At regular intervals, I feel compelled to remind market participants that things don’t really work the way most people think they do.
As I put it late last week in “Never Call The Top,” failing to appreciate the mechanistic ebb and flow of modern markets is destined to leave one bereft and hopelessly behind the curve.
In the more expansive “How To Make Sense Of Stocks In Modern Markets,” I wrote that increasingly, attempts to “explain” equities without explicitly referencing various manifestations of self-feeding loops and instances of the proverbial tail wagging the dog are doomed to inadequacy.
Fast forward a few days, and Nomura’s Charlie McElligott delivered a masterclass using Monday’s dramatic surge in Tesla as a case study.
The vast majority of the commentary on Tesla to start the week revolved around the company’s market cap breaching $1 trillion and Elon Musk’s net worth ballooning to a quarter of that. Those are eye-popping, headline-friendly numbers to be sure. But they’re just factoids. The read-through for society is important, and I’ll get to that later. But when it comes to markets, the critical nuance is found in the options space.
“$16.1 billion of premium was spent on TSLA options [Monday],” McElligott wrote, noting that Tesla thus singlehandedly accounted for more than half “of the entire US options market Monday, and more than the combined options premium spent on nearly the next 100 most widely-traded options on the day.” That includes SPY, QQQ and other popular single-names.
He continued, noting that “the total options volume of 3.55mm contracts in TSLA was also a single-day record,” but that’s not even the most incredible part. 54% of Monday’s record options flow was concentrated in October 29 weeklies. That included 1.2mm Calls “for just this Friday’s expiration,” Charlie noted, adding that the ratio of call premium to put premium was “an unheard of” 18:1.
Why does this matter? You’ve heard of weaponized gamma, right? Reddit figured it out last year on the way to engineering self-fulfilling prophecies in a hodgepodge of names. Well this, McElligott emphasized Tuesday, is the very definition of weaponized Gamma.
“In this case, short-dated Call options creat[e] a ton of (negative) convexity for Dealers who are short these options, then forced to aggressively hedge the Delta on account of the sensitivity to the upcoming imminent expiration,'” he wrote.
And it gets better. For months, market participants have attempted to hedge what Charlie called “ARKK doomsday downside,” which is just a colloquial way of saying clients are concerned that rising rates will torpedo hyper-growth shares and richly-valued names seen as particularly sensitive to higher yields, both due to expectations of policy tightening and inflation concerns.
Downside puts on ARKK are one way to express that worry, and the trade “has [been] daisy-chained around the Street,” McElligott said Tuesday.
The “daisy-chained” characterization is crucial. “Dealers are short substantial ARKK Gamma,” Charlie went on to write, before noting that the accelerant potential may have been somewhat mitigated. “Many were long TSLA Gamma against it,” he said, on the way to delivering what he called the punchline:
TSLA alone is 5.65% weight of QQQ alone, and 2.15% of SPY—so if my chicken scratch, back-of-envelope math is correct, this means that TSLA was over ~70% of the gain in QQQ Monday, and ~50% of the SPY gain Monday.
Note also (and for me, this is the most important takeaway because it contextualizes things via key modern market structure dynamics) that this played out against a backdrop where positioning was already in long gamma territory in QQQ options (insulating markets in the absence of a shock-down catalyst) and the grind lower in realized volatility was already poised to engender additional mechanical exposure adds.
Now, the dynamic is extreme in QQQ (figures below), while on account of the reset lower in volatility, Nomura’s vol control model tipped a possible re-allocation bid of up to $36.6 billion assuming a flat daily change.
I’ll quote myself again, from the first linked article here at the outset: Why every equities strategist isn’t compelled to explicitly acknowledge these dynamics and otherwise incorporate them into their analysis is beyond me.
McElligott summed it up. “Mechanical forces don’t care about macro, policy or growth narratives,” he said Tuesday.
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