(Bloomberg) — Thursday’s Nasdaq nosedive dispensed painful lessons in how options-market leverage can blow up in an investor’s face.
Losses in benchmark indexes were brutal enough, getting to 6% in the Nasdaq 100, or about $730 billion erased. In single-stock equity contracts they were downright existential, with some instruments wiped out in the space of a few hours. Volumes in puts and especially calls has been exploding in recent weeks, much of it in the tiny lot sizes denoting individual traders.
While it’s never hard to pick out staggering losses in options when markets tumble, and plenty of examples exist of well-timed puts, today’s losses were particularly harrowing for the longs. A call with a $125 strike price on Apple Inc. shares, expiring tomorrow, plunged 89% as shares sank 8% to $121. A bullish wager for Tesla Inc. to reach $500 by Friday’s expiry lost 90% as the stock dropped 9% to $407. And a call on Zoom Video Communications Inc. with a strike price of $420 became essentially worthless as shares hit $381.
The hazards of a badly timed options trade are severe. How well understood they are by newbie traders is a point of debate on Wall Street, where veterans have looked on with skepticism as tiny traders spent August brandishing evidence of their winnings on Twitter. Whether small-time day traders foresaw the risks or not, they understand them better after Thursday.
“It’s probably the first feeling of pain for a lot of these neophyte investors,” said Alon Rosin, Oppenheimer’s head of institutional equity derivatives. “When were they going to get burned? You’re seeing that today.”
The presence of individual investors in the options market has been growing. Volumes for single stock options with less than two weeks to maturity now make up 69% of options volume, not far off a peak of 75% in late July that was a record in Goldman Sachs data going back to 2013. The short-dated nature of the contracts is a tell-tale sign of retail traders, according to BTIG LLC.
“The retail investor has been a very strong buyer of upside call options, the short-dated weeklys, monthlys,” Julian Emanuel, chief equity and derivatives strategist at BTIG, said on Bloomberg Television. “That’s the dynamic you didn’t see exactly in 2000 because you didn’t have weekly options at that point but that kind of enthusiasm was part and parcel of what we saw in 2000.”
They’ve been more optimistic than ever. Last week across U.S. exchanges, people bought 22 million more bullish call contracts than they did puts, a record, according to Sundial Capital Research Inc.
Hope came crashing down on Thursday, when the technology-heavy Nasdaq 100 plunged by the most since March after rising in 11 of the past 13 sessions to notch almost daily records. High-flying megacap winners led the carnage, after their seemingly relentless rally pushed the relative strength of the Nasdaq over the S&P 500 to the highest on record.
Day traders burned by the abrupt drop quickly turned to the Internet. On the 1.5 million-member Reddit forum called r/wallstreetbets, user pavanthedataguy bemoaned the ‘worst timing’ in his purchase of Amazon.com Inc. and DocuSign Inc. calls, expiring next Friday. Another user, commenting under the name Commercial-Glass-625, posted a screenshot of his mostly-red options account and asked, ‘Am I doing this right?’
However people on the Internet felt, in a year like this one, it’s hard to frame the plunge as being out of the blue. With a pandemic raging, a recession lingering, and quick-draw retail day traders dominating flows, big days like Thursday have become anguishingly commonplace. There have been eight other instances of the Nasdaq 100 falling 4% or more since February. In the two years before that, it happened twice.
Before today, booming demand for call options forced dealers to recalibrate their hedges, buying stocks in the process and feeding into a bullish “snowball,” according to Miller Tabak + Co.
“The brokers would hedge themselves by buying the underlying stock. As the stock continued to rally, it would give people confidence to buy even more stock and call options and the entire thing would feed on itself,” Matt Maley, the firm’s chief market strategist. “And so higher it goes, and the problem is the same thing can happen on the downside, and that’s what we’re seeing.”
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