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Good morning. After yesterday’s failed attempt to rationalise the behaviour of AMC investors, I bow today before the mad speculators, those who trade options in particular. Perhaps rationality will be back on the menu next week.
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I mean, honestly:
That’s three days! It’s $30; no wait it’s $72; no $38 and I really mean it this time; no, sorry, it’s $68 for sure; OK fine, fine, it’s $50. (The chart is from Refinitiv.)
Yesterday, I tried to understand what was going on with AMC shares in terms of the economic virtues investors might see in the company. This was a fool’s errand. All the more so, because I ignored the gorilla in the room in any discussion of meme stock madness: the options market.
It is a truth widely (but not universally) acknowledged that a bonkers meme stock is at least partly under the control of the options market. There is more than one control mechanism. The simplest is informational. When stock investors see a lot of call buying, they anticipate future stock buying, and try to get ahead of it.
Another, trickier mechanism is hedging. When an investor who wants to speculate on a stock buys a call option to do so, the market maker who sold her the call doesn’t want to take the other side of the trade. Ideally, they would have another customer taking an opposite position in a put option, leaving the market maker earning some spread but taking no risk. But if there is more demand for calls than puts — from a bunch of lunatic retail investors, say — the dealer can buy the underlying stock as a hedge. Now the key detail: if the price of the stock rises, the market maker needs to buy more shares for the hedge to be effective. That adds fuel to the rally in the stock, requiring more buying to hedge, and on and on. The stock becomes, temporarily, an options-market puppet.
So is the AMC bacchanal an options puppet show?
Garrett DeSimone, head of quantitative research at OptionMetrics, an options data and analysis firm, says the action in the AMC options market has been extraordinary. The stock price volatility implied by AMC options prices was around 300 per cent when we spoke Thursday; it had hit 800 per cent at one point recently. He says those numbers are “so crazy” that it is hard to immediately estimate the impact on the underlying stock price.
DeSimone sent along data about the volume of call and put option buying, which I have plotted against the stock price up to the end of Wednesday. Each unit of volume is a standard contract for the right to buy or sell 100 shares:
This correlation is far from perfect, but it sure is suggestive.
How much of this is retail options trading? Well, OptionMetrics tracks small lot trades (less than 10 contracts) as a proxy for retail buying. Here’s the small-lot volume since March, showing an even steeper increase recently:
I asked DeSimone whether he thought the meme stock market was still a story of individual investors beating institutions investors by “taking over” trading in individual names, or whether the pros had figured out how to make money off of the retail-led volatility. He said:
“The market is still trying to figure this out . . . In an environment where there is 800 per cent volatility the old rules go out the window. My own feeling is a lot of retail investors will be left holding the bag on this stuff. The institutions always figure it out first.”
I also spoke to Lily Francus and Alex Good, independent options traders and members of the fin-Twitterati. They were confident that options-driven trading accounted for a “substantial fraction” of the trading in AMC on Wednesday. They also made an interesting observation: that while market makers were “caught off guard” by earlier meme-stock vortices, this time they think the market makers — the likes of Citadel Securities and Jane Street — are “absolutely minting money” in Good’s words.
Their evidence for this? Tightening bid-ask spreads on options. “It shows that the market makers are active and trading both sides” of the options market, Francus said. Tight spreads means market makers are actively competing for the options business in AMC, rather than shying away from its risks.
Market makers are not the only ones making money in this madhouse, of course: AMC announced yesterday that it would sell another 25m of its shares to the public. And why would they stop there?
More housing data to chew over
Last week I wrote about US house prices spiking, and wondered about the role of institutional capital inflows had in that. As a way to track institutional money flowing into houses, I used Mortgage Bankers Association data about the number of new mortgages being taken out by non-occupants. That data looked like this:
There is another good data source, as it turns out, and it shows that even more of the US market is held by investors. John Burns Real Estate Consulting tracks non-owner purchases by looking at the number of homes where the real estate tax payer’s address is different from that of the home itself. This captures cash purchases which the MBA data cannot. Burns just tabulated the numbers for the first quarter. Here they are:
Striking numbers: in Phoenix, New York, Austin, Tampa and Las Vegas, about a third of the market is investors! But if you look at the national trend in investor ownership, it looks stable-to-down over time:
Rick Palacios, director of research at Burns, makes an important point. Back when the proportion of investor purchases was higher than today, from 2010-15, that was because purchases by occupants were way down, leaving institutional buy-to-rent investors and house-flippers much of the field. But now the occupant market is red hot, and even so investor owners are a quarter of the market. He views institutional interest in US residential real estate as a “mania”.
Are we headed into 2005 territory again, where the hot money (over-levered house flippers back then, yield-chasing institutional investors today) could leave the market quickly, leading to a crash? Palacios thinks not:
“There are hundreds of [institutional investment] platforms that will have a permanent footprint in the single family housing market. They are here to stay . . . their investment window is decades and decades. Our view is that this [capital] is around for the long haul, and it will change the market structurally.”
One good read
It causes me physical pain to recommend the work of my competitor John Authers of Bloomberg, but my conscience requires me to point out that he wrote a newsletter a few days ago that you must read if you have not already. It is about the relationship between bonds, stocks and inflation, riffing off of a very good report from Absolute Strategy Research. If the argument is correct, and rising inflation alters the relationship between bond and stock prices, we could be in for a wild few years.