“I’ve actually never seen a stock go up endlessly on nothing.”
That’s according to CNBC’s Jim Cramer who commented Monday on Tesla Inc’s (TSLA) near-vertical price rise on the heels of record quarterly revenue and profit, as well as news that Hertz Global Holdings Inc (HTZZ), a rental car company that recently left bankruptcy, would order 100,000 vehicles from the manufacturer.
Last week, SpotGamma unpacked the dynamics driving the stock higher, as well as predictions that ultimately panned out, early this week. Let’s get into what we see, going forward!
The Primer: Alongside commentaries on forums like WallStreetBets, shares of Tesla were further primed for upside when rental company Hertz announced its intent to order vehicles from the manufacturer.
The Squeeze: Though the volatility may have started out as a squeeze of shorts, as evidenced by increased short interest into the news announcement, the event quickly transpired into what we, here at SpotGamma, call a Weaponized Gamma Squeeze.
On the positive news, retail investors aggressively bought stock and short-term call options forcing the market into “short-gamma” and counterparties, who take the other side and warehouse options risk, to hedge by buying underlying shares into strength.
“In other words, the tail wagging the dog.”
Explanation: Coming into Tuesday of last week, nearly 2.5 million options contracts were traded on the stock, a multi-year high, with the most active contract expiring Friday.
As the week progressed, given that the participation was concentrated in the shorter-dated Weeklies expiring Friday, volatility declined as the high-theta options quickly deteriorated; this dynamic led to pressure by dealer supply.
To explain, there are two knowns: as volatility contracts, options will slide down their term structure (vanna) and skew decays (charm). When this happens on the put side, especially in the S&P 500 complex, if the dealer is primarily short put and short futures, participants can expect to see supportive inflows when these big participants cover their short futures hedges.
On the call side, in the case of Tesla, where we believe dealers are short calls, long stock, the dynamic is flipped. Participants can expect to see pressure when dealers sell their long stock.
SpotGamma said this would happen and so, after a brief liquidation, volatility compressed and the stock traded sideways to higher, before closing near the $1,100 high-gamma strike.
After a reduction in dealer gamma exposure, Friday, the stock moved out of range and value, to new highs, Monday.
Expectations: With over a million calls trading Monday, primarily concentrated in shorter-dated expiries, it’s likely that volatility continues into the most serious part of the decay process which is expected to occur mid-week.
Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator side-by-side with Tesla’s intraday stock price. Participants aggressively entered into long-delta positions that forced counterparties to purchase stock into the price rise.
Given that there is a large base of gamma at the $1,100 strike still, SpotGamma sees this level acting as short-term support on any consolidation into the November 5 expiry, for which we see the $1,200 strike being most favored, now.
Graphic: Snapshot of SpotGamma’s modeling of options positioning for Tesla. Note that $1,100 is the key gamma strike.
We caution readers: “These rampant moves are appearing to be more widespread, and we believe this invokes instability that usually ends badly.” – SpotGamma founder Brent Kochuba