Goldman Spots A Historic Inversion In The Market

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by Tyler Durden
Friday, Jul 24, 2020 - 01:40 PM

Back in May when we explained "how retail investors took over the stock market" (which Bloomberg again confirmed overnight when it reported that hedge funds are now chasing robinhood investors, and buying whatever Millennial and GenZ daytraders are buying) we said that the recent surge in options trading - which has far more impact on market flows due to embedded leverage - has had a key role in this transformation, and cited Goldman data which showed that "individual investor active trading is playing an increased role in market volatility, particularly in select stocks. In the shares market, 2.3% of all volume is made up of trades for $2,000 or less. The increase in small trades has been even more notable in the options market, where 13% of all trades are for 1 contract."

Since then, options trading by retail investors has exploded and according to a follow up from Goldman, which has spotted an unprecedented market inversion, for the first time ever, the volume of option trades surpassed that of ordinary shares! Translation: the derivative is now more liquid and popular than the actual underlying.

According to Goldman's John Marshall and Vishal Vivek, who first spotted the dramatic surge in retail option trading, single stock options volumes rose to record highs in July, with notional volumes up 129% YTD and 35% over the past month alone as retail investors flooded markets to blow their government stimulus checks on "sure things" with leverage.

And in the most dramatic observations yet, the average daily value of options traded has exceeded shares for the first time, with July single stock options volumes currently tracking 114% of shares volumes.

While equity trading activity increased to all-time highs in March of this year when the flood of retail investors first hit Robinhood, Schwab and Etrade, and has declined since then, options trading activity has increased 129% YTD (up 35% from June levels), which helps expain why various HFT outfits are paying so much to frontrun Robinhood option trades.

It will certainly not come as a surprise that according to Goldman's recent analysis, increased activity by individual investors was the single biggest contributor to growth in volumes this year. Options trading activity by individual investors comprised 10% of volumes in large liquid names at the beginning of 2020, and is currently up to 15%. This compares to a 60% increase in total single stock options contract volumes YTD.

Some more observations: Goldman estimates that individual investor activity has doubled in the past year for S&P 500 stocks. For options on S&P 500 stocks, individual investor activity is up 40% over the past year.

(1) Shares: While individual investor activity in mega-caps has accounted for a smaller percentage of volume than for the bottom 400 names in the S&P 500 on an absolute basis, mega-cap individual investor participation has increased over the past three months.

(2) Options: Individual investor activity in both the top 50 and the top 500 US names has continued a steady climb over the past few months, with a larger recent increase in the proportion of volume among the top 50.

It gets crazier: a significant portion of this increase has been driven by higher volumes in short dated contracts, as investors are literally using massive leverage to wager on near-term momentum moves such as those often highlighted OTM calls traded in Tesla stock.

As Goldman explains, "the proliferation of weekly options, and increased focus on using options to trade catalysts, has likely boosted growth in shorter dated (options with less than 2 weeks to expiry) trading strategies. While weekly maturities on single stocks became popular in 2012, volumes in short dated options typically comprised 50-60% of total volumes until 2017. This changed in 2018, as the volatility spike early in the year likely led to investors increasingly trading short dated options, driven by low absolute premiums and better visibility of the catalyst path. In 2020, volumes in short dated options have increased to record highs."

As a result, single stock options with maturities less than 2 weeks now comprise 75% of all maturities, up from 65% a year ago. Meanwhile, in recent weeks, investors have further increased focus on trading calls with volumes of short dated call options having increased rapidly relative to puts.

In the context of these findings, Goldman next looked at yesterday's sharp selloff and found several additional bizarre patterns:

  • Stocks where individual investors were most active in OPTIONS over the past two weeks were down 1.3% yesterday, consistent with the 1.5% decline in the average stock in the NDX.
  • Stocks where individual investors were most active in SHARES over the past two weeks were up 0.7% yesterday, while the average stock in the SPX was down 0.2%.

According to Goldman, this shows that individual investors have tended to be most active in the SHARES of stocks that have recently underperformed (i.e. buying the dip); this sets up for outperformance when the market broadly exhibits a trend reversal.

At the same time, individuals tend to be most active in the OPTIONS of stocks that have recently seen strong performance (i.e. momentum); therefore, yesterday's decline in these names is also consistent with a reversal of recent momentum. The report also found that popular options names are highly correlated with the NDX over time, making put buying on the NDX an attractive way for investors to hedge against a continuation of yesterday's move.

Finally, for those asking where the retail option trade footprint is largest, here is a look at which stocks have fueled the sharp rise in options volumes:

Options volumes have been driven higher by an increase in trading in many of the large market cap names. AMZN, TSLA, AAPL, NFLX and FB had the highest volumes in July. Among the top 25 underliers with high notional volumes, MRNA, WMT, NKLA and TSLA saw the biggest jump relative to the prior 12-months.

Notably, bullish sentiment on a number of names, as indicated by options market skew, is at extremely high levels. Three-month normalized put-call skew in AMZN, TSLA, SQ and MRNA have declined to below 0. Negative skew is a relatively rare statistic for large cap names such as AMZN (where three month skew is currently at all-time lows), implying crowding in long AMZN calls.

One final warning: if and when a trend reversal in the names listed above, watch out below as months of aggressive retail chasing of momentum will hit a brick wall and then go into reverse.