Credit: Dickson Phua || Heavy use of derivatives is like a traffic jam. In the short term, you go where everyone else goes.
I’ve written about this topic a few times:
What if a party or parties take an investment position that is large relative to the amount they can afford to lose? The above articles addressed questions related to the following crises and mini-crises:
- The London whale
- Has PIMCO got too big for the derivatives market?
- The explosion in the floating rate investment contract market in 1993
- The Equitable death in 1991.
- Long-term capital management
- The 2005 correlation crisis on the CDO market
- AIG and subprime mortgages
But today the excitement is there:
Whether Softbank is taking inappropriate risk to catch up in a bad year, or whether lots of individuals, hedge funds, etc. with stocks and call options (and total return swaps, etc.) on a large-cap tech momentum- Placing Trades It has been a lot of hot money tracking the trades that dominated 2020.
In the short term, the momentum often lingers until it becomes too expensive to hold the momentum asset. Call prices are getting too high for newbies, and real money investors are coming to the conclusion that it is time to take profits.
When a market is cheap, buying out-of-the-money options can give the market a kick as the option buying forces those who sold the options to hedge. While it makes sense to hedge options with options, at some point someone either has to go naked and not hedge or hedge with common stock.
However, when the market is expensive and volatility gets higher, the economics of trading become more difficult until the trade is reversed and the momentum effect goes the other way. Softbank may have been foolhardy or desperate, but if they closed their trades last week it may have been the end of the noneconomic buy that began in early August. You may have set the top for large-cap tech.
The same happened to technology in 2000 and financial data in 2007-8. Conversely, European financial stocks were forced by regulators in 2002 to sell US stocks at the lower end. Forced sellers often create market lows. Greedy buyers often create market tops.
And why is that The last one to respond to momentum looks like an idiot. But it seems rational at the time as he doesn’t want to take any more losses or is tired of missing out on the gains.
The main problem is an overcrowded trade in large-cap technology. The current articles focus on derivatives deals around this crowded trade, but that’s not the problem. Creating derivative positions alone does nothing. It depends on who holds the derived positions.
- How well are you capitalized?
- Do you have the ability to hold?
- Do you know what to do in a crisis?
If they are thinly capitalized or have a short time horizon for other reasons, they will be closely following the dynamics. In this respect, the risk of derivatives corresponds in the worst case to the credit risk and in the best case to overfill. When investors act to avoid a worst case scenario, selling pressures can be severe.
To that end, I tell you, “Ease your large-cap tech positions.” Those who hold these positions have a short time horizon and can run away. There is no way these companies can grow into their reviews. So don’t think that you can hold onto it for years. This is just a mania and as such it will come to an end.
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