Global stock markets have undergone unprecedented movement since the beginning of the COVID-19 pandemic. Despite reaching all-time highs in mid-February, by the end of the month, major indices across the globe marked their worst one-week sell-off since the 2008 Great Financial Crisis. Stock valuations experienced extreme volatility throughout March, while US oil traded at unprecedented negative prices in April.

Yet, following massive economic stimulus, the S&P 500 and NASDAQ in America rallied from April to early September in the wake of big-tech strength. Analysts cited a “melt-up” in prices led by loose Federal Reserve policy as companies like Amazon, Facebook, and Tesla saw their stock reach all-time highs.

However, by the end of August, the sector appeared to be over-heated. Sure enough, a correction in the first week of September marked the worst sell-off in months. Veteran investors like Bruce Bittles were not surprised. The investment strategist previously told CNBC, “High valuations in [and technical indicators for] the mega-cap stocks are stretched far beyond historical levels...which often suggests a consolidation/correction phase is likely." However, as the dust settled, media sources suggested that an aggressive trading strategy employed by SoftBank was to blame.

SoftBank and Tech

SoftBank is anything but a minor operation. The Japanese multinational conglomerate routinely nets more than $30 billion in annual gross profits underpinning its approximately $300 billion in net assets. It also runs Vision Fund, the largest technology-focused venture capital fund in the world.

As such, its no stranger to investing in tech companies like Alibaba, Slack, Nvidia, and smartphone chip designer ARM. Yet, it has experienced disappointment with start-ups like WeWork in recent years.

More importantly, however, August regulatory filings showed SoftBank had acquired a sizable position in Netflix, Tesla, Microsoft, Alphabet, and a $1.2 billion stake in Amazon. The move marked an expansion of its investment strategy beyond unlisted startups. According to CEO Masayoshi Son, the purchases were part of a new investment management subsidiary meant to park excess cash in liquid stocks. Japanese retail investors had similarly piled into the space throughout 2020.

Options and Volatility

By the end of August, concerns were accumulating that the stock market, especially the tech sector, may be forming a bubble. Numerous indicators began suggesting investor exuberance following the mid-year rally which saw record-breaking financial markets become widely divorced from the dire reality of the pandemic-slammed real economy.

Furthermore, a speculative frenzy in stock derivatives led to expansive volume in call options trading over the period. Call options are a type of stock derivative purchased by bullish, or optimistic investors. The contracts allow purchasers to buy the underlying stock at a specified price over a specified time frame. If the underlying stock price rises above the contracted option price, purchasers can then execute the option and acquire the asset at an effective discount to the market rate or trade the option for a profit.

Although separate from a stock's price, a spike in demand for call options can affect the underlying stock valuation. An increase in the purchase of call options forces stock brokers to purchase the underlying stock, pushing up the stock price and increasing the value of the options. This type of price momentum, however, increases the overall volatility of the stock. When demand for the option falls, momentum reverses and can lead to a collapse in stock prices. Overall, this type of trading is known as “momentum trading” and is widely considered high-risk.

So, when The Financial Times reported that SoftBank had influenced a market frenzy by heavily engaging in this risky strategy, shareholders were none too impressed.

Consequences

Before the September sell-off, rumors had been circulating among option traders that a big player was buying massive amounts of the derivative. The options in question were tied to rallying tech stocks like Amazon, Nvidia, and Tesla. By the time insiders outed SoftBank's shopping spree, the conglomerate had amassed $4 billion in gains.

Yet, seasoned professionals quickly derided the strategy. Peter Boockvar, chief investment officer at Bleakley Advisory Group, likened SoftBank's bet to "a trip to the casino." He noted to CNBC that if SoftBank "is supposed to be an investment company taking a long-term horizon, then trying to juice your short-term return through options, you've turned into a hedge fund." This sentiment was widespread across media outlets, and the company's stock fell seven percent, representing a $12 billion loss in market cap.

Although Son initially received the lion’s share of the blame, the September downturn was likely over-attributed to his gamble. The COVID-19 pandemic has had wide-ranging and perverse effects on financial markets. To begin with, amateur retail investors, stuck at home during the lockdown, have been trading to excessive degrees and overindulging risky strategies like options trading. While Son and SoftBank played their role, they represent only a portion of the speculative frenzy. Furthermore, shareholders appear to have forgiven the company as its stock has since rebounded from the faux pas.