: measures of share volatility, rather than plummeting as they usually do when stocks surge, rose in tandem. Wall Street analysts have come to consider that a tell-tale sign that burgeoning demand for stock options — whose prices inform gauges like the Cboe NDX Volatility Index — is fueling the gains.
Such lockstep moves hearken to August and early September, when stocks and volatility rose together just before a swift reversal that sent the Nasdaq 100 into a correction. Then as now, the market for single-stock contracts remains unusually brisk, a trend that because of its impact on dealer hedging is capable of amplifying swings.
“Last month we had some distortions in the market which were led by extremely large call option buying. And it really doesn’t matter who it could be this time, but that phenomenon exists,” said Lawrence Creatura, a fund manager at PRSPCTV Capital LLC. “If investors en masse turn to the option markets before the equity markets, we’ll have a situation where the tail wags the dog and the markets moves in response to those option purchases.”
Surging appetite for bullish calls among both retail and institutional traders has been a repeating storyline of 2020, with stuck-at-home day traders lured to cheap bets on tech stocks like Alphabet Inc. and Amazon.com Inc., whose single shares cost well over $ 1,000 apiece. Thirst for the contracts has the potential to ignite feedback loops in the options market’s infrastructure, where dealers must balance demand in many cases by purchasing underlying stock. The Nasdaq 100 rose for a fourth day Monday, rallying 3.1 per cent. It is now within 2.7 per cent of its Sept. 2 all-time high. The volatility index tied to it also rose, which is unusual. Normally when stocks go up, measures of turbulence decrease. But that relationship has been muddled in 2020: there’s been five days when the Cboe Volatility Index rose alongside a gain of at least 1.5 per cent in the S&P 500, the most since 2003, data compiled by Bloomberg show.
Another explanation for Monday’s price action is simpler: recent underperformance in giant tech stocks. Before Monday, the large-cap Nasdaq 100 had trailed the small-cap Russell 2000 index by 6 percentage points in October, on track for the worst relative return in three years. Disparities like that signaled mean reversion in the past few months, according to Evercore ISI. The Russell 2000 gained just 0.7 per cent Monday.
Other factors were at play, too. Shares of Amazon.com Inc. and Apple Inc. — which together account for about a quarter of the Nasdaq 100 — each jumped more than 5 per cent ahead of Amazon’s Prime Day and an Apple product event where it’s expected to unveil a new iPhone. Analysts at RBC Capital Markets raised their price target on Apple to $ 132 — about 13 per cent above where the stock closed Friday. Deutsche Bank analysts raised their price targets on companies including Facebook Inc. and Alphabet Inc., expecting a strong recovery for digital advertising.
According to Steve Sosnick, chief strategist at Interactive Brokers, the outsize moves in Amazon and Apple shares were themselves so extraordinary that they could whip up their own volatility, thereby affecting measures for the broader Nasdaq 100. Still, he said, the stocks up/volatility up dynamic could be a warning sign for a reversal and pointed to seeming complacency in the options market.
Take the Cboe equity put-call ratio, for instance, which dropped below 0.4 late last week for just the sixth time this year. The measure’s 30-day moving average has climbed from mid-August to 0.5, but is still hovering near record lows, a sign that bullish bets are still elevated relative to bearish wagers.
Bullish Apple calls accounted for four of the 10 most-traded options contracts Monday as the stock jumped 6.4 per cent. Calls expiring Friday at a strike of $ 125 saw 310,000 contracts changing hands, trading at price that’s more than quadrupled from last week’s close. Amazon call volume was almost double the average over the prior five days after spiking to more than 340,000 contracts Friday, the most since January.
Likely adding to the situation is the coming options expiry on Friday, according to RBC derivatives strategist Amy Wu Silverman. That event can force so-called gamma hedging (“gamma” is a term for option price drift that dealers often seek to offset by buying or selling the underlying stock).
To Chris Murphy, co-head of derivatives strategy at Susquehanna International Group, elements of market’s today are reminiscent of August’s froth. Among them, stocks are surging on light volume as traders opt for call options over bearish puts, all as measures of implied volatility rise.
“We are seeing some of the same ‘signs of froth’ emerging that we saw in early August,” Murphy wrote to clients Monday. “This does not mean imminent downside, because as August showed the markets can remain frothy for a while, but this is something to watch.”
He’s not the only one on watch. Nathan Thooft, Manulife Investment Management’s head of global asset allocation, says the stocks up/volatility up dynamic has been a topic of discussion among his team.
“There does seem to be something at play there when it comes to the vol markets and what they’re doing,” he said. “The question is, will we see a repeat of what we saw a month or so ago? I don’t know. Things sometimes repeat and sometimes we learn from those mistakes and they don’t repeat. But we’re looking at it and we’re talking about it.”