I heard one unmistakeable sound on Thursday and Friday. It was the sound of market makers driving away in Brinks trucks, you know, the kind that transports boatloads of money. Before I delve into the thievery that took place on Wall Street last week, let me first remind you of the annualized returns of the following calendar days of the month:
19th: -33.46%
20th: -7.57%
21st: 6.07%
22nd: -13.08%
23rd: -3.08%
24th: -3.74%
25th: -6.17%
This is nothing new. That 19th to 25th period of every calendar month since 1950 has produced annualized returns of -8.78%. You can thank our market maker system for that. The primary role of the market maker, as most understand it, is to provide liquidity. And they do fulfill that role. But they're not going to provide liquidity if it's not profitable. Market makers are "for profit" financial companies and the way they make most of their money is by preying on unsuspecting, greedy and fearful traders. Monthly options expire the third Friday of every month, which was yesterday. Market makers take the opposite side of options trades, so when traders grow very optimistic, the equity only put call ratio will fall as fewer puts are traded, while calls are the "option of choice". Take a current look at the 5 day SMA of the $CPCE:
Over the past 5 years, the 5 day SMA of the CPCE has moved below .50 on just two occasions. The first was January 2020 and the second was February 2020. While we didn't see a major market drop into options expiration week in January, we did see the big drop the week after options expiration and that's what the history of the stock market teaches us. We must be aware of options-related selling every month around this time.
At EarningsBeats.com, we are rolling out an options-related webinar every month going forward to discuss the short-term risks of options expiration. The stocks that were hit the hardest the past two days were the stocks most at risk because of net in-the-money call premium. I want to simply consider the call premium that was on the table as of Wednesday's close with respect to the SPY (ETF that tracks the S&P 500):
This is a calculation of net premium of call options as of Wednesday. This is how much the Open Interest was worth, taking the in-the-money call premium and subtracting the in-the-money put premium.
Over $171 million!!!
This is just one ETF option chain! So imagine the total value of net call premium across the entire market. Would you like to know where we ended on Friday after the SPY dropped nearly 5 bucks over two days?
The net premium moved from $171 million in net call premium to $22 million in net put premium! If you were wondering why the stock market took a tumble last week, look no further than the impact of a really bullish options world.
By my calculation, net call premium dropped $10 million every time the SPY fell 24 cents. So imagine the euphoria of market makers as you follow last week's drop in the SPY:
KA-CHING!!! Back up the Brinks trucks!
It wasn't enough to wipe out ALL of the net call premium, but the blue circle above even shows a rally into the final 20-30 minutes to cut into the net put premium that had resulted.
Ruthless.
It's because of these shenanigans that I've decided to host an impromptu webinar on Monday, February 24th at 4:30pm EST. I want to make it open to the public. Options expiration has no long-term impact to those of you that buy and hold, but if you ever trade stocks in the near-term, you MUST be aware of this market-moving phenomenon. We'll be sending out webinar room instructions to our entire community on Monday morning, which will include all of our FREE EB Digest subscribers. To join me for this webinar, simply subscribe to our free newsletter, if you haven't already, using THIS LINK.
Happy trading!
Tom
