Shares of a handful of companies like GameStop Body.
GME 92.71%
and BlackBerry Ltd.
they have seen three-figure gains in recent weeks, part of a frenzy caused by individual investors. Here’s what you need to know.
GameStop shares have risen more than sevenfold in 2021, up 2.5 percent from the S&P 500. Video game retailer Grapevine, Texas, has become a favorite of online retailers investing in Reddit-promoted WallStreetBets.
These investors target short sellers who bet that shares will fall because of what they consider the company’s business challenges. Cart Goldman Sachs Group Inc. of the 50 stocks with the highest short-term interest rates – Wall Street bets that the shares will fall – rose 25% for the year to Friday. The rise in sharply shortened stock prices, such as GameStop, has led to large losses on equity-based hedge funds, leading to a $ 2.75 billion emergency transaction to save such a company.
GameStop shares began to take off on January 11, after the company said it had agreed to add three new directors to its board, and the rally accelerated in the following days. In part, earnings reflect popularity in recent months of impulse trading, the practice of investing in firms whose stock prices are rising in anticipation that they will continue to do, and an increase in the last year in options trading, which allows them to make big bets with a relatively small initial investment.
How are the options in this?
Options are contracts that allow investors to buy or sell a stock at a specified price, either on or until a specified expiration date. They have become increasingly popular with small investors in recent years as brokerages have made their trading cheaper and easier. The trading volume of options recorded a record last year, averaging just under 30 million contracts per day. This year, that number is over 40 million, according to Options Clearing Corp. – an increase of more than one third.
The options are especially popular among WallStreetBets users, which has emerged as a hotbed for day traders who exchange trading ideas and accumulate in hot stocks.
How do GameStop traders use options?
The options have two options: call options, which give the right to buy shares under specified conditions, and offer options that give the right to sell them. Calls are especially popular with the WallStreetBets crowd, as buying them is a cheap way to bet that a stock will increase.
Take market action on Tuesday, for example. GameStop closed at $ 147.98 per share. At the time, call options that allowed investors to buy GameStop shares for up to $ 200 each Friday were trading at about $ 19 per share – a fraction of the cost of a real share. If you bought such an option and GameStop piled up, the price of your option would increase and you might sell it for a quick profit. If you owned real GameStop shares, you would also benefit from the rally, but you probably won’t get as high a return as for calls.
Alternatively, the use of options can help reduce risk for investors. For example, if you buy GameStop shares, you can protect your portfolio by buying options that allow you to sell GameStop at, say, $ 100 per share. That way, if GameStop drops below $ 100, you can exercise your selling options, offsetting the stock loss.
Why increase shares if the stock is in options?
When you buy a call option, someone else has to sell it to you. This is usually a market maker – an electronic trading firm that buys and sells shares, options or other assets during the day, such as Citadel Securities LLC or Susquehanna International Group LLP.
Market makers do not deal with placing long-term bets on companies’ share prices. So, when such a company sells you a GameStop call option, the market maker generally covers this risk through a separate transaction. He will often buy shares of GameStop.
More about GameStop’s Rise
In lingo options, this is called delta hedging and therefore intense buying of call options can increase the price of the underlying shares. Moreover, as stock prices approach the level at which call options can be exercised – $ 200 in the GameStop example above – market makers can intensify their stock purchases to maintain a neutral position.
The trading volume of GameStop options has exploded in the last two weeks, according to data provider Trade Alert. For most of the past week, calls have been traded more actively than transactions, a sign that investors have generally been more bearish than bearish stocks. Two executives with options market firms said that delta coverage has played a role in recent hot action rallies, such as GameStop.
In extreme cases, this can become a self-reinforcing mechanism, with day traders buying more calls and causing market makers to buy stocks, raising stock prices and encouraging more traders to take action.
“He can take his own life,” said Steve Sosnick, chief strategist at Interactive Brokers.
What do the experts say?
The scale and pace of the rally in GameStop, BlackBerry and other actions this year surprised Wall Street by surprise and no one knows how long the gains will continue or which companies could be caught in the next frenzy.
But industry veterans warn that a one-share rally based on the speculative buying of small options by small investors will inevitably collapse for a number of reasons. Of these: many of these firms were subjected to business stress even before stock prices rose and their valuations rose sharply. Valuations and fundamentals tend to be closely linked over time, analysts say, and higher valuations mean stocks are prone to sharp declines.
Investors who buy their call options at the beginning of the rally, then go out before it overtakes, will take advantage, possibly quite nicely. Many already have, judging by Reddit posts, a single user claiming to have made over $ 11 million by trading GameStop calls.
But buying later in a frenzy, when prices are already high, means taking on extraordinary levels of risk, traders say. Many buyers will end up with expensive calling options that quickly lose value and probably expire worthless. Meanwhile, rising stocks are likely to bring investors with deep pockets into the position of betting against them. As the day-to-day trading crowd moves on to other stocks, the boom that fueled three-digit gains is likely to collapse, warn traders and portfolio managers.
“Finally, a bigger aggressor intervenes,” said Stino Milito, co-chief operating officer at Dash Financial Technologies, an options brokerage firm. “You make big boys say, ‘It’s ridiculous. This cannot continue. ‘”
Write to Alexander Osipovich at [email protected]
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