How Unusual Trading Fueled the Stock Market’s Incredible Rally—and Fall

The Financial Times attributed some of the trading volume to SoftBank Group (9984.Japan) in a Friday report, quoting “people familiar with the matter.

The Financial Times attributed some of the trading volume to SoftBank Group (9984.Japan) in a Friday report, quoting “people familiar with the matter.” Options traders Barron’s spoke to declined to name names, and SoftBank declined to comment.

Regardless, bullish call-option buying has exploded. A call gives the holder the right to buy a stock for a set price in the future. Over the past month in the FAANGMT stocks, traders have bought almost 15 times the number of calls expiring in November over the equivalent number of put options, which give the holder the right to sell a stock at a fixed price in the future.

More calls are typically sold than puts. That makes sense. The market goes up over time. But the recent tech ratio is extreme. By comparison, the ratio for 3M (MMM)—a large, diversified industrial conglomerate—is about 2-to-1 over the past month.

When call-option buying spikes, it drives the call sellers to buy underlying stock. When brokers sell options contracts, they don’t want to take the risk of what happens to the underlying stock. They only want to earn a commission selling—and trading—the options. That means they often own the underlying stock to hedge their book.

That’s one way to explain the 20% rise of the FAANGMT stocks from the end of July through midweek, before the tech rout picked up steam. It’s also a way to explain the recent two-day market collapse. Option trading volume Thursday was down by roughly one-third compared with recent average levels.

But there’s another factor roiling options that affects the stock market: Gamma is exploding.

Options traders refer to “the Greeks” when talking about things that influence option pricing. Delta measures how much options pricing changes compared with a change in the underlying stock price. It is typically less than 100%. If Apple’s stock goes up $1 and the delta is 50, for example, traders can expect an Apple option price to go up 50 cents.


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Gamma is the rate of change in delta. When gamma rises, delta goes higher than 50 in the above example. When delta rises faster than expected, it can really mess with broker hedging strategies.

In the Apple example, when gamma is behaving, a broker needs one Apple share for every two options sold. A $1 gain in Apple stock will be offset by two 50-cent losses on the option contracts. But if gamma jumps and delta moves to, say, 1, the broker has to buy another Apple share to offset the loss on two options contracts.

Options delta in the FAANGMT stocks is up about 85% since the beginning of the year. 3M delta, by comparison, is up about 25%.

Is this the real reason stocks have been volatile? Unfortunately, no. Options traders, buried deep in broker equity departments, don’t fully buy both explanations. They tell Barron’s there has been more buying activity, but the gamma argument supposes that brokers were caught off guard and that brokers don’t have any other hedging tools.

Options are a piece of the puzzle. Options activity can also be up because the stock market is up. Sometimes the dog really is wagging the tail and not the other way around.

What is also true on Wall Street is that stock-price momentum is a thing and trading begets more trading. Options and hedging impacts are one reason that is true. What’s also true is when options trading picks up—be it by SoftBank or other players—people will follow suit. FOMO, or fear of missing out, is real.

In the long run, all these technical factors matter less to stock prices. But they matter over the short run. And investors need to watch for factors like option trading so they can live to see the long run.

Write to Al Root at allen.root@dowjones.com