Softbank bet big on call-options and Technology stocks are sinking.
So goes the latest big story. Business-reporting wants a whale, a giant trade that went awry. A cause for why Tech stocks just corrected (off 10%).
In reality the market today rarely works that way. Rather than one big fish there are a thousand minnows, swimming schools occasionally bringing the market down.
We wrote about this last week, regarding short volume. You should read it. We highlighted a key risk right before the market fell.
The same things driving stocks up unassailably toward the heavens, which should first have gotten our attention, often return them to earth. But we humans see no flaws in rising stocks.
Back to Softbank. If you’ve not read the stories, we’ll summarize. CNBC, the Wall Street Journal and other sources have reported on unconfirmed speculation the big Japanese private equity firm bet the equivalent of $50 billion on higher prices for Tech stocks.
Maybe it’s true. Softbank owned about $4 billion of Tech stocks in the last 13Fs for the quarter ended June 30 (the filings the SEC wants to make less useful, by the way).
Rumor is Softbank levered those holdings by buying call options, rights to own shares at below-market prices if they’re worth more than a threshold level later, on big Tech stocks like MSFT and AAPL.
Here’s where the story ends and market structure begins. The truth is the market neither requires a leviathan to destabilize it, nor turns on this colossus or that. It’s minnows.
It’s always thrumming and humming in the lines and cables and boxes of the data network called the stock market. And everything is magnified.
A single trade for a single stock, coupled with an order to sell options or buy them, sets off a chain of events. Machines send signals like radar – ping! – into the network to learn if someone might take the other side of this trade.
Simultaneously, lurking mechanical predators are listening for radar and hearing the pings hitting a stock – MSFT! Wait, there are trades hitting the options market. Get over to both fast and raise the price!
Compound, compound, compound.
Prices rise. Retail traders say to themselves, “Let’s buy tech stocks! Wait, let’s buy options too!”
And the same lurking machines buy those trades from the pipelines of online brokerage firms, assessing the buy/sell imbalance. They rush to the options market to raise prices there too, because once the machines own the trades from retail investors, they are no longer customer orders. And the machines calculate demand and run prices up.
And index futures contracts rise, and the options on those. Then index funds using options and futures to true up index-tracking lift demand for options and futures, magnifying their own upside.
Read prospectuses, folks. Most index funds can spend up to 10% of assets on substitutes for tracking purposes, and a giant futures contract expires the last trading day of each month that helps indexed money square its assets with the benchmark.
And then the arbitragers for Exchange Traded Funds drive up the prices of ETF shares to keep pace with rising stocks, options, futures.
And there are options on ETFs.
Every price move is magnified by machines. Up and up and up go stocks and people wonder does the stock market reflect reality?
The thing about prices is you never know precisely when they hit a zenith, the top of the arc. The last pump of your childhood legs in the playground swing, and that fleeting weightlessness.
And then whoosh! Down you come.
Did Softbank make money or lose it? I don’t know and it makes no difference. What I just described is relentlessly occurring every fraction of every second in the stock and options markets and there comes a moment of harmonic convergence after long arcs up and down, up and down, like children on swing sets.
It’s a thousand cuts, not a sword. Schools of minnows, not a whale. The problem isn’t Softbank. It’s a market that depends on the machine-driven electromagnification of every action and reaction.
The reason we know is we measure it. For public companies, and investors. You can wait for stories after the fact surmising sea monsters swam through. Or you can watch it on the screen and see all the minnows, as we do (read last week’s MSM).
What’s next? The same thing. Again.