ASH BENNINGTON: It's Wednesday, September 16th, 2020, just after market close in London. This is the Real Vision Daily Briefing. I'm Ash Bennington joined shortly by our managing editor Roger Hirst, but first, an unscripted daily briefing with Haley Draznin. Haley, welcome back.
HALEY DRAZNIN: Hey, Ash, good to be here.
ASH BENNINGTON: Haley, what are you looking at today?
HALEY DRAZNIN: Retail sales were out this morning and spending appears to have grown at a slower pace in August than prior summer months. A tepid 0.6% versus the expected 1% high that we were planning on seeing and I think this highlights the consumer spending patterns that we're seeing. The Federal relief bill for unemployed people dried up a bit and Americans are spending less. They have less in their wallets and that's reflecting this number. We did, when looking closer at the numbers, did see a boost in clothing, in furniture, in electronics, and I think this might be a result of this confusing school year that we're starting.
ASH BENNINGTON: Yeah, exactly to your point. Retail sales up 0.6%, consensus range 0.2% to 2.5%, so toward the lower end of the range. Most intriguingly, perhaps, prior month 1.2%. Roughly a 50% fall off of the rate of increase in the retail sales number from last month. Looking a little deeper into the data, x vehicles, it's a little bit stronger 0.7%.
HALEY DRAZNIN: Equity markets are up despite these slower retail numbers and I think it goes to show that the markets aren't so sensitive to economic data as much these days. At the time we're filming this, we're waiting on the Fed and also, investors in the coming weeks are waiting to see for another stimulus package out of Congress.
ASH BENNINGTON: Yeah, exactly. Maybe that's even you putting it too terribly, Haley, it's the markets are just totally disconnected from anything that seems to be happening with the real economy.
HALEY DRAZNIN: It's this juxtaposition we've been covering between the real economy and the markets that we'll continue to cover in the coming months.
ASH BENNINGTON: Yeah, that's exactly right. Haley, what else are you looking at?
HALEY DRAZNIN: More on the US equity market, we're seeing a surge in IPOs this week, take Snowflake, for example, the cloud based data company, it debuted today and more than doubled its opening price, I think at 245, $245. It shared and it was listed at $120 so incredible to see that investors want more high growth stocks than the things that have rallied so far this year.
ASH BENNINGTON: Obviously, we're recording here at about 2pm Eastern time so we have some time left before the end of the trading day. Your mileage may vary.
HALEY DRAZNIN: It's hard to believe given the pandemic but 2020 is proving to be one of the biggest money raising years for new issues since the tech boom 20 years ago, and I think a lot of it has to do with this new Fed policy and the idea that there are very few places for investors to park capital outside of equities. Companies really seem to be racing to IPO under this premise.
ASH BENNINGTON: Yeah, I think that's a really great metaphor. We've talked about this before. This does harken back to the tech boom when I was one of the young guys on Wall Street. Just reading through doing a little bit of research on Snowflake coming in here, it really is like a checklist of all the buzzwords we have. Let's see. We got AI, we got big data, data lake, data exchange, cloud, cloud compute, Software as a Service, service as revenue. It really does check every box in this particular domain of stocks that are hot.
Look, it's important to realize that this is a story that's very different than Nikola, which we talked about yesterday. Last year, the company revenue rose 174% to $265 million. Over a quarter of a billion dollars in revenue, fastest growing business application into 2019 according to data from Okta. They're raising $3.5 billion, total valuation of $33 billion. I think one of the more intriguing factors that's gotten market attention is Warren Buffett who has historically been allergic to tech stocks, has been allergic to companies that he doesn't understand is investing hundreds of millions of dollars into this company.
HALEY DRAZNIN: Yeah, it's amazing. Snowflake CEO is selling half of his 8 million shares to Buffett's Berkshire Hathaway. As you said, this typically isn't in Buffett's playbook so it's definitely making it attractive.
ASH BENNINGTON: It's an interesting story too. Look, I don't want to get too far over my skis here. It's been a long time since I've been in the tech space but the company does something that's really interesting. Effectively, what they're doing is they're doing cloud database services that allow for more virtualized data analytics and basically what that means is they're disaggregating the data layer from the compute or analytics layer, and they're framing it in a way so that you can get more software, more hardware, analyzing and churning through this data so it is very much a very 2020 story.
HALEY DRAZNIN: It's interesting not a lot of competition except Oracle and Amazon's Redfish.
ASH BENNINGTON: I would be willing to bet that Mr. Bezos and Mr. Ellison are going to be investing more capital in this space very shortly.
HALEY DRAZNIN: As I always say, we'll keep our eye on it.
ASH BENNINGTON: Well, there's a lot to keep an eye on. Haley Draznin, thanks for joining us.
HALEY DRAZNIN: Thanks for having me, Ash.
ASH BENNINGTON: Roger Hirst, welcome back.
ROGER HIRST: Hi, Ash, good to be here.
ASH BENNINGTON: It's been a few weeks.
ROGER HIRST: It has, I think, two, maybe three weeks. It's been quite a dramatic couple of weeks in many ways at least in the US equity market.
ASH BENNINGTON: Roger, exactly to that point, the three things that have been on my mind, options, options, options. You've been so eloquent in explaining this on the Refinitiv channel that's partnered with Real Vision, and I thought that this would be a great opportunity to have you unpack a little bit about how you see the world and how the fundamentals of this market work.
ROGER HIRST: I think there's a couple of things. Obviously, everyone talks about the options whale. I think that the whale, SoftBank, has been perhaps less of an influence, certainly been in there but it's maybe been a follower rather than the driver. I've called the retail has been the megalodon of the markets, the retail meg, they've been the real drivers of this. They've been driving-- it's been incredible size. We've seen the notional of options has got to 140% of the cash market. Three years ago, that used to be around about 40%. These are huge numbers.
What's been really fascinating is that the size of the options contracts have generally been under 50 lots. 50 lots is 5000 shares, so 100 shares per contract, 50 lots is 5000 shares or under. They've been trading a little and often whereas the options whale, it looks like they were doing largely call spreads and often doing them delta neutral because I think they were selling out of stock positions and buying call spreads. If you're doing that, you're having less impact on the direction and also having less impact on the absolute volatility. With the retail guys, they've been in size, they've been buying calls, which means they're buying volatility and because of the market makers who are selling the calls have to buy the stock as a hedge, they've been pushing the market up.
There's been this options-led equity exuberance, but I think the other thing that I've been talking about is that it still feels like this is an unwind of an exuberance on the upside and an unwind of exuberance to the downside, but it's basically an air pocket. As yet nothing obviously structural in what we're seeing is really dominated by those equities, in particular, options on seven mega cap tech stocks, which are driving all that volume.
ASH BENNINGTON: There's a lot to unpack there. I find this absolutely fascinating, the real whale, or as you put it, the megalodon isn't one particular institutional investor, it's your friends and neighbors who are actually participating in the option space in a way that they haven't in the past. I want to jump to hearing you explain the significance and the mechanisms that this market worked by because you've done such a great job on this. You mentioned delta, we talked a little bit off camera in past about gamma, explain how these Greeks work and what the impact is on a relative and absolute basis to the US equity market.
ROGER HIRST: What these guys are doing is attending, the majority of what they're buying are options with less than two weeks to expiry. An options contract is a bit like insurance, you buy insurance for a year, once it runs out, you have to renew. Well, these are options that only have two weeks to run. We've got the big expiries actually on Friday of this week. You have the quarterly expires which are March June, September, December with the big volume. What generally happens is as you get closer to that expiry, the natural thing is the gamma picks up. If you've got this-- if this is expiry, if you're at the money, then the gamma required increase as you go to expiry.
The reason behind that is that if you're two months away or more than two weeks away, you buy an at the money option. If stock is at 100, strike is at 100, you probably have to have a 50 delta hedge. Let's say you're on the day of expiry, now, this is an extreme example. As a market maker who sold that call, If it's at 101, you have to deliver all the stock. If it's at 99, you have to deliver nothing. That stock starts moving around and market makers conceivably have to buy 100, sell 100, buy 100, sell 100. In reality, they don't do that, they manage themselves or they might pin the stock above or below the strike. Anyway, that's the gamma that picks up.
Now, what we've been seeing is this upward pressure as we got close to the September expiry, as we move through these strikes, as you get close to the strikes, close to expiry, the number of stocks you have to buy per unit of underlying increases and increases and it goes like this, like this, like this, and then it goes zoom, straight through and rally through I call these the gamma hammer, your base positions and it whams through. This was a great way of playing these opportunities. At the end of 1999, myself and Raul were doing this and we shorted the French market which expired at the end of the year, whereas everything else was [?] fighting for the French market and everyone's away, we saw it happening into the end of '99.
That's what we've been seeing here. It's been a led by these retail guys just buying long calls, not hedged, a market maker sells a call, buys a stock against it. As the market moved up, they had to buy, it all works in reverse. You eventually go blast through all your gamma, blast through your hedges, runs out of steam loses momentum and reverse and then the same thing happens in reverse which is what we've been seeing the last two weeks. I think a lot of this will disappear after the September expiry. This is the triple reaching, quadruple reaching in the US where you get index options, single stock options, options on the futures or there's no volume there and the futures themselves all expire, either in the morning in the index level or single stocks at the end of the day, it happens in Europe as well.
ASH BENNINGTON: The mechanics of the way this works are so crucial to understanding the market and the gyrations that we've seen. As you said, it increases volatility around particular expiry periods that have nothing to do with anything that's fundamental, for example, with earnings or with macroeconomic fundamentals.
ROGER HIRST: Yeah, and we've seen this before. You may recall back in March, again, I never made any predictions before someone say, you didn't say that. I said you've got to watch for expiries because you get inflection points regularly. When you get a big move into and around an expiry, you often get an inflection point. On at the time, I said, remember the low of December 2018 was the first trading day after the December expiry which is Christmas Eve. The lower the March selloff, COVID selloff was the day after the March expiry, and expiry was on 21st, the second and third, Monday the 24th, it's the 20th, Monday, the 23rd was the low, we had the package from the Fed as well. That was also a low.
A week and a half before the June expiry, we had the 5% air pocket. Two weeks before this expiry, we just had a 10% air pocket on the NASDAQ. They should be critical to people's thinking. They don't define the direction, but they can accelerate the direction of the market in both directions because of the inventory management that has to go on around. I always just say look, be aware that we're coming up to one and we've got the mark the September expiry on Friday of this week. We've probably seen a lot of gamma now moving out of the market, the shortest dated options really now were one month from here to the October expiry. Just change that dynamic a little bit.
ASH BENNINGTON: Talking about the air pocket, Roger, you were ahead of the curve on that. For viewers who watched the Refinitiv show, they got that ahead of when it actually happened in terms of your-- I don't want to call it a forecast but your analysis of what had potentially been lurking beneath the surface.
ROGER HIRST: That was pure luck, obviously, because we go out once a week and the daily we do is normally a Wednesday when actually this week, and it happened that the Wednesday was the day before, the selloff kicked in. We actually said the week before that, we've said, look, we can see that data usage is ridiculously low. People are away from their desks. Implied volatility is very, very high. The market realized volatility was very, very low. Volatility was expensive, driven by two things, retail buying it, but also as we're getting closer and closer to the election, you've got this incredible bump in the VIX curve.
Five months ago, you're along the way out but as you get closer, you're moving up the curve. The October VIX futures currently are around about 30. When September expires and we roll along to October, the VIX will go up again just because we're going up that curve. Those were really driving it and as I just said, look, this is an air pocket waiting to happen. I don't think it'll be a structural move. I think it will be an air pocket move, and that's what we've got.
The other side of this, the other bit of this is obviously the options whale. The options whale has been buying these call spreads. You buy, let's say you got a strike of 100 again, you're buying the 105, you're selling the 110, the 105 might need a 20 delta hedge and the 110 might need a five delta hedge. You've got a 15 delta, it's a smaller delta, there's less impact on the market. If they're selling the stock against it anyway, it's neutral. Then there's only a small amount of rolling back. I don't think they're having the big impact here. I just think it's the retail, and they're just doing it in this incredible size.
They've got the momentum trade, they've got the wind behind their backs, and they're doing it and I think it's an exuberance, but I don't think it's a structural risk, because they're playing from the long side. Yes, they might be using all their savings. Yes, they might even be using leverage, which would be a bit of a worry, because you're long premium, you can only lose your premium and no more. It might be all your savings, but that's where you can lose.
ASH BENNINGTON: Roger, you just mentioned that you didn't think this was anything more than really an air pocket in the market. Why do you think that?
ROGER HIRST: There's a couple of things at this stage. The first one was that I only look at something like credit spreads. Now, the credit market is obviously being deformed by the activities of the central bank who are buying corporate bonds. When I looked at something like the 5-year credit swaps, so this is the index, it's got a nice little coincidental pattern with the VIX. When we saw the VIX going up with this latest move, so we did see vol picking up a little bit, VIX spikes, but the credit derivative index didn't. Now, VIX has gone up and it's moved back down again. There wasn't a big threat coming from the credit market. Now, the problem with this is that the credit markets not giving good signals because it's a default market by the central banks.
The second element to the low as well is that we can look at HYG, which is the high yield ETF and LQD, which is the investment grade one and those peaked and then have been flatlining for actually more than a month. The S&P has been, again, following that into recovery and then had this spike up in the last the two weeks before the air pocket, in the air pocket back then. Again, the S&P went through a round trip whilst the high yield and the investment grade did nothing.
Then the third thing is vol of vol. This is the key thing, which is volatility of volatility so options on the VIX, volatility of volatility. When things get really hairy, often the volatility of volatility really goes up. That's when you have these structural short positions. We had that in volmageddon in 2018. There's a massive short vol, structural short vol position yield enhancement. When that moved, when the market moved, vol of vol exploded higher over the next two years and built up again so then when we had the March implosion, vol and vol exploded higher. This time around on this move, vol of vol has been very, very well behaved, it hasn't moved aggressively.
Again, it's because this market has been driven by the retail from the long side buying options, driving the market up, driving volatility up plus that election impact. You can see this with Apple. Apple price up, the apple VIX, AAPL VIX on Bloomberg for instance, moved up as well and then when Apple sold off, Apple VIX sold off because people are now looking into profits and selling options. Again, it shows you that there's not that massive structural short that can often unwind positions. In 1987, people sold puts all the way up. When the market collapsed, those puts got blown out and you had unlimited losses. This time round, it's being driven from the long side where as long as I'm not using a leverage in their margin account to buy the premiums, they're limited to losses on those premiums only.
The structure is less critical. I still think the next phase of the market is