How Leverage, Zero-Day Options and ETFs Are Changing the Market

During their recent episode, Taylor, Carlisle, and Zeke Ashton discussed How Leverage, Zero-Day Options and ETFs Are Changing the Market. Here’s an excerpt from the episode:

[Zeke] I mean, they’re now, you know, they’ve basically been approved by the CFTC from what I can understand. And what they are is, I mean, they’re basically swaps in my view, except rather than having a delivery date sometime in the future, basically it’s every day there’s a settlement. So the winner of the perpetual future, and the reason they’re called perpetual is they don’t have an expiry date.
And so what happens is, is basically if, you know, if you and I have, if we’re on the opposite sides of a perpetual futures contract, you know, if I made money today, you have to put some chips in to the, you know, into the table. And if I lose money to you tomorrow, I’ve got to slide those chips back to you. And so there’s also not a major clearing operation that I can see.

I think one of the benefits of owning a company like Intercontinental Exchange, and one of the reasons that we picked that one and CME is they both have, they both have their own internal clearing operation, which protects investors from, you know, basically the other side, not being able to meet their margin call. And so obviously it’s a very new perpetual futures is a very new product. And so we’ll just kind of have to see how well it, how well it takes off, but it’s just another, in my view, it’s just another way, another flavour of risk-taking that has been introduced to the markets.

And it does feel, you know, we talked about, Hey, does this feel riskier than 2021 or 2020? The fact that I think options and levered ETFs are a little bit of the tail that’s wagging the dog sometimes in the sense that I don’t know if you guys have noticed this, but there are days when the S and P 500 or the NASDAQ 100 feels perfectly calm, but there’ll be massive individual stock price changes kind of across our portfolios. I think I read a statistic that the, the average, the volatility of individual stocks relative to the indexes is something like four times what it normally would be.

And that feels right to me. It feels right when, for example, a company will report earnings. And, you know, I’ll look at the earnings and I’ll say to myself, well, it wasn’t quite as good as I hoped.

And the stock probably deserves to be down three or 4%. And you’ll look up and the stock’s down 21% or something like that. And then I’ll feel the same way on the opposite side where a company will report and I’ll say, well, this is a little better than I was hoping.

And the stock might be up 25%. And it feels like that is a function of a couple of things. Number one, you know, we talked about the, how much passive flows represent, you know, as a percentage of the market’s volume.

I do think that, you know, on a day-to-day basis, that’s really true. I think some of these stocks are thinner than you would expect them to be, particularly around earnings dates. But I also think it’s the options that are being, you know, people are playing options into earnings dates, whether they’re long or short.

And then obviously they have to respond very quickly after the company reports. And then there’s got to be somebody that takes the other side of those positions, whether that’s market makers or somebody else. So, you know, it’s one of those things where you get into the plumbing, which it’s very difficult to understand.

And I don’t completely understand it, but my feeling is, is that options are such a bigger component of, you know, sort of market bets today than they’ve ever been. And I do think that’s driving incremental volatility on stocks on a day-to-day basis.