The Northern Star Newsletter 9/10/20 - Stocks Stall as Recovery Continues
Message from Jon
Wednesday Sept 23rd
Where we are and what we know now
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Here's what happened...
"Delta hedging is an options trading strategy that aims to reduce, or hedge, the directional risk associated with price movements in the underlying asset. The approach uses options to offset the risk to either a single other option holding or an entire portfolio of holdings. The investor tries to reach a delta neutral state and not have a directional bias on the hedge..." -Investopedia 1
This all began in late July, in our opinion. A small company (sarcasm here), named Softbank, out of Japan started buying call options on most of the Mega Cap Technology Stocks in the NASDAQ. As a matter of fact now, Masayoshi Son, CEO of Softbank, bought up approximately $50B worth of call options on Amazon, Microsoft, Netflix, Apple and Tesla creating a very lopsided supply and demand ratio in the Mega Cap Technology stocks as well as the S&P 500 and NASDAQ indexes.3,4
A very basic version of what happens is when a naked call option is bought: the seller has to take a hedge against the stock in case it goes up or down in a concerted manner. This seller (usually a bank) will take an actual position in the underlying security to hedge the risk of the price of the security as it climbs or falls according to the call option's strike price. Complicated, I know, and frankly above my paygrade here, but oh well...
Since naked options have an unlimited gain or loss to them, unlike the covered calls that we have invested in for some clients, the risk can be exponential-meaning that if the price of the stock goes high, they may have to buy a percentage of the underlying option. When it goes even higher, they may have to buy more and more and more but in larger quantities as the price increases.
In essence, they become a forced buyer. Well, what goes up must come down...
When the stock falls, due to one reason or another, those who were once forced buyers now become forced sellers to unwind their risk exposure as well, and now, the stock falls even faster.
Softbank is the "Whale" behind the momentum in the tech stocks since July. Those who were, are, and may be buyers due to FOMO or some other interest levels in technology and the general indexes are getting pinched in their trades as of yet and could quite frankly see more pain before it gets better. 5,6 We too bought some technology as a momentum trade in a growth portfolio only to see that one trade get hit by the recent whale's shift in direction and its wake.
This too will pass. Building a portfolio with proper mechanics, weighting, design and allocations all help to mitigate the potential for a killer whale attack such as this one.
Could the markets continue to fall? Sure. Here's a clue though. In our opinion, if this decline was a systemic faltering of the underlying economy or breakdown in supply and demand in equities or a shift in monetary policy, we would be seeing this decline in equities across both domestic, foreign and emerging markets. We are not. In our research and opinion, we are seeing this breakdown and correction contained in the US markets alone.
Does that mean that this will not spread? No, it does not, in our opinion.
Does that mean that the tech investments are bad for portfolios? In the short-term, it will be tough, but in the long term, not at all as we see it. You may need to dollar-cost average to get a lower cost basis, but the companies-provided the ones you bought were high quality-are still good high-quality companies.2
Again, focus on what matters most...your goals, accomplishing your needs, wants and wishes, and arriving at retirement comfortably and able to enjoy your time.
Till we speak again, have a productive, albeit short week!
Stocks Stall as Recovery Continues
WEEKLY UPDATE - SEPTEMBER 8, 2020
The Week on Wall StreetA late week sell-off sent stocks broadly lower as investors took some profits after stocks reached all-time highs earlier in the week. The Dow Jones Industrial Average slid 1.82%, while the Standard & Poor's 500 slumped 2.31%. The Nasdaq Composite index dropped 3.27% for the week. The MSCI EAFE index, which tracks developed overseas stock markets, fell 0.62%.