There are two certainties in today's market: The tech sector has been beaten down and interest rates are higher.
And while analysts widely anticipate an easing in the Fed's rate hikes this year, institutional investors are increasingly using a dangerous tactic to take advantage of market falls. That shift could be leading to an increase in misleading data about investor sentiment.
What's happening: Investors are purchasing put options, the bearish bet that a stock will fall during a set period of time, on certain tech stocks, at historic rates.
Apple and Amazon each lost more than $830 billion in market cap in 2022, and other big tech stocks like Meta and Nvidia lost about 75% and 57% of their value over the 12-month period. Those huge upsets were bigger than even the most pessimistic market analysts had forecast.
The losses also created a booming market for investors who hold put option contracts that allow investors to sell shares of these stocks at a price higher than their current levels.
Shares of Zoom, for example, closed at $70 on Monday, but put options contracts that are set to expire in just a few days can be exercised for $77 per share. Nvidia, which ended Monday at $156 has an option set to expire this week that can be exercised for $170, according to Nasdaq data.
Investors typically purchase put options as an insurance policy. They give traders the ability to sell shares at a certain locked-in price by a certain date. Now, investors who have these options are selling their contracts for a premium and then reinvesting the money.
The number of traded US contracts surged past the 10-billion mark in 2022 for the first time ever, more than doubling from the level three years ago.
The options surge makes sense in a year when the S&P 500 shed 20%. Trading in puts grew by more than 30% compared to 2021. Bullish call contracts meanwhile — which allow investors to purchase stock at locked-in price — fell by 12%.
Analysts at SpotGamma say the trend is likely to continue, spurred on by Wall Street firms who see this as an "arbitrage" trade and not by retail investors looking to protect their investments.
"The sharp decline of many single stocks over the past year has driven many 'put' positions deep in the money," they wrote.
Big changes: Professional traders and algorithmic-powered institutions are getting involved in these trades, according to Bloomberg data, especially around economic data releases or Federal Reserve policy decisions: Trading of such contracts more than doubled to nearly 11% of daily average stock-options volume in the fourth quarter, up from an average around 5%, according to a report by the Wall Street Journal. These quick options trades are increasingly contributing to overall market volatility, say analysts.
The increase in financial options arbitrage could also be leading to false conclusions around investor sentiment, as the ratio of put options (which are bearish) to call options (bullish) changes on the Chicago Board Options Exchange.
This ratio is generally seen as a way to measure how "fearful" or "greedy" investors are. CNN Business's own Fear and Greed Index includes an analysis of the put and call ratio (amongst nine factors). The ratio recently rose as high as 2.4, after passing 1.5 for the first time ever last month, according to Dow Jones Data.
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