Stocks plummeted Wednesday as short selling continued, and the Federal Reserves messaging may have disappointed investors. Meanwhile, it isnt a coincidence the market weakness is happening now of all times.The
Dow Jones Industrial Average
tumbled 633.87 points, or 2.05%, to close at 30,303.17. The
S&P 500
fell 98.85 points, or 2.57%, to end at 3,750.77, and the
Nasdaq Composite
dove 355.47, or 2,61% to close the day at 13,270.60. The biggest S&P 500 gainer was storage and information-management firm
Iron Mountain
(ticker: IRM), which saw shares surge 10.8%. Much of the stock markets fall continues to be attributable to the options market.
(GME), Bed Bath & Beyond (BBBY), and
AMC Entertainment Holdings
(AMC)stocks from a laundry list of gainersrose 134%, 43%, and 301%, respectively. Part of the run-up in these previously shorted stocks is happening because retail traders are buying call options on these stocks, which means the brokers who write the call optionsthe right to buy a stock at a predetermined pricehave to hedge against those contracts by buying the shares, sending prices ever higher, Steve Sosnick, chief strategist at Interactive Brokers, explained to Barrons.
The volume of options contracts traded Tuesday was 39.3 million, almost twice the trailing one-year low, according to data from the Office of the Comptroller of Currency, an independent bureau of the U.S. Department of the Treasury. Of those options, more than 30 million were calls, not putsthe right to sell a stock at a certain price. With each call representing roughly 100 shares of underlying stock, there were several billions of shares impacted by the activity, which also means the total value of equity impacted was a magnitude higher, since most shares are worth many dollars. Data for Wednesday arent out yet. The impact on short sellers: they have to cover their shorts.
This has a spillover effect on the broader market.
S&P futures came for sale this morning amid more margin-call concerns (like we saw Monday) as some of the most-shorted U.S. companies continue to squeeze higher, wrote Tom Essaye, founder of Sevens Report Research. As explained Tuesday, those who were previously short these stocks now have to cover their bearish bets by buying back the shares. Funds that face margin calls have to either deposit available cash with their brokers who lent the shares, or sell stock they had been long in to raise cash.
This comes as strategists have been calling for a correction. Stocks are a bit overextended according to some metrics, and investors holding less cash than in past months. It may make sense to sell some stocks in this context rather than to draw on existing cash. You combine that [lower cash levels] with things being extended anyway, and the market could experience turbulence, David Miller, chief investment officer at Catalyst Capital Advisors, told Barrons.
The major indexes spent much of the day down 1.5%. Then, after Fed commentary, the market tumbled down another leg. The Fed unsurprisingly kept rates where they are, but Miller said the central bank did little to assuage investor fears that it will reduce the size of its bond-buying programs soon. Less demand for bonds from the Fed likely means lower bond prices, higher yields and borrowing costs, and a strain on the economy and stocks.
You put those two together, the options piece and the Fed, those were the two biggest things today, Miller said.
If the vaccine story remains intact, this could quickly become a buying opportunity.
Write to Jacob Sonenshine at