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<p><strong>By: Evan Giannakis, Head of derivatives at Momentum Securities</strong></p>

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<h2>Lockdown boredom boosts risky derivatives trading</h2>

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<p>Retail investors are playing an increased role in market volatility, particularly in a selected group of global technology, biotech, entertainment and consumer goods companies. This is according to Evan Giannakis, Head of derivatives at Momentum Securities.   </p>

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<p>“Current data indicates that more than 2% of all volume in equity trades in the United States is made up of trades of $2000 or less. The increase in small trades has been even more notable in the options market, where more than 12% of all trades are for 1 contract only. These smaller trades also focus on particular counters such as TESLA.”</p>

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<p>Giannakis explains that there are a number of factors driving this phenomenon. “Firstly, the US Federal Reserve has flooded the market with unprecedented levels of liquidity, printing 10% of their total debt in a three month period, underpinning the equity bull market. Secondly, low cost platforms like Robinhood has opened up equity and derivative investing to a whole new segment of the population. Combine this with the fact that we are in an environment where sporting events have been cancelled, entertainment businesses are running at much reduced capacity and people are sitting at home receiving government stimulus cheques. What we are seeing can actually better be described as wagering on “sure things” with leverage rather than investing.”</p>

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<p>Market commentators have noted over the last few months that the valuations of many equities, in particular the technology stocks listed on the Nasdaq, are now completely disconnected from the underlying global economic reality. “We are also seeing an unprecedented market inversion in the US, where, for the first time ever, the volume of option trades surpassed that of ordinary shares.” Giannakis continues.</p>

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<p>This is underscored by the fact that single stock options volumes rose to record highs in July, with notional volumes up by more than 125% YTD and more than 30% over the past month alone. “It is estimated that individual investor activity has doubled in the past year for S&P500 stocks. A significant portion of this increase has been driven by higher volumes in short dated contracts, as investors are literally using leverage to wager on near-term momentum moves such as those often highlighted trades in Tesla stocks. As a result, single-stock options and futures with maturities less than 3 months now comprise more than 3/4 of all maturities. Buying the dip and momentum calls are proving the most popular strategies.” Giannakis elaborates.</p>

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<p>Giannakis explains that single-stock futures are future contracts on individual stocks between two investors. The buyer promises to pay a specified price for example for 100 shares of a single stock at a predetermined future point. The seller promises to deliver the stock at the specified price on the specified future date. Investors have to put up 20 percent of the value. Unlike owning the actual underlying shares, single stock futures do not convey voting rights.</p>

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<p>“Out of the four broad assets classes: property, bonds, cash and equities, equities traditionally are considered the riskiest. Trading equity derivatives on margin ratchets up this risk considerably,” says Giannakis.</p>

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<p>“To illustrate, let’s assume you buy a R1million house. You put down a R200,000 deposit (margin in derivative contract terms) and borrow the remaining R800,000 from a bank. Your intention is to sell this house at profit at some point in the future (a long position), however, suppose your house is revalued every day. Should the value fall below R1million, you will have to settle the difference with your bank at the end of the day. This is what is known as a margin call.”</p>

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<p>“If the market moves against you it can be very scary. Using the house example, you can lose R1million on a R200,000 investment. On a short position, where you are betting that the price of your investment will go down, you can in theory lose a lot more. In an overheated market this strategy is very dangerous for retail investors, particularly at a time when institutional investors are flocking into traditional safe havens like gold, a canary in the mine,” warns Giannakis. </p>

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<p>“That is not to say that there is no place for derivatives in a retail investor’s portfolio. They can be a valuable hedging element in a portfolio where, for example, a client has long held equity positions which they do not want to liquidate as a result of capital gains tax implications. At Momentum Securities, we assist our clients with derivative strategies in their partially managed portfolios. Our advice to clients is to first and foremost fully understand the associated risks when trading derivatives on margin. Be clear on what you are trying to achieve, what your end goal is and importantly do not invest more that 15% of your portfolio in derivatives,” concludes Giannakis.</p>

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