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European markets steady after ugly tech selloff
Ugly, ugly, ugly. That could be the description of yesterday’s brutal sell off in tech stocks which led a broad market decline. The selling in some of the big tech darlings yesterday was spectacular: Tesla –9%, Apple –8%, Microsoft –6%, Zoom –10%. The Nasdaq settled down -5% for the day but off its lows and it’s only back to where it was last week, which simply shows what an extreme melt-up it’s been. The S&P 500 closed down -3.5%.
Ugly is the only word.
US Presidential election gets messy
Ugly is also the description of the general state of the economy and politics in the US and, arguably to a somewhat lesser extent, the U.K. The US presidential battle is getting nasty as hell. We should have expected this – it will likely get much worse. But the implications for the market need serious consideration.
I worry there is an increasingly grave risk the election result is contested to a point where the concept of a smooth handover of power is tested – well beyond ‘hanging chads’. American democracy is in peril and this should worry us all.
Neither Democrats nor Republicans have covered themselves in glory thus far and the fighting will only become more acrimonious. The election is now by far the most serious risk to markets in that it could fatally undermine faith in the American system that has underpinned the West for 80 years.
Will today’s US NFP disappoint?
Meanwhile the US economy remains in serious trouble. Jobless claims remain exceptionally high. Although yesterday’s initial claims was better the only stat that really mattered after the Department of Labor changed the way it measured things was this: The total number of people claiming benefits in all programs for the week ending August 15th was 29,224,546, an increase of 2,195,835 from the previous week.
Today’s nonfarm payrolls – expected at +1.375m – may well surprise to the downside, as the ever-insightful Christophe Barraud argues in his blog. The U.K. economy is hardly in better shape with the furlough scheme setting up the prospect of a wave of unemployment.
Whilst this is happening, all the central banks can do is further inflate the bubble. Yesterday’s sell off was about excessive buying in a handful of stocks, bad money in the markets chasing an ever-decreasing number of stocks, and a volatility skew that told us things were not right and heading to a rollover.
Excessive call option volumes leading to market makers needing to buy the underlying stocks seemingly chased the markets higher, but retail buying has played a strong part too. It’s all been rather unseemly and a correction is required – there may be further to run lower ahead of the election as risk ramps up.
We’d been worried by spiking Vix futures whilst the market was making all-time highs and so it proved to be a red flag. The question longer term for this market is whether we should be confident earnings will recover. That remains a problem, but not intractable – a vaccine would help a lot.
On the interest rate side of the equation, the Fed remains on side and will keep rates on the floor – as discussed earlier this week, stretched valuations may not matter if the Fed is never going to raise rates.
European equities quickly recover after tech selloff hits sentiment
European equities were dragged lower by the tech-induced sell-off on Wall Street yesterday but recovered in early trade on Friday morning. With sentiment rolling over in the big US names, any rally may prove to be a selling opportunity.
Shares in Spanish banks Bankia and Caixabank shot higher on plans to merge, lifting the entire Spanish banking sector. UK house builders were under pressure after the Competition and Markets Authority (CMA) announced enforcement cases against Barratt Developments, Countryside Properties, Persimmon Homes and Taylor Wimpey.
The CMA said it found ‘troubling evidence of potentially unfair terms concerning ground rents in leasehold contracts and potential mis-selling’, adding that it is worried leasehold homeowners ‘may have been unfairly treated and that buyers may have been misled by developers’. Shares in the four accused dipped though TW recovered as of send time.
Vix futures, which we’ve been tracking higher with some trepidation as a sign of a toppy market, spiked. Oct futures settled above 38.
The weekly S&P 500 chart, which I said yesterday morning was starting to push the envelope to breaking point, looks a little different but still stretched.
FTSE 100 – last night closed at the 38.2% retracement level at 5850 before the selling in the US dragged the futures even lower. Higher this morning but susceptible to a pullback should the US selling continue for a second day ahead of the Labor Day weekend.
Recent IPOs in 2020: What’s happened so far?
Although there have only been a few so far in 2020, recent IPOs have proven just how much pent-up investor demand there is.
Debut stocks surge as companies tap pent-up demand
It took a while for the IPO market to come back online in 2020, with the coronavirus pandemic slamming the brakes on many planned stock market debuts. But recent IPOs have shown that the demand has not gone away. Many of the companies who have gone public have seen an explosion of interest in their stock.
In fact, according to Renaissance Capital, the first week of June was the first time in two years that all the IPOs held raised more than original expected, whether because they ended up pricing above their target range, or because they increased the number of shares on offer.
2020’s recent IPOs
JDE Peet held Europe’s largest IPO since 2018 when it went public at the end of May. The world’s second-largest packaged coffee maker raised nearly €2.3 billion. The investor roadshow was held virtually and it took just three days to sell all the shares – usually company management has to travel the world for at least a fortnight to meet investors and drum up interest.
ZoomInfo surged on its stock market debut. The company sold 44.5 million shares at $21 per share – above its target price range, which itself had been revised higher from an earlier range of $16-$18.
But even at the higher price investors snapped up the stock, causing it to open 90% higher on its first day of trading, with the first trade recorded at $40. This pushed the company’s market cap up from $8 billion to $14 billion.
Warner Music Group
The company sold 77 million shares – up 7 million from what was originally planned – at a price of $25 per share. This gave the company a market capitalisation of roughly $12.7 billion, and early trading on the day of the IPO saw this valuation surge 15% to just under $15 billion.
The company had initially signalled its intentions to go public in February, but the coronavirus pandemic meant this had to be delayed.
Pliant had to double its share offering ahead of its IPO at the start of June, with the company raising $144 million against initial plans for $86 million. The company has said the proceeds of the floatation will last it until 2023.
Vroom raced higher when the stock went public on June 9th. The company prices its IPO at $22 per share, raising just under $500 million, giving it a valuation of $2.5 billion. The stock surged over 100% on the first day of trading, hitting $45.
Some of these IPOs have seen huge demand, but there’s still plenty more to come – check out the biggest 2020 IPOs investors can’t wait for.
IPO: The ultimate trader’s guide to initial public offerings
An initial public offering or IPO can be an exciting trading opportunity. It’s the first chance that most investors and traders get to grab a slice of some of the hottest new companies.
But what is an IPO, and how does it work?
In this article:
- IPO meaning
- How does an IPO work?
- IPO versus direct listing
- Can I trade IPOs?
What is an IPO?
An IPO, also known as a flotation, is where a private company sells new shares to public investors. It’s a way of raising capital to fund further growth and innovation, and also allows existing investors to reap the rewards of backing the company during its start-up phase.
Up until this point, the company is privately owned by the people founded it, and any staff or early investors who were given shares.
How does an initial public offering work?
A company that wishes to go public will need to meet certain criteria laid out by the domestic market regulator – such as the Securities and Exchange Commission (SEC) in the United States. Companies can also choose what exchange they want to list on, such as the New York Stock Exchange or the NASDAQ, and these too have their own requirements.
Companies need the help of an underwriter or underwriters to hold an IPO. These are investment banks such as Goldman Sachs, Morgan Stanley, and JPMorgan, and are responsible for arranging and marketing the initial public offering.
It’s common for underwriters to assume all the risk of the IPO by buying all of the new shares being issued by the company, and then selling the stock to public investors.
IPOs: Roadshows and pricing
In the run-up to an IPO, a company will issue a prospectus and hold investor roadshows across the country in which it is listing in order to drum up interest in the flotation. The prospectus will give a target price range for the shares to be issued. This is often adjusted to reflect market demand as the company’s stock debut draws near.
Sometimes the stock of the company is so in demand ahead of its initial public offering that the company decides to issue more shares than originally planned – usually the underwriters are given the power to automatically increase the size of the issuance by a set amount of shares if demand warrants it.
Check out the upcoming 2020 IPOs to stay on top of the roadshows and pricing data of this year’s most anticipated public offerings.
What happens if demand is higher or lower than expected?
Although the underwriter buys the new shares at the final initial offer price, the stock can open above or below this price on its first day of trading. If the company going public and the underwriters have overestimated demand for the stock, the underwriter may have to sell the shares for a lower price than it bought them.
And if demand has been underestimated, the underwriter may be able to sell the stock for a much higher price than it bought them. Doing so is likely to damage their reputation, however, so underwriters have an incentive to try and sell the shares for as close to the initial offer price as possible.
What’s the difference between an IPO and a direct listing?
Companies who don’t want to hold an initial public offering may instead opt for a direct listing. With an IPO, the company going public is selling new shares, giving away control of more of the business.
A direct listing, on the other hand, is where a company allows its existing shareholders to sell the stock on public markets. This allows early investors to reap the benefits of backing the company, and allows the company to trade publicly without giving away control through the issuing of new shares.
A company does not need to hire underwriters in order to hold a direct listing – saving it a lot of money in fees. This also means existing investors may be able to sell their stock for a higher price.
Can I trade IPOs?
IPOs can represent some of the biggest trading opportunities on the stock market. Companies such as Beyond Meat have seen their stock surge since they went public, while others, like Uber and Lyft, have performed poorly.
With Marketsx you can trade companies before they go public with our exclusive grey markets, or trade CFDs on the hottest companies on the day they debut, as well as taking positions on ETFs that track the newest stocks on the market.
What is Stock Market Gamma?
Buried beneath the market lies a remarkable force. It lurks within the mathematical equations that govern derivatives. We’re talking about stock market gamma. It sounds geeky and boring but its impact is simple: when the market is positive gamma, it’s less volatile; when it’s short, things can get moving. It creates a feedback loop. Welcome to the power of gamma.
What is stock market gamma, then?
Put simply, gamma is the change in an option’s delta for a given move in the price of the underlying asset. If you think that doesn’t sound simple, you’d be right.
Let’s go back to the basics of how derivatives work. Once we know that, we will explain how it affects the whole market.
As you know, options are instruments that give the owner the right, but not the obligation, to buy or sell the underlying asset. As the name suggests, they give you a choice. For example, a call option on 10,000 shares of Apple is the right to buy those shares in the future at an exercise price that we strike today. You might decide not to exercise that right when the time comes, because markets move around. That’s very different to just buying Apple today. You own it at today’s price. The option gives you much more flexibility.
The flexibility that comes with an option means that it’s more complicated to determine its price. A share in Apple is $315. That reflects the equity value of the company. But an option on Apple? There’s more factors to consider. More uncertainty about the future. What happens if markets get more volatile? What happens if your option is long rather than short dated? What interest rate would your money earn at the bank if you left it there and didn’t own this option? All of this was boiled down into the Black-Scholes Options Pricing model, which took into account the volatility of the asset, the length of time until the option expired, and the risk-free rate, amongst other factors.
The price of a share in Apple can go up or down. But with options all of these other factors can go up or down. That means managing the risk of an option is more complicated. A market-maker in Apple stock just has to cover the bid-offer spread. But a market-maker in Apple options has to consider how to cover all these other factors, like how volatility moves and time ticks by until the options expire. But don’t worry, because there’s a mathematical model to cover all of that too. And each factor is represented by a Greek letter.
Why are the Greeks important for trading stocks?
Options market-makers spend their time trying to cover all of their Greek risk. Think of it like a game of whack-a-mole: they flatten their exposure to time, but then exposure to volatility pops up. They flatten that, but then exposure to interest rates pop up. It’s much more exhausting than just simply being exposed to a stock price going up or down. But it also offers plenty more opportunities to make money.
You might remember Delta from your algebra classes where it simply refers to a “change”. When it comes to derivatives it refers to how the price of the option changes as the underlying asset price changes. So when the price of Apple moves, the price of options on Apple changes by its delta.
Now we are back to where we started. Stock option gamma is the change in delta. Once market-makers know this number, they can automatically hedge their positions. The game of whack-a-mole requires hardly any effort. Just set the machines to calibrate the maths, and bingo their positions are covered.
How the financial crisis affected stock market gamma
For a long time gamma in the stock market didn’t matter much at all, except to the option nerds like those of us at BlondeMoney. But then something happened. After the financial crisis, more and more cheap money was pumped into the system. The authorities wanted to make sure that we would all take risk, and lots of it. If not, we could have disappeared into a debt deflation trap out of which we might never have recovered. This effectively mandated the short volatility trade, distorting the price of risk.
Remember that volatility affects the price of options. As everyone sold volatility, market-makers owned something that kept falling in price. They had to cover this risk. In the game of whack-a-mole, the little blighter marked volatility kept popping up no matter how hard they tried to shove it back down. It meant that every day volatility fell, they didn’t want to be left holding the long volatility hot potato.
What does positive gamma mean?
When market makers own all this volatility, they are positive gamma. To try and eke out some kind of return from this position, they have to buy low and sell high. And if prices aren’t moving around much, because it’s all lovely-wonderful-happy-no-volatility-in-sight times, then they have a smaller and smaller range out of which to make money. They’re all buying just below the market and selling just above, which tightens the range even further, making a rangebound market trade in an even tighter range.
Welcome to the power of gamma. It’s a feedback loop – a stock market gamma trap.
What happens to gamma when the stock market receives a big shock?
Suddenly there is a lot of volatility. People want to own it, and that leaves the market makers short of volatility just when it’s going up in price. To cover this position, their gamma exposure in the stock market reverses. They are buying as the market goes up and selling when it goes down. Gamma can also be a negative feedback loop.
Why is gamma in the stock market so powerful?
When everyone has the same position at the same time, and covers it the same way at the same time, its impact is magnified. That’s why stock option gamma is now such a powerful force. Everyone has the same mathematical models automatically hedging volatility positions the same way at the same time.
Has this changed since the stock market sell off?
No. In fact, the big switch from positive to negative gamma on the S&P500 helped to exacerbate the sell off. All that’s happened since then is renewed intervention from the authorities, which has started the short-volatility trade off again. The market is now in positive gamma territory, so it will be less volatile until there’s another unexpected shock. Like, say, a huge corporate earnings recession in the teeth of the worst economic downturn of our lifetimes.
But, even then, for this to cause a market crash, we would have to see gamma turn negative.
In conclusion, gamma is a powerful force and we ignore it at our peril.