The masses aren’t asses anymore.
For decades, great fortunes have been made on Wall Street by people who believed in a few simple, intellectually arrogant ideas. Among them: John and Jane Investor always do the wrong thing at the wrong time. When the public trades put and call options, and often stocks, they generally lose money—so the Street’s mandarins could do the opposite and “fade the little guy” to make money.
The little guy usually had only enough money to trade a few options contracts or a few hundred shares of stock at a time, and was usually out of touch with market tempos. Options dealers—a paranoid bunch who always think the world is ending—rarely hedged retail orders, which is the ultimate expression of disdain. It means they think someone is so stupid that taking the opposite side of their trades is like taking lollipops from babies.
As the Cboe Options Exchange dealers who sold upside calls on
(ticker: IBM) would say, in celebration of the poor timing of individual investors, “Sell the 280s and buy a Mercedes.”
Over time, the masses have gotten wiser. Online brokerage firms emerged and sold dealers—such as Citadel Securities and Susquehanna Investment Group—the right to trade against customer flow first, provided they execute orders at the national best bid or offer. This “payment for order flow” arrangement is why Robinhood and others can offer commission-free trading, which is a big part of the reason retail traders are now beating the holy hell out of Wall Street’s sophisticated traders.
Thanks to the lure of free trading, the boredom of a pandemic, and the popularity of stock message boards like Reddit, many John and Jane Investors have merged into a wolf pack not at all unlike how institutional traders have long behaved.
The Reddit Wolf Pack delights in finding heavily shorted stocks, especially those shorted by hedge funds, buying bullish calls, and then buying stock to increase the value of their options. In many ways, the Reddit trade is a page from the hedge fund strategy playbook.
The Reddit Wolf Pack was credited with causing heavily-shorted
(BB) to surge as much as 145%, and 48%, respectively, on Tuesday. At one point, when GameStop and BlackBerry were surging, the stock market declined so much for no visible reason, institutional traders opined that some of the hedge funds that short stocks had imploded because retail investors triggered a short squeeze—with short sellers forced to cash out of their positions to stem further losses. The stocks behaved with even more volatility on Wednesday.
It was later revealed that one hedge fund, Melvin Capital Management, took in an emergency $2.75 billion cash infusion from hedge fund grandees Citadel and Point72 Asset Management.
We anticipated some of this call-buying behavior (“Why the Options Market Could Get Even Crazier in 2021,” Dec. 17, 2020), but nothing at this level.
With the caveat that the cost of capital is low, making risk taking more attractive than usual, it’s worth considering a tactical trade just in case all of the momentum fades away, or something else trips up the mob.
SPDR S&P 500
(SPY) March puts with strike prices that are 5% or so below the market price. The put purchase expresses a simple short-term view that stocks could continue to go down over the next seven weeks or so if the Wolf Pack’s momentum ebbs, Covid-19 once more seems uncontrollable, or if Congress fails to approve additional fiscal stimulus. The expiration covers the March 17 conclusion of a two-day Federal Reserve rate-setting committee and all sorts of partisan political sniping.
If stocks never decline again, at least not during the expiration cycle, all is not lost. Just talk with your tax advisor about using the loss to offset gains.