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The options market may be fueling the turbulence in tech shares

by capitalizefinancial
May 12, 2021
in Markets
0

Inflation, valuations, rising rates — all are being suggested as causes for this week’s tech implosion, but a less-publicized catalyst may be the market for stock options.

This alternate theory has it that Wall Street derivatives dealers are exacerbating market swings through hedging their books to offset brisk demand for protection against a selloff, through what’s known as gamma hedging. That’s when options market makers buy or sell an underlying stock to manage their risk as the price of the shares moves.

An academic study last year found evidence that options dealers indeed contribute to intraday volatility as they balance their exposures in this way. The volatility has been on full display lately, with the Nasdaq 100 slumping as much as 2% Tuesday before erasing most of the loss. It ended lower for a second day after Monday’s rout, sending a measure of implied volatility for the gauge to the highest since March.

The thinking goes that a rush for puts on the biggest tech ETF, known as QQQ, has left dealers with a lopsided number of short positions. In order to balance their books, these options market makers buy Nasdaq futures when they rise, and sell when they fall, a volatility-intensifying practice known as “negative gamma.”

 

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