The recent market volatility has revealed a fascinating shift in investor behavior. Instead of the traditional panic buying of S&P 500 puts (which grants the right to sell a stock at a certain price by a certain date) to hedge their portfolios, a growing number are taking the opposite approach: selling puts on their favorite stocks during price drops.
This isn’t entirely new – put selling naturally increases during downturns. However, the sheer volume observed in recent selloffs, particularly on days like the major decline witnessed last Monday, has caught the eye of market analysts. Susquehanna Financial Group highlighted this activity in big names like Amazon (AMZN), Nvidia (NVDA), Target (TGT), Uber (UBER), Warner Music Group (WMG), Albemarle (ALB), Citizens Financial Group (CFG), Chevron (CVX), Halliburton (HAL), and PayPal (PYPL).
Why is this significant?
Put selling signifies a bullish undercurrent lurking beneath the surface of the options market. By selling puts, investors are essentially expressing their willingness to buy stocks at lower prices, demonstrating a more sophisticated approach to “buying the dip.”
Traditionally, buying the dip involves purchasing shares directly during a stock decline. Put selling, however, provides an alternative. Investors collect a premium from the options market in exchange for the obligation to buy the stock at a specific price (strike price) by a specific date (expiration).
Here’s an example: Imagine a stock trading at $50. An investor sells a September $45 put for $1. This means they’re obligated to buy the stock at an effective price of $44 ($45 strike price minus the $1 received for selling the put). If the stock rebounds above $45 by expiration, the investor keeps the premium.
A Behavioral Shift?
For decades, investor behavior during significant declines followed a fairly predictable pattern: mass panic buying of S&P 500 puts to hedge their portfolios. Fear often trumped reason, leading to “price insensitive” behavior – a term used in options markets to describe extreme pessimism that’s actually bullish for stocks because investors are willing to pay any price for protection.
While there was still a surge in defensive index puts to hedge against Monday’s decline, the substantial increase in individual stock put selling suggests a potential turning point in investor psychology. After years of potentially wasting money on expensive index puts (as stocks tend to recover eventually), some investors appear to be learning to capitalize on the fear of others.
The Risks and the Rationale
The success of this strategy hinges heavily on how investors finance their put sales. Margin financing (borrowing money from a brokerage) can backfire if a sustained downturn occurs. Without a quick rebound, investors could face margin calls, forcing them to sell their positions to cover losses. This forced selling could further exacerbate market weakness.
Cash-secured put selling, where investors deposit funds to cover potential stock purchases before selling puts, significantly reduces this risk by minimizing leverage.
The broader adoption of put selling could also reflect generational changes. Many newer investors haven’t experienced market environments where “buying the dip” wasn’t a viable strategy.
The Defining Moment Awaits
The put-selling strategy will undoubtedly face a defining moment – a period where stocks don’t experience their typical rapid recovery. This will be a test by fire, revealing whether put selling acts as a stabilizing force or a hidden weakness in the market.
