The options market is in the throes of a speculative mania.
As the stock market keeps bouncing around record highs, the number of shares that are controlled by options has exceeded the number of shares that have traded. This construct is unusual—and potentially dangerous to the stock market’s equilibrium.
What’s fueling this trend? Investors have traditionally used longer-dated options to manage the risk of owning stocks. The most actively traded options contracts now increasingly range from a day to a week so that investors—ranging from individuals to hedge funds—can gamble on short-term stock price movements.
An options contract represents 100 shares of an associated stock. Bullish calls or bearish puts cost much less than buying or shorting stocks outright.
Anyone who trades short-dated options to wager on short-term stock movements can potentially earn a large return for a small sum.
The obsession with short-dated options —a relatively new phenomenon that is generating extraordinary trading volume—is reminiscent of the 1920s bucket shops that enabled people to gamble on stock price movements without owning shares. In 1929, the speculative fever finally broke, the stock market collapsed, and the Great Depression began.
The options market mania is focused on so-called zero-days-to-expiration, or 0DTE, options on indexes such as the S&P 500 and other market benchmarks. Options that expire in one day are listed on indexes only, but efforts are under way to change that. If the options industry can figure out how to simplify complicated trade settlement issues, 0DTE options will soon follow on single stocks—and the speculative mania will burn even hotter.
We have characterized options that expire in under a week as financial fentanyl, The truncated expirations seem to mostly incite aggressive speculation as they reduce put and call prices into Wall Street’s version of cheap scratch-off lottery tickets.
It’s premature to conclude that a stock market crash is coming, but this stock and options trading anomaly is unusual. It has occurred 12 times since January 2019, according to a recent Goldman Sachs research report. The last time options volumes exceeded stock volumes was in 2021. Such a surge tends to precede a period of underperformance in the stock market. When options volumes stall, so do stocks.
The current options-trading mania is dominated by hot tech stocks like Nvidia, Tesla, Meta Platforms, Apple, Microsoft, Super Micro Computer, and Amazon.com. Many of these stocks are so expensive that only wealthy investors can afford to buy 100 shares—and even they might pause at paying top dollar for such steeply valued names.
Goldman’s John Marshall, who has organized the nuanced chaos of options trading into a market framework that can be studied, advised his clients in a recent note that the options market provides rich details about investor expectations for coming catalysts, such as earnings or investor-day meetings. Options volumes also offer insights into how individual investors and hedge funds are positioning. This information is important because it can reveal if investors are bullish or bearish about a stock before an event moves the stock.
Many experienced investors think trading options ahead of earnings is the equivalent of tossing coins into the air. But the temptation still exists, and short-dated options provide inexpensive wagers.
Lots of people in the U.S. are struggling financially. Many more love gambling. Exchanges that list short-term options, and electronic brokers that offer easy access to options, have created a speculative virus. Time will tell if the trend sickens the entire market, or just feeds upon itself.
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Originally Posted March 20, 2024 – The Latest Options Craze Resembles Past Manias. That’s Not a Good Thing.
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