‘Tis The Season

’Tis the season to be jolly! The scents of pine cone, mistletoe, and speculation fill the air! Wait… what’s that last bit, you ask? Speculation? Yes, it’s everywhere. Last month, I noted the rise in US margin debt levels and record low credit spreads. Both are indicators of strong risk appetite among investors.

That appetite is showing up in markets as investors gobble up risk assets anywhere they can find them, from stocks, to high yield bonds, to cryptocurrencies. The feeding frenzy is foraging even beyond cash/spot markets and into derivative/futures markets.

According to a report from Citadel, retail options trading activity has spiked to eye-watering levels over the past year. The leverage inherent to derivatives like options contracts, and their speculative nature, exacerbate issues with margin debt.

Maybe the most emblematic harbinger of speculative fervor is the proliferation of “betting” platforms (read “gambling”). Maybe you’ve heard the advertisements for apps like DraftKings or FanDuel where “investors”can legally place wagers from their phones on everything from winners, to point spreads, and even specific in-game events!

And why stop at sports betting? Investors can now bet on anything from election outcomes to rain or shine through products like forecast contracts and binary options. To be fair, futures contracts for weather have long existed in derivatives markets. However, they primarily existed as insurance for practical purposes, like farmers hedging their annual crop against bad weather. The new iteration of contracts, like if the temperature will reach 90 degree F in Dallas tomorrow, serves little purpose beside sheer speculation.

I’m not passing judgment on the morality of betting on the weather. But what I am saying is when we hear commercials encouraging main street to gamble on everything from sports to sunshine, then we’ve also reached a point in the market cycle that warrants heightened caution. ‘Tis the season to be jolly, but not one for investors to be careless. Happy Holidays and be careful out there!

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Victor K. Lai, CFA