The deposit game: A warning shot has been fired
By Peter Garnry, Head of Equity Strategy at Saxo
The US equity market got a big jolt yesterday. SVB Financial plunged 60% as one of the most prolific venture capital firms advised its clients to withdraw cash from the bank. This forced the bank to sell out of its bond holdings creating a USD 1.8bn loss and the need for raising equity capital. SVB Financial is down in pre-market trading as the market is nervous about the bank stay afloat. Depending on the US jobs report we could see significant intraday volatility into the weekend and the open on Monday will also be a key test for the equity market that has profoundly changed with the massive surge in zero-dat-to-expiry options.
A test of the ODTE options market?
Yesterday’s big moves across US banks pushed down the S&P 500 futures by 1.9% extending the negative momentum in today’s session by another 0.4%. If the US jobs reports later today at 13:30 GMT fails to calm the market, then the sell-off could accelerate into the close with potentially the first real test of whether zero-day-to-expiry (0DTE) options are a systemic risk to the wider equity market. In recent weeks, JPMorgan has argued that they pose a significant risk in terms of accelerating a decline under the right conditions while Bank of America has argued that the options book is often balanced and thus 0DTE options are not a problem. Cboe was also out yesterday arguing why these very popular options are not a problem. 0DTE options are now close to 45% of the daily equity options volume in US equity markets.
Despite the big moves yesterday in US banks and hawkish messages earlier this week from Powell on inflation and the direction of policy rates, the VIX Index did not react as much as feared increasing only 3.5-points closing at 22.61. This VIX level is at a small premium above the 19.8 average historical level, but actually trading significantly above the current realised volatility.
Back in early 2018, the VIX blow up was a profound event in volatility markets that exploded in the hands of investors following years of short volatility positions had been building to a fragile size of the volatility market.
Today, the question is whether the next volatility event will evolve around the 0DTE options. It all depends on whether we get an intraday gamma squeeze which is the concept that if we get a big negative move intraday and the option market makers are short gamma (the rate of change in an option’s delta as a function of the underlying price), then the only way to hedge the options book is to aggressively sell the underlying (in this case the S&P 500) accelerating the move on the downside.
Whether we will observe this behaviour today is not given, explained by our Chief Investment Officer Steen Jakobsen on today’s Saxo Market Call podcast. It all depends on the reaction to today’s US jobs report. Depending on how trading goes today in SVB Financial the real risk is the weekend and the subsequent open print on Monday.
SVB Financial and the deposit game
Back to the real driver of things yesterday, namely SVB Financial, also known as Silicon Valley Bank. Its shares fell 60% yesterday triggered by Silvergate Capital’s decision to liquidate its business following the implosion of the crypto market. SVB customers were pulling deposits out of the bank as the prolific venture capital fund Founders Fund advised its startup companies to withdraw funds from SVB. This deposit outflow is forcing the bank to sell bonds worth $21bn at a combined post-tax loss of $1.8bn forcing SVB Financial to announce a public offering of common stock worth $1.25bn and $500mn of depository shares. This news jolted the equity market sending US banking stocks down across the board with First Republic Bank (-17%), Signature Bank (-12%), and Zions Bancshares (-11%) leading the declines. But even major banks such as JPMorgan Chase was down as much as 5.4%.
SVB Financial is a large US bank that is key for venture capital ecosystem in Silicon Valley with a balance sheet of $212bn as of 31 December 2022 and 8,500 employees. The reason why there is a panic around the deposits is because of venture capital firms advising clients to pull their deposits, because the companies that are last out of the door will lose their operating cash. Many startups raise significant amount of money in VC rounds that often give them one or two years of runway operating at a loss. All this excess capital is often placed at banks and SVB has been a big recipient of this excess cash growing their deposits from $10bn in Q4 2009 to $173bn in Q4 2022.
In the event of a bankruptcy this could be a systemic blow to many startups and risking their operations, in addition to creating big problems for venture capital firms. This is only one of the reason why the hedge fund manager Bill Ackman has been out saying that the US government might consider bailing out SVB Financial as the bank is too important for the startup ecosystem. SVB shares are down additionally 44% in pre-market trading.
