Chasing bigger gains, some have exposed themselves to potentially devastating losses through riskier plays, such as concentrated positions and trading options
Some investors have been tempted to chase bigger gains—and have exposed themselves to potentially devastating losses—through riskier plays, such as concentrated positions, trading options and leveraged exchange-traded funds. Others are borrowing against their investment portfolios, pushing margin balances to the first record in more than two years, to buy even more stock.
The stock market is on the verge of closing out one of its frothiest runs in years. Some of the biggest fortune makers include Tesla, up 691% so far this year, and fuel-cell company Plug Power Inc., more than 1,000% higher. Zoom Video Communications Inc. has added 451%, while scores of biotech stocks have also soared, including Covid-19 vaccine maker Moderna Inc., up 532%.
“The stock market is euphoric right now,” said James Angel, a Georgetown University finance professor. “A lot of people are extrapolating from the recent past and going, ‘Wow, the market’s gone up a lot and I think it’ll go up more.’ We’ve seen this play out before, and it doesn’t end well.”
In the final week of 2020, investors will be watching for last-minute changes to a Covid-19 relief package after President Trump demanded higher payouts for Americans. The pandemic itself remains in focus as cases, hospitalizations and deaths soar across much of the country.
A strong indicator of stock-market euphoria flashed red last month. Investors borrowed a record $722.1 billion against their investment portfolios through November, according to the Financial Industry Regulatory Authority, topping the previous high of $668.9 billion from May 2018.
The milestone is an ominous one for the stock market—margin debt records tend to precede bouts of volatility, as seen in 2000 and 2008.
Investors using margin debt pledge their securities in exchange for loans from brokerage firms to make further investments. They can get into trouble if their collateral falls below a certain threshold, triggering a margin call. They then have the option of either putting up more money or selling the securities underlying the loans. Many investors also use their margin balances to trade options, contracts that give them the right to buy or sell shares at a specific price, later. Options trading exploded this year as individual investors flocked to the stock market. A record number of options contracts have traded this year. An average of 29 million changed hands each day this year, a 48% jump from 2019, according to data from Options Clearing Corp. Traders can tap options to hedge their portfolios from stock declines or make bets that major indexes and individual companies will go up or down in value. Using some of the riskier strategies, traders can also lose more than they put in. Of course, individual investors who overextend themselves have been burned before. Nick Note: If ever their was a market I want to short this is it.