I’ve got my Valentine, for which I’m grateful every day.  Whether the market finds love after yesterday’s blood remains to be seen.

Back when the Romans celebrated Lupercalia, there was blood.  Romans knifed a goat to arouse the gods of fertility and then flicked bloody strips of hide at the young women, who welcomed the blood as an aphrodisiac, I guess you could call it.

dreamstime m 206876446

Photo 206876446 | Valentine © Splank | Dreamstime.com

I’m glad we’ve dropped that practice. We don’t own any goats. It became St Valentine’s Day and a Christian meme in the 5th century. I’ll spare you more history while wishing you a happy one!

The blood yesterday ran especially in the Russell 2000, which gave up a quarter of its quarterly gains before clawing some back into the close.  In fact, small caps jumped 21% in November and December, then gave back nearly half into January options-expirations, then got them back by Monday before crumbling Tuesday.

You’re being poorly served by this market, smallcaps. You should complain to the SEC! If you’re persistent, you might get a fairer one.

Anyway. Now it’s options-expirations time again.  There’s a lesson for investors and issuers.

Yesterday’s Consumer Price Index data that came in a little higher than expected didn’t randomly clock stocks. There’s context.

Speaking of which, I’m hosting an Interactive Brokers webinar today called, “Why Monthly Options Expirations are Landmines for Traders.” Join and heckle! No need to be an IBKR customer.

Back to the lesson.  CPI data should no more have knocked the market down than should ORCL’s earnings last quarter. 

Let me offer an analogy. We’re seeing gifted young Texas musician Sarah Jarosz next weekend at Strings, the Steamboat Springs performing arts center. Suppose the venue sold calls on the front-row seats. And sold them out.

And suppose a day before, Sarah was out, replaced by a rap artist.  I’ve got nothing against rap. Apparently our dog Clyde is a fan because during the Super Bowl halftime show we looked over while Usher was rapping and Clyde had a sublime expression.

Anyway, calls are rights but not obligations.  So suddenly the show could go from sold out to wide open on the front row.

This is what happens when you report earnings right before the options on your stock lapse and renew, public companies.  The implied value in them changes.  They can be 20% or more of your value. Boom! Your stock does something you don’t expect.

That happened to the market yesterday on CPI data. Today, VIX volatility options renewed. What the market thought was true about volatility changed before they expired. That’s enough to destabilize the entire market because it’s dependent on derivatives.

These are things you need to think about, public companies and investors.

We worry about beating or missing consensus. I’m unconvinced it matters. Most of the money owning stocks now doesn’t follow consensus. And most of the sellside isn’t executing trades. They’re routing to machines that see trades as a monetizable product.

Yeah but Tim.  Our stock gyrates if we miss. 

It might gyrate if you beat too.  But investors aren’t doing that to you. Machines set prices. And hedge funds bet directionally – with their own models and data.

CPI data hit with a raft of derivatives about to recalibrate, including currency and interest-rate hedges and bets.  And the VIX. And index options tomorrow. And a bucket of stock and index options Friday. 

Oh, and MSCI indexes just rebalanced on Monday.

Markets that depend on derivatives are continuously at risk of behaving unexpectedly because you never know when the whole front row is going to go empty.

What to do, investors?  Know the calendar. Stocks may not do what you expect during expirations. You might want to skip them.

And issuers?  We report earnings the same old way, touting changes, bulletizing a bunch of details, carrying on in our earnings releases for 15-20 pages.  Passives have taken $500 billion from stock-pickers annually for 15 years. Your top 25 holders are likely Passive.

Humans are creatures of habit and none more so than the corporate general counsel. But someone has got to drag the c-suite into reality. Your earnings release is an anachronism.

I checked 13Fs for a big company machinating about managing its sellsiders. Over 60% of its shares are held by its top 25 holders, and maybe one of those is a stock-picker. (And 70% of assets at the seven largest money managers now are Passive.)

If the sellside serves stock-pickers, who own less than 40% of the stock, is that productive time?

You will serve your dominating Passive holders best by minimizing volatility.  The stock market might move 2% in a day just a time or two per year (yesterday was thus a big outlier).  Less than 1% of days.

Passive money wants tracking errors of less than 2%.  More, and they get in trouble with regulators and fund distributors. So, the whole market conforms to Passive behavior.

You know what rocks that boat?  Data right into options-expirations, yes. And earnings.  Volatility harms your top 25 and gets you booted from Passive baskets.

What do you say each quarter in your earnings release that hurts your Passives? Maybe it’s time, issuers, to make some new practices your Valentine. We can help you find love. So to speak.

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