The TSLA Options Market is an order of magnitude larger than any other

This started as a TMC forum post, but it turned out so long and interesting that I decided to post it here as well.

Size of the TSLA Options Market

I wrote about this in one my recent blog posts too, but here is a bit more detailed comparison between some of the largest options markets.

 

These are the option markets with the highest open interest found here. TSLA is ranked #24, and 15 out of the top 20 are not individual stocks but funds.

Looking at this chart, one might think that TSLA is among the largest option markets, but that doesn't tell the entire story. Let's make some calculations to see what these open interests translate into in terms of dollars waged relative to market cap:

#8 BAC: Bank of America

As of March 25th, this is the highest open interest option market of any stock. Looking at Barchart, it appears that 10% of the 4M open interest is (far) OTM call options expiring this week, and these options are trading between $0.01 and $0.11.

 

Even the Jan'22 options that have decently large open interest, only really cost about $10.

It'd take a lot of time to calculate the exact value of all these outstanding options, but let's say the average price of a BAC option is $5 (I'm very confident it's much lower). Then the value of all outstanding BAC options would be $5 * 100 * 4,000,000 = $2B.

Relative to BAC's current market cap of $187B, that is a little over 1% of market cap.

#15 APPL: Apple

Apple has an even larger number of far OTM options set to expire this week that are worth <$1. It looks to me to be over 15% of all currently outstanding options.

Although there doesn't appear to be that much open interest for LEAPS expiring in 2022 in the case of APPL, there are for example ~25k Jan'21 contracts outstanding at strike prices of $145 and $150 with values of ~$140.

Once again, it's very hard to calculate the exact value of all outstanding options, I'd have to write a program that fetches the information and puts out the value, but for now let's assume the average APPL option contract is worth $60 (probably a lot lower in reality). That'd mean the value of all outstanding APPL options is $60 * 100 * 2,800,000 = $16.8B.

Relative to APPL's current market cap of $1,250B, that is once again a little over 1% of market cap, just like BAC.

#24 TSLA: Tesla

In the case of TSLA, it appears that a far smaller % of all open interest is tied up in far OTM options expiring this week worth <$1. To me it appears to be ~7-8%.

More importantly, there appear to be ~30k Jun'22 contracts outstanding trading at between ~$100 and ~$300, and another 35-40k Jan'22 contracts trading at between $65 and $400.

Due to TSLA's high stock price and high option premiums, the average price of a TSLA option is bound to be far higher than that of APPL/BAC, but let's stick with a very conservative estimation of $70. This'd mean that all outstanding TSLA options are worth $70 * 100 * 1,800,000 = $12.6B.

Relative to TSLA's current market cap of $137B, that is nearly 10%. In other words:

The TSLA options market is an order of magnitude larger than the next largest stock options markets.

As a result, the extent to which TSLA MMs (Market Makers) have to delta hedge is far larger than that of other MMs. This alone would make TSLA a somewhat more volatile stock than other stocks, but what really, fundamentally changes how this all applies to TSLA is the nature of its investor base and those investors' view of what the company is worth. I described the nature of this investor base in my recent blog post:

The Mechanisms That Fueled TSLA'S Meteoric Q1'20 Rise

But in essence it's as follows. TSLA's SP was kept down in the gutter for a very long time, and a lot of big funds that invested in TSLA a couple of years ago (or even as early as 2012/2013) thought it was a good investment back then. Perhaps they bought for $300 with a $500 price target, perhaps they bought for $180 with a $1,000 price target, perhaps they bought in 2012 for $30 with a $300 price target, but all of these investors have one thing in common. They held on to their TSLA investments for years and years, they saw the company progress and its future potential increase, and they've likely updated their price targets accordingly.

Tesla has always been a company with very high potential and a lot investors who believe it could be the largest company in the world in the future, but the fact that the company made so much progress while the SP was being manipulatively kept low, meant that a lot of investors increased their already high price targets even further, and are now even more unwilling to sell until massive massive SP increases.

This is what Tim Seymour and Cathie Woods saw eye to eye on a year ago in this CNBC interview:

(Timestamp 11:56)

When there's a battle between bulls and bears with drastically different viewpoints. The longer this goes on, or in other words "the longer the base", the bigger the breakout once one side loses the battle. This combined with the delta hedging mechanisms, is why TSLA is pretty much the most volatile large stock right now.

Another example of how this works

Say a company reports very strong earnings on a Friday and it shoots up from $550 to $650 in AH trading. Over the weekend all the big funds will be discussing the company's ER and decide whether they want to decrease/increase their positions. Say the good earnings were so good that even at the already higher SP of $650, although some funds want to take profits, more funds want to increase their positions, and the net result is a desired buying of 2M shares at that new SP.

The following Monday the markets open, and the net buying of an initial 1M shares drives up the SP further to $700. Now the valuation has increased another 10% after the initial 20% rise. That means that likely a lot more sellers will show up, who maybe weren't quite tempted enough to sell at $650, so the 2nd 1M shares that the funds wanted to buy post-ER, will be absorbed by the extra sellers that show up at $700.

In the case of TSLA, what happened is that the buying of shares post Q4'19 ER forced MMs to buy even more shares in order to stay delta neutral. So instead of 2M desired by funds, perhaps MMs also had to buy 1M to hedge risk after the price increased to $650 in AH trading. Then the initial buying of 1M shares that drove up the SP to $700, perhaps forced the MMs to buy another 0.5M shares, so now there's still a desire for 2.5M shares by MMs and funds.

But whereas in the first example, a lot of sellers showed up at $700, in the case of TSLA, maybe only an additional 0.5M shares in selling pressure showed up. So then the SP shot up to $750 as 0.5M shares went from old investors to new investors and MMs, but once again the delta hedging effect forced MMs to buy another 0.5M shares due to the increase in SP to $750, so now there is still a desire from MMs and new investors to buy 2.5M shares at a SP of $750.

These numbers are of course not accurate and it's an oversimplication, but it should show how it works. What added more fuel to the fire on February 3rd and 4th is the media attention that TSLA got (typing "should I" in google showed 1st search result "should I buy TSLA?"), and the amount of short term traders that undoubtedly took notice and decided they wanted to profit from this volatility, and of course short sellers who decided enough was enough.

Hopefully this explains why although delta hedging is not unique to TSLA, no, this situation is vastly different from any other stock.