Published Date: 2020-09-11 | Source: INCE|Community | Author: Viv Govender | Rand Swiss | Wealth Manager
Many of you may have been surprised by the recent rise in markets, despite the fact the real economy remains depressed. Well, news recently broke that may be able to explain, at least a part of the outperformance. An exceptionally large investor may be effectively pushing markets.
The investor in question is Softbank. If you haven't heard of them before, Softbank is a legendary Japanese investment holding company. It runs the Vision Fund, the world's largest tech-based venture capital fund. Recently, it's made a series of rather bad investments, which may be one reason why it's taken this controversial approach. It has been accused of trying to engineer a gamma squeeze.
If you're not familiar with option pricing or trading terms, a little bit of explanation may be required.
A squeeze refers to a situation when someone is forced to buy or sell an asset, even though they believe they're getting a bad deal. A recent, well-known case was the 2008 VW short squeeze. Here short sellers were forced to buy VW shares due to a lack of available stock.
This squeeze was caused by Porsche announcing it had increased its stake in VW. The news caused those who had taken short positions in the share to panic, as they knew this was likely going to cause the price of VW to rise. Unfortunately, panic made things worse. The price of VW shot up spectacularly (over 80% in one day). Intraday the share more than tripled. It briefly became the most valuable company in the world.
Gamma is the relationship between the price of an option and the price of the underlying share on which it is based. When a financial institution sells an option, it takes on the risk of paying out, if the option becomes profitable. If an institution were to sell a call option, they would be liable to payout if the underlying share went up massively. In such a case, to limit their losses they may be forced to buy the underlying share, to limit their exposure.
Keeping these concepts in mind, here is a brief rundown of the Gamma Squeeze technique. An investor with substantial funds buys call options in a Share X. They also make it known that they are doing this. Other investors, aware that this is likely to cause the price of Share X to rise, also start buying. This raises the risk of the option seller having to payout. The option seller is then also forced to buy. This further pushes the price up.
The technique works best when market volumes are light, as they traditionally are over the northern hemisphere summer and when there are other buyers available to amplify the buy signal. The emergence of retail brokerages such as Robinhood provided this.
It currently looks like at least some of the rise of Tesla, and maybe even some of the bigger tech stocks has been fuelled by a gamma squeeze.
As you would expect this technique doesn't result in a permanent increase in share prices. Once the short squeeze on VW ended, the share quickly returned to a more reasonable level. Now that the cat is out of the bag regarding the gamma squeeze, we could expect some of the price gains to be lost. Just how big the retracement will be is uncertain. One stock that has already suffered is Softbank itself down 7% on Monday.
If you want to find out more about the Nasdaq whale and the mechanics Ingham Analytics covers it here...
Article Written By Viv Govender | Wealth Manager | Rand Swiss
Viv Govender is a wealth manager and market analyst, specialising in the macroeconomic environment. He frequently appears in the media, contributing to channels such BBC, CCN, SABC, CNBC, SAFM, 702 and ETV. He is also a regular guest speaker at a number of prominent business schools and advanced education programmes having previously been a member of academia teaching at UKZN and DUT.