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The shares of electronic trading app provider Robinhood (HOOD - Free Report) rallied 50% yesterday to close at $70.39. After going public at $38/share just a week ago (and then initially declining), Robinhood is now up 85% in its first week as a public company. Who knows, by the time you read this later today, the shares might even be up more...
You might be thinking that you should hook your wagon to this star and see if you can’t make a big score on what has definitely become the hottest stock in the market, rivaling even the meteoric ascents* of GameStop (GME - Free Report) and AMC Entertainment (AMC - Free Report) earlier this year.
Since this is the “Bear of the Day” you might be expecting me to bash Robinhood as a company, but you aren't going to find that here. (Though if you are interested in hearing me do that, listen in to Tracey Ryniec’s Market Edge Podcast this week.)
Instead, I’m simply going to explain what I think is a major mechanical factor in the runup we just saw, and you can make your own decision about whether you want to go ahead and place that buy order.
The Float
When a stock goes public via a traditional IPO – as Robinhood did – not all shares are sold to the public. Most of the shares that are owned by the company’s founders and early private investors remain in their hands and only a fraction of the total shares outstanding find new buyers. In the case of Robinhood, 52.4 million shares were sold to the public - out of approximately 835 million outstanding.
If you want to sell the shares short, you have to borrow them first - and only a very small fraction are available for you to borrow. It’s impossible to know the exact number of shares out for loan, but the word on the street is that it has been extremely difficult to get a locate in Robinhood shares.
(A “locate” means that your broker has found actual shares for you to borrow and sell.)
The Options
After a stock goes public via an IPO, options on that stock are not available to trade until a week later. In the case of Robinhood, the day that options trading was first available was Wednesday.
A popular phenomenon lately has been for aggressive retail traders with a large tolerance for risk and an equally large appetite for outsized profits to buy short-dated call options rather than buy the shares themselves.
Because they’re looking for maximum leverage on the trade, these traders tend to gravitate toward the highest strike calls, because they're the least expensive and they can buy the largest number of them, thus “controlling” the largest number of shares.
On Wednesday, 70 was the highest strike listed in Robinhood options. The volume traded in the August 70 calls was 79K contracts. The next two most heavily traded options were the 65 calls and the 60 calls at about 15K each. All other strikes traded a tiny fraction of that.
The volume in the 47 strike calls (which were at-the-money when the stock opened for trading) was 190 contracts.
In the next listed month – September – once again the 70 calls were the most heavily traded, with 9K changing hands, followed by the 65 and 60 calls with about 2K/each. Many other September options were barely traded at all.
It’s a fairly safe assumption that the prevailing direction of order flow in all those 60-70 strike call trades was retail investors buying them and market-makers selling them.
The Perfect Storm
When market makers sell calls, they usually hedge the position by buying shares of stock. So after each call buy by retail traders, there was likely to have been an offsetting stock purchase by the market-maker who sold the calls.
In normal circumstances, there are stock traders and market makers stacked up on both sides of the market. When the price rises a bit, they become more willing to sell. It's a higher price. Buy low, sell high. It's in Chapter One of the textbook.
You can buy pretty much all of the Apple (AAPL - Free Report) calls you'd like, and the market-maker who sells them to you will have no problem buying all the shares he wants to hedge the trade, including from traders who are willing to assume a short position in the stock. AAPL shares are extraordinarily liquid. Buy all you want, sell all you want, borrow all you want. Whatever.
Robinhood shares are not liquid. Remember, it’s almost impossible to sell them short right now. All those call buys sent market makers looking for shares to buy in an environment in which it was exceedingly difficult to sell short, so they had to pay progressively higher prices to get the shares they needed. It's a very simple supply-and-demand effect. The shares ripped higher.
(If you’re worried about the option market makers, don't. They were selling options at 250% implied volatility. If you don’t know what that means, it’s a story for another day, but suffice it to say that they’re doing quite well.)
And that’s it. The end of my story.
It’s far from the only factor that sent HOOD shares soaring, but it almost certainly played a big part.
So if you want to buy shares that just rallied 50% in a single session largely because of a mechanical reason, be my guest.
It might happen again - several times over, in fact. Really.
Also, the Chicago Cubs are currently 51-57 and you can get 400-1 for them to win the World Series on DraftKings (DKNG - Free Report) today. Why not grab a piece of that, too? Everybody loves the cubbies!
*Although I just used it, I've always been a little baffled about the term "meteoric rise." From the perspective of Earth, meteors don't rise. They fall.
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Bear of the Day: Robinhood (HOOD)
The shares of electronic trading app provider Robinhood (HOOD - Free Report) rallied 50% yesterday to close at $70.39. After going public at $38/share just a week ago (and then initially declining), Robinhood is now up 85% in its first week as a public company. Who knows, by the time you read this later today, the shares might even be up more...
You might be thinking that you should hook your wagon to this star and see if you can’t make a big score on what has definitely become the hottest stock in the market, rivaling even the meteoric ascents* of GameStop (GME - Free Report) and AMC Entertainment (AMC - Free Report) earlier this year.
Since this is the “Bear of the Day” you might be expecting me to bash Robinhood as a company, but you aren't going to find that here. (Though if you are interested in hearing me do that, listen in to Tracey Ryniec’s Market Edge Podcast this week.)
Instead, I’m simply going to explain what I think is a major mechanical factor in the runup we just saw, and you can make your own decision about whether you want to go ahead and place that buy order.
The Float
When a stock goes public via a traditional IPO – as Robinhood did – not all shares are sold to the public. Most of the shares that are owned by the company’s founders and early private investors remain in their hands and only a fraction of the total shares outstanding find new buyers. In the case of Robinhood, 52.4 million shares were sold to the public - out of approximately 835 million outstanding.
If you want to sell the shares short, you have to borrow them first - and only a very small fraction are available for you to borrow. It’s impossible to know the exact number of shares out for loan, but the word on the street is that it has been extremely difficult to get a locate in Robinhood shares.
(A “locate” means that your broker has found actual shares for you to borrow and sell.)
The Options
After a stock goes public via an IPO, options on that stock are not available to trade until a week later. In the case of Robinhood, the day that options trading was first available was Wednesday.
A popular phenomenon lately has been for aggressive retail traders with a large tolerance for risk and an equally large appetite for outsized profits to buy short-dated call options rather than buy the shares themselves.
Because they’re looking for maximum leverage on the trade, these traders tend to gravitate toward the highest strike calls, because they're the least expensive and they can buy the largest number of them, thus “controlling” the largest number of shares.
On Wednesday, 70 was the highest strike listed in Robinhood options. The volume traded in the August 70 calls was 79K contracts. The next two most heavily traded options were the 65 calls and the 60 calls at about 15K each. All other strikes traded a tiny fraction of that.
The volume in the 47 strike calls (which were at-the-money when the stock opened for trading) was 190 contracts.
In the next listed month – September – once again the 70 calls were the most heavily traded, with 9K changing hands, followed by the 65 and 60 calls with about 2K/each. Many other September options were barely traded at all.
It’s a fairly safe assumption that the prevailing direction of order flow in all those 60-70 strike call trades was retail investors buying them and market-makers selling them.
The Perfect Storm
When market makers sell calls, they usually hedge the position by buying shares of stock. So after each call buy by retail traders, there was likely to have been an offsetting stock purchase by the market-maker who sold the calls.
In normal circumstances, there are stock traders and market makers stacked up on both sides of the market. When the price rises a bit, they become more willing to sell. It's a higher price. Buy low, sell high. It's in Chapter One of the textbook.
You can buy pretty much all of the Apple (AAPL - Free Report) calls you'd like, and the market-maker who sells them to you will have no problem buying all the shares he wants to hedge the trade, including from traders who are willing to assume a short position in the stock. AAPL shares are extraordinarily liquid. Buy all you want, sell all you want, borrow all you want. Whatever.
Robinhood shares are not liquid. Remember, it’s almost impossible to sell them short right now. All those call buys sent market makers looking for shares to buy in an environment in which it was exceedingly difficult to sell short, so they had to pay progressively higher prices to get the shares they needed. It's a very simple supply-and-demand effect. The shares ripped higher.
(If you’re worried about the option market makers, don't. They were selling options at 250% implied volatility. If you don’t know what that means, it’s a story for another day, but suffice it to say that they’re doing quite well.)
And that’s it. The end of my story.
It’s far from the only factor that sent HOOD shares soaring, but it almost certainly played a big part.
So if you want to buy shares that just rallied 50% in a single session largely because of a mechanical reason, be my guest.
It might happen again - several times over, in fact. Really.
Also, the Chicago Cubs are currently 51-57 and you can get 400-1 for them to win the World Series on DraftKings (DKNG - Free Report) today. Why not grab a piece of that, too? Everybody loves the cubbies!
*Although I just used it, I've always been a little baffled about the term "meteoric rise." From the perspective of Earth, meteors don't rise. They fall.