4th February 2021

The first month of 2021 was certainly eventful!  The markets started on a strong footing after the Democrats won the Georgia runoff elections which triggered optimism of their ability to pass larger fiscal stimulus through congress to support the US economy.  The beginning of vaccine rollouts across the developed world provided money managers with what they needed to believe in the reflation narrative which was further fuelled by a weaker dollar.  The positive reflation trade sentiment resulted in strong commodity markets particularly led by Oil and Grains, whilst Copper which had been very strong late last year took a breather. However, precious metals struggled to gather any momentum due to real yields ticking up, as bond markets started to price in some cyclical inflation expectations for the latter part of the year. US 10Y treasury yields backed up 30 basis points in a week after trading sideways for most of December, begging the question, at what level of yields would the equity market get concerned.  

In FX, the USD bearish case was very consensus as the DXY broke down towards 89 in early January.  This 88/89 range was a major long term support and so the greenback managed to stage a bounce, which is typical of the first test of major technical support, unwinding some of the extreme bearish USD sentiment.  This also put the brakes on some of the other reflation trades.  Although despite the DXY grinding higher for most of January and currently sitting around 91.5, the CRB index is holding up extremely well, signalling that the broad commodity strength may not just be an inverse dollar play but something more fundamental like supply shortages across the complex.

Outside of the macro, the most notable action of the month came in the small-cap single stock arena, namely Gamestop and the other popular “meme” stocks such as AMC, Blackberry and Nokia.  These stocks had become the darlings of the popular social media Reddit forum called “Wall St Bets”.  It had been pointed out on that forum that Gamestop in particular had a very high short interest (140% of the free float) which meant that if enough shares were bought, then it could trigger a short squeeze which would require the big hedge fund shorts to cover their exposure and potentially lose billions.  
As it transpired, the stock managed to rally more than 1000% in a few days causing huge pain to a couple of large short-selling hedge funds, which then ended up being bailed out by some even larger funds.  To make matters worse, many of the retail brokerage platforms found themselves needing more capital as requested by clearing houses due to the extreme volatility.  These constraints resulted in trading restrictions for individuals where they could only close existing trades, essentially a ban on buying more stock.  Naturally this triggered a wave of selling and all those stocks sold off more than 50%, erasing many of the unrealised gains people had made.  The “retail army” as they are now known were understandably upset, as it appeared to them as if there was some collusion between the likes of Robinhood (the brokers) and Citadel (the hedge funds) to create a market collapse in these stocks so that the shorts could recover their losses at the expense of retail traders who were still holding the shares.  Class action lawsuits have been filed against Robinhood and many customers have left to go to other platforms which do not sell their flow data and were not imposing such trading restrictions.

The sense that many of the younger generation have, that the market is rigged against them, will only be amplified by this example where finally, even once they had figured out how to beat the large funds at their own game, the game was halted to allow the rich and powerful to be made whole again.  The aim of sites like Robinhood who charge zero commissions on stock trading was to democratise finance and level the playing field, however when put to the test, it seems maybe their intentions are not so pure.  The response from the Reddit crowd after being burned, was to try and take on the Silver market, which apparently would be less likely to ban trading and also had a big short position, this time with the banks such as JP Morgan.  The 20% rally in Silver lasted about 3 days and was quickly reversed as futures margins were increased, as is normal during time of increased volatility, and most likely some dormant producers used the uptick in prices to hedge some of their future production.

Over the past few years, the rise in populism across the world and the increasing inequality between the rich and poor have been a direct result of the policies of central banks to prop up the stock market and depress interest rates.  This has been further exacerbated since COVID came along, as the asset rich have been bailed out by excessive money printing which inevitably finds its way into asset prices whilst the poor have seen their businesses shuttered and been mailed cheques in the post to stay at home and keep quiet.

Is it any surprise that these regular people, with nothing to do and nowhere to go, have chosen to express their discontent with the system by rallying together on the internet and saying “we want part of the action”. Whether it is Barstool Sports founder David Portnoy becoming a trader and piling into airline stocks last summer,  Bitcoin and other crypto assets quadrupling in price last year or the latest Gamestop fiasco.  The revolution has begun, and the battleground is capital markets.  Whereas people may have been worried about pitchforks on the ground, this uprising is happening using technology on trading platforms and with free money issued by the government.  Even some of the wealthiest people in the world like Elon Musk and Chamath Palihapitiya are cheerleading the retail revolution and calling out some of the malpractices on Wall St.  What makes this new retail force in financial markets so powerful is that they are happy to openly share their ideas, not afraid to lose money or look stupid and have massive risk appetite with no investors to answer to.  This level of co-ordination and the leverage they can get in options markets on their capital makes them arguably a much more important flow in markets than any institution.
Personally, I love the rise of the “retail army” and I wish them well in their quest for equitable and efficient free markets.  What concerns me is that the majority of them really have no idea about risk management, and whilst this makes them very good at running winning positions, it will also most likely be their downfall and may cost many of them their entire portfolio.  I have made it my personal mission to teach as many people as possible how to trade options in a sensible, measured and risk controlled fashion.  So far my students have managed to participate in some of the big moves in the markets, in particular crypto,  but have also learned how to avoid the pitfalls and hedge their exposures efficiently.  Being armed with the knowledge that has helped me navigate through some of the most volatile markets in history, is something I would recommend to every new trader.

The modern day revolution has begun, choose your weapon!

Optionality in a portfolio is becoming more and more important as the diversification benefits of other asset classes are diminishing. We at OPTIONS INSIGHT provide training services for anyone looking to add options trading skills to their toolkit. 

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