PED had an excellent article about options in general and AAPL in particular. I have no interest in using options but I appreciated the explanation enough that I included the complete text of the article. It's also worth reading the comments at his site, IMO.
What the hell happened to Apple last week? Published September 5, 2020 by Philip Elmer-DeWitt
An explainer for market newbies from friend-of-the-blog Kathy Corby
You’re new to trading and you’ve just lost a lot of money in the options market. If you listened to the cautious old traders who blathered on about risk management, maybe not all of it. If you didn’t listen, I’m sorry.
So, what just happened?
Most everyone understands stocks. For a certain amount of money, determined largely by the laws of supply and demand, you can purchase part of a company—literally, a share. But not many people understand options. Options are derivatives—they take their value from the price of the stock to which they pertain, called, for options purposes, the underlying. They don’t give you a piece of the company.
There are two and only two types of options—calls and puts—although they are often traded in well-defined groups or combinations. If you purchase an option, you have a right, one for which you have paid hard cash. If you sell an option, you incur an obligation.
If you purchase a call, you have the right to “call” shares to you of the underlying stock, at a certain price, and during a certain agreed upon timeframe. If you sell a call, you are paid to incur an obligation: to have shares called away from you, at a certain price and during a specific timeframe. With puts it’s other way around, but you can ignore puts for now because this is a story about calls
Now you know what you need to know to understand the week of August 31-September 5th.
OK, we are in Japan now. It is there, in Tokyo, that Softbank Corporation, a multinational conglomerate, and the second largest public company in Japan (after Toyota) is located. It was founded and is still run by Masayoshi Son. Softbank owns massive investments in many companies, including Amazon, Microsoft, Netflix, and Tesla. Over the past weeks, it was learned Friday, SoftBank carried through a coordinated program of call buying, purchasing four billion dollars worth of calls, thus driving up the price of those calls. But because the market makers who sold the calls needed to purchase stocks to offset their own risk, the prices of the underlying stocks rose at the same time. The calls themselves, being leveraged and in fact unlikely to be profitable, were cheap and didn’t even need to pay off later, although some undoubtedly did. The effect of the buying spree was in fact to drive up the prices of shares meaning that they could be sold later at a large profit. And drive them up, they did.
Now, Softbank wasn’t the only purchaser of those calls. Individual “retail” investors took notice. “Look! Stock and options prices prices only go up!” Some (lucky/smart) investors bought the shares themselves, and suffered large but tolerable losses in the carnage to follow. But others, seeking a way to get rich more quickly, used the leverage provided by options. Of course, those options were also being purchased by Softbank, and so became more and more expensive, and less and less likely to be profitable if the stock price fell. And on a rapid decrease of the price of the underlyings, these calls would lose almost all of their value, and “expire worthless”— run out of time and resale value, leaving nothing in the hands of the hopeful traders except bitter experience.
Early in the week, traders noticed the unusual increase in the price of calls, and became anxious. Some hedged their investments, or exited trades at specific profit targets. Market anomalies tend to have that effect on watchful and appropriately paranoid traders. A “tell” of trouble brewing was the increase in the “VIX”, a derivative of options prices that goes up in value when options become expensive. Usually this occurs when there is uncertainty in the markets that cause hedging behavior in the form of put buying. This time around, however, was different. The VIX was going up, and the market was going up, and the price and value of calls was going up— all three together. A spring was being wound up somewhere.
Prices of many stocks had shot through the imaginary roof in the weeks leading up to September 2nd. Then in the bright dawn of September 2nd, Apple share prices opened at a new all time high, and suddenly began to plunge.
Someone, somewhere, was selling massive numbers of shares, and operating on the law of supply and demand as market do, the price responded. Nvidia followed the same pattern on the same day. Tesla shares actually had begun to plummet the day before, and Amazon followed the next day. Microsoft, those juicy chip stocks, even Zoom— they all came tumbling down in the space of two and a half days, then inexplicably braked mid-day, reversed and headed higher again. As they say on Twitter, SMH (shaking my head).
Apple’s high on 9/2 was 137.98; its low on 9/4 was 110.89: nearly a 20% drop in share price. And this occurred on no news regarding the company and on generally good news regarding the fate of world financial markets. Apple was the same juggernaut of past and future profit as two days previously. On just the first day of the bloodbath, Apple lost in market cap the value of the lowest 470 companies in the S and P 500—one hundred eighty billion dollars erased from pension funds, investment funds, hedge funds, and— from the portfolio values of countless individual investors. Some were retirees, or hoped soon to be. Some had invested the downpayment for a house, or their kid’s college money, or the rent for this month. Some were making their first hopeful foray into the investment markets, having overlooked the statement that “options involve risks and are not suitable for all investors” that they needed to claim to have read, in order to be granted options trading privileges by their brokers. But the big time sellers who pulled the plug made out like, well, like bandits. As in matters of the heart, first cured is best cured.
So far, it’s not confirmed that Softbank started the selling that soon snowballed into panic. Required regulatory filings revealed the stock and options purchases, but when and even if these were sold, we don’t know yet. And we might not ever know, not for sure. But even if we did, what was done appears to be perfectly legal. The answer to the incredulous empty handed investor’s question: “Can they do that?”— is an unequivocal yes.
So now you know. And by good fortune, we have a long weekend and the markets are closed for the long weekend. So, have a happy Labor Day and forget about the markets. See you Tuesday at 9:30 Eastern time.
My take: Thanks, Kathy!