Softbank Share Price Tumbles On Risky Tech Derivatives Bet

The revelation that Japanese technology investor Softbank is the big tech ‘whale’ that has been buying up billions of dollars-worth of risky derivatives yesterday resulted in a 7% hit to the company’s share price. Nervous investors in Softbank’s stock, 30% of whom are small retail investors, headed for the exit doors, concerned about the implications of the company’s heavy exposure to any sustained correction of technology share prices.

News first broke on Friday that it was the Tokyo-based technology investor that was the mystery ‘whale’ investor buying up around $50 billion of tech stock options in recent weeks. The aggressive bet on a continuation of the tech rally that followed the March markets sell-off has become a self-fulfilling prophecy, credited with driving stretched-looking valuations further upwards.

Derivatives options are leveraged positions on stocks or other financial instruments and can be either ‘long’ or ‘short’. A long options position means the holder will profit if prices rise and a short position if they fall. The use of leverage means any profits are multiplied relative to the extent of the leverage. However, the same is true of losses. If markets move in the wrong direction, losses are multiplied relevant to the leverage employed.

On Friday reports detailed call options purchased by Softbank on a number of large U.S. tech companies with the bet focused on the ‘Big 6’ of the FAANG stocks and Microsoft. However, options on other tech stocks have also been invested in, including Tesla, which has seen especially spectacular recent gains.

Softbank’s spending spree meant traders who sold these buy options to the tech investor were forced to buy the underlying securities, actual stock in the companies, to hedge their exposure. That mass hedging of $50 billion worth of buy options, it is now believed, has been the major catalyst in driving the market ever upwards. The tech-centric Nasdaq index is up around 75% since its March low, despite falling 7% since last Wednesday.

So far, the aggressive strategy has worked out for Softbank, with its derivatives trading activities estimated as having earned it a paper profit of around $4 billion so far. But if prices move sharply the other way, Softbank’s paper profits could very quickly turn into actual losses.

Softbank was almost wiped out during the dotcom crash 20 years ago, having then also built up aggressive exposure to tech stocks. CEO Masayoshi Son personally lost $70 billion of his own cash, credited as the biggest individual investment loss in history. Both Son and Softbank recovered thanks to a couple of successful investments in the years following the dotcom crash, most notably making hundreds of billions as a result of an early investment in Chinese ecommerce giant Alibaba.

But Softbank’s investors are now worried the company may be setting itself up for a repeat of the fate that befell it during that market crash 20 years ago. The tech landscape has changed over the past two decades with the tech giants bringing in huge and diversified revenues. Dotcom companies were often loss making or earned very modest revenues relative to their giddy valuations.

But as well as investing in highly profitable and now well established tech giants, Softbank has also ploughed billions into tech companies that have consistently racked up huge losses in their pursuit of scale and profitability. Softbank’s $100 billion Vision Fund is often referred to as the world’s biggest tech investor but it has also been accused of inflating tech start-up valuations.

WeWork is the fund’s biggest failure after the coworking office space manager failed to successfully list last year after institutional investors rejected its business model and raised serious concerns over the company’s corporate governance. But Softbank and the Vision Fund also own large stakes in other tech companies some distance from achieving profitability, with Uber a notable example. Other companies Softbank holds stakes in include Tiktok-owner Bytedance and the professional messaging app Slack.

Mr Son is renowned as an investor that often bases his decisions on intuition. When that works out well, as in the case of the 2000 backing of Alibaba that has netted the company more than $130 billion, gains can be spectacular. But it also often goes wrong, as the $10 billion lost last year on the WeWork investment is testament to.

Softbank has been forced into an assets sale this year in order to reduce debts, with Arm, the UK-based microchips company acquired in 2016, one of the high-profile holdings up for sale. Once again though, it looks as though Mr Son is willing to play with fire in the pursuit of profiting through the $50 billion of options-based exposure Softbank has now built up.

If it works out, Softbank will be back on top. If it doesn’t, it could become a new low point in the investor’s boom and bust cycle. That’s clearly now a concern for investors, many of whom have already voiced their position by scaling back their exposure to Softbank itself.