The Wild Summer of 2020 Turned Small Investors Into Whales

It’s no surprise that professional traders—hardly paragons of rationality—would point to ordinary investors when things get weird. But it’s true that there seems to have been more driving the Covid-era bounce than rate cuts and government stimulus. The rise of commission-free trading, the ease of fractional share ownership, and maybe the gloomy-giddy feeling that there’s nothing better to do fueled a new public fascination with the stock market. Retail traders now account for 20% of equity trading, up from 15% last year, according to an analysis by Larry Tabb of Bloomberg Intelligence.

So perhaps the end of summer and the easing of pandemic lockdowns really did have some psychological effect, contributing to the 5% slide in the S&P 500 since the recent high. “Whether you’re a teacher, a restaurateur, gym owner, or even a sports handicapper—September comes around, you’re probably going to return to your day job,” says Julian Emanuel, chief equity and derivatives strategist at the brokerage BTIG. “So your focus on trading the market is, by definition, going to diminish.”

In a market where buy-and-hold investors collide in a mosh pit with hedge funds, lightning-quick computers, and now an army of new traders just learning the game, there’s room for debate about who’s moving prices. That’s also true when it comes to the market’s newest obsession: the role of equity options.

Trading of these derivatives exploded during the summer, and there’s reason to believe it played a role in propelling popular technology stocks—and the benchmark indexes they dominate—into the stratosphere. Retail investors were buying call options, which give them the right to buy a stock at a certain price by a certain date.

To understand call options, consider Apple Inc., a stock that cost about $114 a share on Sept. 14. One of the most frequently traded calls on Apple costs only $1.29 and allows its owner to buy a share for $120, known as the option’s “strike” price, by Sept. 25. If the share price doesn’t hit $120 by then, the option expires, and its owner loses their entire investment. But big gains in a share price can lead to even bigger gains in options prices—if Apple rises to $140 by that date, the option that cost $1.29 should be worth in the neighborhood of $20 (the difference between $120 and $140). That’s a gain of 1,500%, the kind of eye-popping short-term return traders dream about.

Options traders don’t buy stocks directly—they’re making side bets. However—and this is crucial to some theories of what happened this summer—gains in call option prices may indirectly pump up the stocks they’re attached to. Rising prices for call options send a bullish message about the stock. Also, the specialized traders called market makers who created the call options have to react and buy the stock. They may have to make good on that call contract and deliver shares to the owner of the option, so they’ll buy some stock as a hedge to make sure they aren’t in a scramble to buy more at a higher price.

“If a retail investor goes out and buys that Tesla call option, they’re buying it from a market maker,” Benn Eifert, chief investment officer of the hedge fund QVR Advisors, told Bloomberg’s Odd Lots podcast. “As it gets closer to the strike, what’s going to happen then is the market maker who was holding the other side of that position is going to need to increase the size of their hedges.” In other words, this summer they needed to buy more stock.

It wasn’t only individuals on Robinhood and other commission-free brokerage platforms who caught options fever. News reports indicated that the Japanese investing conglomerate SoftBank Group was actively buying call options targeting high-flying tech stocks.

Big players that are capable of moving markets with large trades are known as whales. The real whale in options markets this summer, however, wasn’t SoftBank but the collective action of the small-money individual traders who generated a “massive amount of ‘unnatural’ buying pressure in a handful of stocks,” according to a report from the research firm SentimenTrader. Among options trades for 10 contracts or less—a likely footprint of retail traders—53% of total volume went into call options that were newly created to meet demand, a record high.

If either whale—SoftBank or the collective bank of moms and pops—has really been a big factor, that may be good news for the market overall, says Michael Purves, chief executive officer of Tallbacken Capital Advisors, which provides research to institutional investors. While some traders were burned by the downturn in tech that started on Sept. 2, that’s not the kind of loss likely to cause a contagion—that is, a pressure to raise cash that causes selling in other markets. “If you’re just buying calls, all you can do is lose your premium, right?” says Purves.

The idea of retail investors as the new whale is one that pros will have to get used to. Could they be a source of demand that will lead to higher-for-longer equity valuations? Or will they create more volatility? Are they causing froth in other exotic assets, such as special-purpose acquisition companies that seek blank checks from investors? “I’m pretty sure the answer is that it will magnify trends already in place,” Purves says. So don’t be surprised if we’re telling the same jokes again soon.

©2020 Bloomberg L.P.