Investor enthusiasm for artificial intelligence’s potential to transform the global economy has fueled massive bets on the sector; However, growing concerns about a possible downturn are prompting investors to seek financial protection against losses, The Wall Street Journal reported Saturday.
“We’re seeing very significant demand from those looking to protect against downsides,” said Stephen Solaka, senior vice president at Gateway Investment Advisers.
Investors and technology executives are increasingly turning to financial instruments such as puts and credit default swaps to protect their investments.
Put options give investors the right to sell shares at a predetermined price before a specified date. For shareholders seeking protection, these contracts can limit potential losses if stock prices fall sharply, although investors must pay a premium for this protection.
The combination of rising borrowing costs for large data center projects and chip purchases, falling stock prices of AI companies and a broader sell-off in stock markets has heightened concerns about the sector’s financial outlook.
Friday’s selloff in tech stocks wiped out more than $1 trillion in market value. The Nasdaq 100 index fell 3.4%, while the broader S&P 500 index fell 1.8%. The S&P 500 technology sector was particularly hard hit, down more than 4.2%, NBC News reported Friday.
AI companies continue to seek billions of dollars in funding, even in the midst of liquidation
The growing demand for financial protection comes as AI companies continue to seek huge amounts of capital to finance infrastructure development and expansion.
According to Solaka, some investors have racked up such substantial gains from tech stocks that they are now prioritizing protecting their wealth over chasing additional returns.
“These people have made so much money that they are resigning to cover up their actions,” Solaka said, adding that some companies restrict employees’ business dealings.
For example, trading in put options tied to AI cloud infrastructure company CoreWeave reached record levels in October and has remained elevated, according to data from Cboe Global Markets.
AI investors turn to credit default swaps to hedge against debt risks
Investors are also turning to credit default swaps, financial contracts that protect against a borrower’s failure to repay debt.
The cost of default insurance for major tech companies, including Amazon, Alphabet, Microsoft, Meta and Oracle, increased over the past month to its highest level since 2021, according to the report.
“There were no exceptions, suggesting general market concern with the sector rather than idiosyncratic credit events at the individual company level,” said Eugene Grinberg, co-founder of bond data provider Solve.
As investments in AI infrastructure increase, trading firm Jump Trading has begun offering financial contracts that allow companies to protect themselves against a possible collapse in the price of computing power.
For example, companies leasing Nvidia chips could use these contracts to set a minimum rental price, protecting their revenue if demand for AI computing power falls.
The growing demand for financial protection is reminiscent of the events described in The big shortwhen investors used credit default swaps to bet against mortgage-backed securities before the 2008 financial crisis. However, unlike those investors, many current tech shareholders are not necessarily betting on a market collapse, but rather seeking to protect gains accrued during the AI boom.
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