Speculation in tech derivatives points to wild swings
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A speculative frenzy in derivatives on US technology stocks is rippling through financial markets, signalling more large swings in the coming months after a rally that has broken records.
Expectations for future volatility in the Nasdaq 100, a benchmark dominated by Apple and a handful of other tech giants, soared to a 16-year high relative to the rest of the market this week, ahead of a sharp market sell-off that hit stocks on Thursday.
Apple, Microsoft, Amazon and Alphabet were all hit by the sell-off.
The Cboe Nasdaq 100 Volatility index, which measures expected turbulence, climbed above 37 on Wednesday — 10 points clear of the equivalent gauge for the broader S&P 500 index. The difference between the two has not been so wide since May 2004, when markets were still working through the aftermath of the dotcom bust.
The outlook for tech stocks has become one of the most discussed, and heavily bet upon, features of the market rebound since March.
Bullish investors have been placing large bets in the options market that eye-popping rallies in popular individual stocks such as Apple and Tesla will continue.
At the same time, many traders are expressing unease that the rally could head into trouble. Though both benchmarks are at all-time highs, the Nasdaq 100 is up 42 per cent this year compared with 11 per cent for the S&P 500.
“Fundamentally, it doesn’t make a lot of sense,” Jim Tierney, head of US growth equities at AllianceBernstein, said of the August rally in tech stocks, suggesting that “something else beyond fundamentals is behind the move”.
“Huge retail volume” and “abnormal call [option] volume in the biggest tech names” had appeared to play a part, he said, though it was “hard to say which is the chicken and which is the egg”.
The S&P 500 and Nasdaq 100 share the same top five mega-caps — Apple, Amazon, Microsoft, Alphabet and Facebook — but the latter index has greater exposure to the tech sector, which has led the market back from its coronavirus rout in March. The Nasdaq 100 also includes Tesla, the Californian electric carmaker that is up sixfold this year and hit a new high this week, making it the sixth largest stock in the index.
Despite being some of the largest companies in the world, these stocks can move by significant percentages in a day without any news, leading some analysts to see a feedback loop involving the options market.
When an investor buys a call option above the current share price — a bet on the price rising, which conveys the right to buy the stock at a fixed price in the future — the seller of the call option often hedges that position by buying the underlying stock, putting upward pressure on the share price.
Henry Schwartz, head of product intelligence for Cboe, said that creates a “vicious circle” of upward pressure, as the rising stock price prompts further purchasing to hedge positions.
Apple, the most popular equity option, accounted for 4.7 per cent of single-name options trading in August, 50 per cent above average, according to Cboe. Tesla accounted for 2.6 per cent of all trading activity last month.
Indices of expected volatility are calculated based on options activity.
Another catalyst propelling implied volatility higher is an increase in investors purchasing put options — which lock in a price at which they can sell in the future — to protect their substantial gains for the current year.
The Nasdaq volatility index suggests the market is wary of the big jump in tech stocks, Mr Tierney said.
Calling a rotation out of tech overdue, he said it was “hard to believe the dislocation in returns continues”.
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