Something bonkers just happened in the stock market … again.
It wasn’t a “flash crash,” or even another “meme stock” surge …
But it took Wall Street by surprise nonetheless.
I’m talking about the epic nosedive suffered by media stocks like Discovery Communications (Ticker: DISCA) and ViacomCBS (Ticker: VIAC) late last week.
What likely took those stocks down isn’t even legal in the United States, and yet, it destroyed tons of DISCA and VIAC shareholders …
So today, let’s dive into the extremely under-the-radar phenomenon of CFDs — what they are, and how you can protect yourself.
WTF is a CFD?
CFD stands for Contract for Difference.
In the absolute simplest terms (because CFDs, like most other things in the finance world, are complex and risky), CFDs are a way to speculate on a security’s price without having to mess with the actual security.
So, unlike options trading, where a speculator can be assigned to buy or sell shares, a CFD investor doesn’t have to bother with all that.
Basically, the trader can bet on the direction of the underlying — whether it will go higher or lower from the time the contract opens to when it closes — and if he or she is right, they can make money on the difference.
However, the key takeaway is CFDs are LEVERAGED investments — meaning gains can be amplified, but so too can losses.
Losing positions can get a MARGIN CALL from the broker, requiring more funds be deposited.
And in a worst-case scenario, the margin call can’t be met …
Plus, unlike stock and options, CFDs aren’t traded on a centralized exchange, so there’s no visibility into how much someone is actually leveraged.
If a trader — or a hedge fund, in the case of VIAC and DISCA — becomes over-leveraged, borrowing too much, they can get caught with their pants around their ankles.
This is apparently what happened last week in the case of the aforementioned media stocks, which triggered a bit of a domino effect on the Street.
Behind the Media Crash
Had you looked at a VIAC chart early last week, when the shares were flirting with $100, odds are you wouldn’t have expected the stock to crash more than 60% over the next few sessions.
And yet, that’s what happened.
Daily chart of VIAC – courtesy of StockCharts
It was a similar situation with DISCA shares, which plummeted more than 50% at their lows on crazy-high volume.
Daily chart of DISCA – courtesy of StockCharts
It seems Archegos Capital Management — a hedge fund run by notorious offshore trader Bill Hwang — was unable to meet a margin call.
Big banks like Goldman Sachs (Ticker: GS) and Morgan Stanley (Ticker: MS) reportedly forced Archegos to dump shares to cover potential losses, and this week financial firms like Credit Suisse (Ticker: CS) and Nomura (Ticker: NMR) said their own quarterly numbers could take a hit due to the exposure.
As such, many bank stocks themselves took a tumble, like Morgan Stanley …
Daily chart of MS – courtesy of StockCharts
Things were even more bleak for Nomura shares …
Daily chart of NMR – courtesy of StockCharts
And the Archegos Capital website has since been taken offline …
Lessons from the Bloodbath
There are a few lessons we can glean from the billions of dollars in selling that seemingly surprised the Street last week.
To start, there’s a broad lesson in being over-leveraged in general: that’s rarely a good thing, especially when you get called out to pay the piper.
Another lesson is — despite reforms put in place since the financial crisis of 2007-2008, banks still face plenty of big-money risk …
And it's a risk that’s hiding under the surface, like the Loch Ness monster.
Because the lack of a centralized exchange for CFDs means one hand likely doesn’t know what the other is doing, so to speak — lenders don’t realize how across-the-board over-leveraged a trader may be.
After all, prior to the past week, how much did YOU know about CFDs? I’m guessing many of you were in the dark, especially if you live and trade in the States, where CFDs are persona non grata.
Even if you were generally aware of CFDs, could you fathom 10 days ago they could orchestrate such a dramatic plunge in seemingly benign stocks like ViacomCBS and Discovery?
That said, the final lesson is: it’s rarely a bad thing to have a hedge in place.
Whether that’s via protective put options on your shares, some other kind of “portfolio insurance,” or a stop of some sort — traders should always have some kind of EXIT PLAN in the event of an unseen catastrophe.
Your Only Option,