SoftBank caused a splash when it emerged as the “Nasdaq whale” that had placed big options bets linked to US stocks, but some analysts suspect the market impact of the Japanese conglomerate is swamped by a massive shoal of much smaller but frenzied fish — retail investors.

Under the direction of founder Masayoshi Son, SoftBank has bought $4bn worth of options on big US technology stocks since the summer, with a notional value of about $30bn, according to people familiar with the matter.

The whale-sized trades have stirred theories that SoftBank intensified the summer rally in US tech stocks and contributed to the recent reversal, with the Nasdaq Composite index shedding about $1.9tn in just three days. However, retail traders have together spent almost $40bn on similar trades just over the past four weeks, according to Sundial Capital Research.

Dean Curnutt, the chief executive of Macro Risk Advisors, a derivatives strategy firm, said those millions of retail traders form a “Mighty Call Trading Legion” with a combined heft bigger than even giant financial institutions. 

“My take is that it’s less SoftBank [driving options markets] and more this collective activity of retail, momentum-oriented crowd,” he said. “The data doesn’t have a mark of a whale. It has the mark of lots of little, tiny whales that add up to one big one.”

Line chart of US equity purchase premiums on call options for trades of 10 contracts or less ($bn)* showing Retail investors pay up for options

Options come in two forms. Calls give holders a right to buy a stock at an agreed “strike” price within a certain date, and are a popular way of magnifying gains. Puts give the right to sell at a certain price, and act as a kind of insurance for investors. The seller of an option, typically a bank, is obliged to deliver the promised shares if call strike prices are triggered, but receives a premium from the option buyer in the meantime, and hedges its exposure.

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SoftBank’s estimated $30bn notional call exposure may seem big, but the overall notional value of calls being traded on US stocks has trebled this year to over $300bn a day, according to Goldman Sachs. Trading volumes for calls connected to the top five S&P 500 stocks averaged $125bn a day in the last week of August, up from $29bn in the same period past year, according to data from hedge fund Man Group.

SoftBank’s trades were eyecatching — especially given that it is mostly known for investments in private tech “unicorns”, rather than options trading. But those calculations suggest it was a modest rather than dominant factor in the rally, analysts say.

Line chart of Assuming SoftBank's $4bn of call purchases distributed equally across three months. showing Even without SoftBank the ratio of US calls-to-puts would be elevated

How much of this upswing is due to the retail investment boom is tricky to determine. But it is clear that small call trades, in lots of 10 contracts or less, have grown in popularity. The amount spent on premiums for call options of this size has surged sixfold to $39.4bn on a rolling four-week basis, according to research by Sundial’s Jason Goepfert, based on data from the Options Clearing Corporation.

A fall in the average length of call maturities also indicates high retail activity. Institutional investors tend to favour one- to three-month options, while retail investors often punt on one-week or even one-day options, which have exploded in volume lately. 

Earlier this summer Goldman Sachs estimated that a fifth of all S&P 500 options traded in the second quarter had a maturity of less than 24 hours, up from around 5 per cent in 2011-16. Since then, short-term options have grown further in popularity.

Column chart of Average daily trading volume by days to contract expiry (millions)* showing Equity options traders focus on the short term

Peter van Dooijeweert, an options specialist at Man, points out that over 1m one- or two-week Apple calls with a $12bn notional value traded last Friday alone. That compares to just 150,000 one-month calls with a notional value of $1.8bn. 

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The combination of booming call volumes, their ever-shrinking maturities and the peculiar dynamics of the options market partly explains why the stock market was so buoyant until recently, and the swiftness of the September drop.

Dealers hedge their own exposure from selling calls by buying the underlying stock. This can create feedback loops, as heavy call-buying forces banks to buy more of the underlying stock, especially if it starts moving towards the strike price. When stocks dip — as has happened lately — banks instead ditch their hedges, exacerbating the sell-off.

Line chart of Share of US equity options market (%) showing Smaller trades indicate retail frenzy in the options market

“Retail doesn’t have the ability to move the market by themselves, but by buying calls they force dealers to hedge themselves, and triggered this parabolic move in tech stocks,” said Ben Onatibia, a strategist at Vanda Research.

Short-term options trading close to their strikes are particularly sensitive to market fluctuations. In practice, that means every dollar of retail option trading can have a greater effect on stocks than institutional buying, Mr Dooijeweert argues.

“This is mostly a retail phenomenon,” he said. “If a couple of million people get together and all buy a few option contracts, that’s a lot of exposure.”

Options-punting retail traders who hang out on online message boards were quick to embrace SoftBank’s aggressive trades as evidence that Mr Son was a kindred spirit. 

“One of us One of us One of us,” wrote one poster on Reddit. Another said: “We need more saints like him and jpow [Fed chair Jay Powell] bless their hearts.”

Line chart of Nasdaq Composite index showing US tech stocks drop into correction territory

Via Financial Times