We have been taking a look at some volume figures with colleagues, and discussing the remarkably low NYSE volumes over the past few days. We were comparing volumes across various exchanges, and wondering about the dark pools of trading that are cleared in off exchange venues. Some wondered if the NYSE volume was primarily the 'retail trade.'
We're not sure just what we think of that yet. But in the course of discussion one of our trader friends brought up the volume of option trades. (Hat tip to George Slezak).
As you know, options are a derivative trade on the future course of a stock or index in a given period of time. Investors normally do not trade in options, unless they are selling covered calls to incrementally increase return, or buying puts to safeguard against downside.
Below are two charts of CBOE volume going back into the 1990's. We were interested to see the spike in volumes of calls in particular around periods of high speculation and important tops.
Another Peak in Speculative Activity?
Are we there again? We're not so sure. But with the data at hand, the overall derivatives volumes including options, and the relative volumes of stocks on transparent exchanges at least, we are concluding that stocks are once again in a speculative bubble, and are "trading like commodities" with less price discovery and only a tenuous connection to the financial fundamentals of individual stocks and the equity markets.
This makes sense. Companies have been spending an inordinate amount of their profits on buybacks of their own stock. This has the putative effect of 'returning value to shareholders' but we suspect it has more to do with washing out the dilution of share floats as management grants themselves enormous amounts of stock options.
However it goes, the current environment is not what might be called 'healthy' by a level-headed economist, especially not one on the pad to a major trading house.
We might add that buying stock option 'calls' is one way to beat the margin requirements and take highly leveraged positions in stocks for periods of time. Despite the recent financial slump we still have roughly 8000 hedge funds out there, in addition to a wave a new retail financial speculation, and 'banks' increasingly dependent on their trading volumes for profits.
This type of wild speculative environment is generally fostered by a loose regulatory environment and even looser credit, and often is the prelude to a serious reversion to the mean of price discovery, aka a stock market crash.
This is the market that has been fostered by the Republican Administration and the Fed. This is hardly what might be called a 'productive economy.' Its an easy money economy. Let's see what happens.
If you have not already done so, please take the time to read The Trillion Dollar Meltdown" which is a couple blog entries below this one. Its worth it.
