Speculation in Call Volume Hits All-Time Extremes

With options expiry this week, we wanted to have a look at the impact it’s having on markets. IT’S HUGE. In the past week we have seen all-time call volume records challenged (viewers can follow the CBOE data here). Seems the new stimulus checks are finding their way into TSLA call options and others. Speculators have had a voracious appetite (call it FOMO plus leverage) and they have been using call spreads and other speculative strategies to add huge leverage. This effect gets magnified around options expiry dates.

1-Year Average Equity Call Volume vs. 1 Month Average Equity Call Volume

The math (greeks) of options trading can be tricky. There are all sorts of information on the web about it. With earnings season starting this week, many will use options to speculate on outcomes. We can use JPM as an example that is reporting earnings this week on (options expiry) Friday. In its simplest form, the buyer of the call option (the speculator) thinks JPM will report an upside surprise. A look at the chart of JPM, the pre-COVID (all-time) high is 141.10 (Jan 2, 2020). It closed at 136.02 Friday. A 137 call traded at 1.92 on Friday and the 141 call traded at 0.83. So a 137-141 call spread would cost about 1.10 (range might be as much as 1.15) depending on a few factors. If you believe the stock will trade to 141 on a positive surprise, you could limit your risk to 1.15 and have a potential profit of 4.00 (141-137). For options trades, we generally like to see at least a 3:1 ratio or higher.

1) Here is where the leverage comes in to play. Let’s say you buy 10 options (100 shares per) which controls 1000 shares of JPM $136*1000=$136,000 in value). The cost of the trade is $1.10 *100=$1,100. So for a grand, you control huge leverage. The seller of the option (hedger) would have to buy the delta to offset the position.

Contract Delta Position Pos Delta
Buy JPM 1/15/21 137C 0.421 10 421
Sell JPM 1/15/21 141C 0.158 -10 -158
Total Hedge Delta 263

The hedger would need to buy 263 shares to hedge your $1100 trade. So the value of the hedge is $136*263=$35,768. Here’s where the math gets tricky and interesting. So as investor buy calls, the hedger buys the underlying stock pushing up its price. Let’s say that pushes the price up to $138. The delta hedge is now 317 shares and an additional 54 shares would need to be bought. This is the gamma effect. It’s the rate of change in the delta. So as leverage is added (by way of call speculation) the hedge amount goes up.

Contract Delta Position Pos Delta
Buy JPM 1/15/21 137C 0.594 10 594
Sell JPM 1/15/21 141C 0.277 -10 -277
Total Hedge Delta 317

On Friday, the options expire. Lets say JPM is right at 141. The call spread owner buys one side at $137 and sells the other at $141 and cash settles for the $4 profit. A win for the speculator. At 141, the delta hedge is 0.5 or 500 shares. That now needs to be sold by the hedger as the options expire. This is why options expiry days are potential turning points with big volume for stocks with speculation as a growing part of the investor base.

Historically, the put/call ratio is more helpful at market lows. Market highs are a very different sentiment and behaviour. What it tells us is the degree of leverage and speculation in the market is a notable risk, but cannot be timed with precision. Usually, it needs an exogenous event to trigger and unwind of the leverage. The interesting part of delta and gamma analysis is that it gets magnified as well on the way down as more put options buying begets more hedgers having to delta sell short stocks. For now, this is a notable risk factor and suggest that we should not be chasing the market higher (unless of course you are a speculator).

Look for more in the coming weeks from our new Berman’s Call Probable Return on Investment Index, PRO-II (pronounced Pro Eyes) Indicator. We will be launching the new website this month so that BNN viewers can follow along with the various risk and opportunity factors we follow.

Subscribe to my new YouTube channel LarryBermanOfficial which is the new site for all our educational content and my new weekly market recap and ETF bull and bear picks of the week. Look for a series of option based educational videos in 2021.


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