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How Options Trading Could Be Fueling a Stock Market Bubble

  • January 26, 2021

“In this situation, dealers are amplifying price movements,” said Andrea Barbon, an assistant professor of finance at the University of St. Gallen in Switzerland, who recently co-wrotea paper that analyzed the relationship between the options markets and market volatility.

The result can be an options market that itself has become a generator of share-price momentum and stocks that appear increasingly untethered from bedrock fundamentals, like expectations for corporate earnings.

“The fundamentals aren’t the driver. That’s not what matters anymore,” said Charlie McElligott, a market analyst with Nomura Securities in New York. “It’s the scale and the growth of the options market as this lottery ticket vehicle, which is especially magnified right now because of the retail frenzy.”

The overwhelming optimism of stock options investors — and the chance that they are fueling a feedback loop of ever-escalating stock prices — is one of the reasons some analysts are concerned that a bubble might be building in the market.

If history is any guide, such bubbles tend not to last. The frenzy back in 2000 was followed by a roughly two-and-a-half-year downturn as the stock market plunged 40 percent.

The downturn doesn’t have to be that steep. In August, the put-call ratio tilted hard as bullishness took hold. Stocks then suffered a sudden tumble in early September, with the SP 500 dropping more than 7 percent over three weeks. The sell-off was led by the same giant technology companies — including Microsoft, Amazon and Alphabet, Google’s parent — that had led much of the market’s monthslong rally.

Few analysts saw a fundamental reason for the drop.

“High levels of speculation usually do run their course,” Mr. Sosnick said.

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