Investors going at the stock market on their own are now in love with the stock market but this new infatuation is making veterans in the market nervous. Garrett DeSimone, current head of quantitative research at OptionMetrics made a statement that, “What we have seen is a focus on short-term, out-of-the-money call options because they have these lottery-like payoffs.” OptionMetrics is an options database & analytics provider that services institutional investors as well as academic researchers.
The buying of these calls has historically been a losing proposition. Some of those bets have paid off in dramatic fashion though, something that has been unusual. This shock has also brought back memories of the dot-com boom of the late 1990s, when a major swell in day trading ended up contributing to the inflation of a massive market bubble.
So what is a call option? They are financial instruments that give holders of them the right, without obligation, to buy the security underlined at a set price, which is known as a strike price, before a specified date. By buying what is called “out of the money” by a wide margin, there is a strike price well above the stock’s current level and investors are betting that the surge in the stock price will give them a great profit.
This activity has been amplified more so recently as individual investors are gathering online on forums such as Reddit’s r/WallStreetBets and elsewhere where people brag about wins or discuss tactics of unifying for similar moves by convincing each other to put funds into a particular stock or to hold on to items suffering losses at that time.
This kind of organized movement has been noted as the primary reason that shares of the video game and collectible retailer GameStop grew by 300% in January. The rally has underlined some phenomenon where smaller, individual investors aggressively bought calls of the companies that have been heavily shorted by large investors like hedge funds. This will force them to exit and would accelerate a rise in prices so they scramble to the exit with their bets so shares can start falling.
Speaking of, GameStop ended Monday at another all-time high while both the S&P 500 and Nasdaq Composite closed at records of their own and the Dow Jones Industrial Average lost for a third straight day. While there has been a surge in retail individual trading and there is a desire for quick day trading victories the short squeezes are a new wrinkle compared to the dot-com boom thoughts.