September 5, 2020
In market terminology a ‘Whale’ is a big fish that dominates markets for a while. Initially nobody knows who they are or exactly what they are doing, but instead observes the unusual behaviour of certain markets. It can be FX, or commodities or derivatives – usually somewhere with a lot of leverage. This summer there appears to have been someone at work in the US Tech space and no sooner had we clicked publish on the monthly than a story appeared in the FT about our good old friends SoftBank, who apparently have been playing games with the options markets.
It was confirmed by a similar story in the Wall Street Journal, but credit ought to go to ZeroHedge.com, which broke the story 24 hours earlier. Mea Culpa, I usually monitor ZeroHedge, but recently it has gone rather off topic for financial markets and become too polemical about guns and gold ( a common risk unfortunately). Perhaps we should have guessed, after all, a number of famous Whales over the years turn out to have been from Japan. In simple terms it appears that the traders at Softbank had a plan to first buy up lots of tech narrative names – Apple, Amazon, Alphabet, Tesla, Nvidia, Zoom etc – and then follow up by buying large amounts of call options in the same names. Market manipulation is a dangerous term to throw around since it is a criminal offence, but let’s be charitable and say that they would almost certainly have been aware of the way the market mechanics would behave. After all, while the VisionFund appears to have been rather clueless when it came to their investments in Won’tWork, WireFraud etc , the guys in charge do know a lot about derivatives markets. After all, they are largely the same credit derivative team from Deutsche Bank that brought you the CDS fiasco back in 2008.
What the traders would know is that if you are big enough in size in the illiquid parts of the derivatives market you can affect not only the derivatives, but also the underlying stocks. This is because in order to hedge themselves, the market makers who sell you the call options have to go into the market and buy the underlying stock. This explains why the Vix was rising even as the markets hit new highs, as well as the unusual fact we also mentioned of the huge proportion of single stock short dated options. In the Greek letter terminology of Derivative geeks, the market makers are short gamma and are trying to delta hedge their positions by buying the underlying. In many ways its been the inverse of March, where buyers of put options were forcing the market makers to sell stocks to hedge their positions.
These battles between traders long gamma and those short gamma happen all the time and it is part of our analytical tool set to explain why markets can overshoot, it’s just that periodically the scale on one side vastly outweights the other. In this instance calls outweighed puts 10 to 1 according to ZeroHedge, leaving the banks selling the calls scrambling to buy the underlying, hence the crazy behaviour of markets in August. According to the WSJ, SoftBank spent $4bn on call options. August is traditionally a low volume month which would almost certainly also have been a factor in the Softbank gameplan. Perhaps Softbank took their profits and sold out of their underlying holdings, but once their option firepower is spent, the risk is that it can all unravel very quickly as the same mechanism that pumped the market up can go into reverse; as prices fall, delta hedging means sell some underlying which exaggerates the fall and so on. To some extent this is clearly already happening, Amazon and Apple are off a little under 10%, while, Zoom and Tesla are down around 20% since the start of the month. Of course, the stocks are still heavily in profit for most people, but when the music suddenly stops a lot of people get off the dance floor.
Meanwhile, having read the FT and the Wall Street Journal, the ‘facts’ about the real reason for the share price behaviour will become well known and this particular round of the game looks to be well and truly up. The downside could be very messy, especially when the US retail punter comes back from the Labor day holiday on Tuesday and reads all about it.