Read on Twitter
How have the Fed and the Federal Government created a massive moral and economic hazard through the options market?
A quick thread.
/1
A quick thread.
/1
First, two things:
1. The Fed is not buying stocks.
2. QE is not the Fed giving money to primary dealers to speculate in the equity markets. It is simply a swap of Federal Reserve liabilities for Treasuries in reserve accounts held at the Fed.
/2
1. The Fed is not buying stocks.
2. QE is not the Fed giving money to primary dealers to speculate in the equity markets. It is simply a swap of Federal Reserve liabilities for Treasuries in reserve accounts held at the Fed.
/2
Small trader call option buying is at record levels by a wide margin. Much of the money being used by retail traders to speculate comes as a result of government COVID crisis measures - stimulus checks, PUA, PPP, eviction moratoriums, student loan deferrals.
/3
/3
The Fed is enabling this call buying frenzy by supporting the other side of the trades, which has essentially put Market Makers and retail call buyers on the same side of the trade.
/4
/4
They've done this by holding rates at effectively zero in short term lending markets through the Federal Funds Rate and a promise to intervene in the Overnight Repo Market to pick up any slack the market cannot handle.
/5
/5
When a market maker sells a call option, they hedge the contract by buying or borrowing shares of the underlying security (at a rate of 100 x the option's delta). Normally, the more action an option gets, the higher the premium rises as Market Makers' exposure increases.
/6
/6
The Fed has reduced risk for the Market Makers in terms of liquidity and interest exposure through its intervention in short term lending markets, and that has allowed Market Makers to get fast and loose with selling call options.
/7
/7
It's also enabled them to build massive exposure to downward moves in equities due to their large hedge positions. Meaning, the Market Makers NEED more and more people to buy calls to keep the flywheel going.
/8
/8
Why is this bad other than the obvious instability and structural weakness it has created in markets?
It's bad because it's encouraged a rampant misallocation of capital - much of it government spent capital.
/9
It's bad because it's encouraged a rampant misallocation of capital - much of it government spent capital.
/9
Today, the Reddit WallStreetBets community coordinated an attack on short sellers of Game Stop $GME. This wasn't about a fundamental belief in the company's value. Game Stop is a dying mall retailer. This was about gambling and driving a vendetta against Citron Research.
/10
/10
Yay! A bunch of retail nobodies pulled one over on a large short seller.
But there are real consequences.
/11
But there are real consequences.
/11
This stunt added 50% or $1.52B to Game Stop's market share. The company will likely do a secondary to raise cash - which they will most likely incinerate. Their insiders - who did a shitty job of running the company - are being rewarded selling shares at unjustified prices.
/12
/12
And where did a lot of this capital that Game Stop will destroy come from? Government programs intended to get the economy back on track. How can we revitalize the economy when so much of the funds intended to do that wind up with companies whose businesses don't justify it?
/14
/14
We can't.
And that's why what the Fed and government are doing is so wrong.
Everyone loves it now because their stocks are going up, but they're missing the bigger picture: these policies that prop the stock market directly hurt the health of the economy.
/15
And that's why what the Fed and government are doing is so wrong.
Everyone loves it now because their stocks are going up, but they're missing the bigger picture: these policies that prop the stock market directly hurt the health of the economy.
/15
/wallstreetbets will get theirs. The party will end. Either more stimulus won't come, the economy will open up and the call frenzy will slow, an exogenous event will zap markets and their positions will blow up, or the Fed will make a gaffe.
/16
/16
The problem is the economic damage is permanent.
/17
/17
If you have something constructive to add, I welcome it.
If you're going to come at me with "YOLO", "You mad, bro", or anything idiotic, you're blocked.
/18
If you're going to come at me with "YOLO", "You mad, bro", or anything idiotic, you're blocked.
/18
@threadreaderapp unroll
