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Commentary

Daily Brief For December 8, 2021

Daily commentary for U.S. broad market indices.

Editor’s Note: The purpose of these commentaries is to align ourselves better for the day ahead. Seldom, however, do we step away to align ourselves with trade across larger time horizons. 

Given the proximity to the new year, I shall be placing more attention on planning.

How do we model a trading plan? Here is one link on things to consider.

What Happened

Overnight, equity index futures were divergent; the Russell 2000 and Dow Jones Industrial Averaged traded weak relative to their peers the S&P 500 and Nasdaq 100. 

This is as scientists discovered a harder-to-detect version of omicron that may be countered with an extra dose of vaccine.

In other news, the U.K. was set to impose new COVID-19 restrictions, the House passed a bill opening the way to a quick debt ceiling increase, and the list of Chinese developers warning they may not be able to meet upcoming financial obligations grew.

Ahead is data on job openings and quits (10:00 AM ET). 

Graphic updated 6:30 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

On strong intraday breadth and divergent market liquidity metrics, the best case outcome occurred, yesterday, evidenced by an upside gap, expansion of range, and separation of value.

Similar to Tuesday’s commentary, though this activity marks participants’ willingness to change the trend, the structure is poor. As a result, there is technical instability.

Specifically, both Monday and Tuesday’s sessions left gaps and p-shaped emotional, multiple-distribution profile structures (i.e., old-money shorts covering).

As said before, participants will look to revisit, repair, and strengthen – build out areas of high volume (HVNodes) via the cave-fill process – these areas of low volume (LVNodes).

Graphic: Divergent delta (i.e., non-committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is attempting to balance).

Context: Has anything really changed since the November monthly options expiration (OPEX)?

Sure, we had some news with respect to COVID-19, China, and U.S. growth, but any associated fears were fast assuaged. 

In the span of four days, the S&P 500 rose nearly 5.00%. That’s just over 200 points!

Much of what we’re seeing is the direct result of changing market structure; participants are more exposed to leveraged products, among other things, which increases the speed with which volatility is realized.

Participants went from being exuberant and underexposed to protection – in the face of weakening breadth/fundamentals – to generating destabilizing demand for protection.

Alongside that demand of (shorter-dated) protection (where options sensitivity to direction is higher) was the market’s entry into short-gamma. In such an environment, counterparties to customers’ options trades exacerbate underlying volatility through hedging. 

Note all that movement in the front-end of the VIX futures term structure, below. Wow!

In the face of all the fear was “natural, passive buying support,” however, and expectations that short-dated protection (if realized volatility was to not be expressed to the downside) would either roll off the table (expire) or be monetized, resulting in counterparties reversing their hedges (initially short stock/futures) and supporting the market (buying to cover).

As said on December 6, and many commentaries before that, this “flow is stabilizing and may play into a seasonally-aligned rally into Christmas as participants see defenses rolled out against the new COVID-19 variant,” and so on.

Based on this week’s trade, thus far, it seems that the bull thesis is playing out. 

So you’re telling me to buy every S&P 500 call under the sun, right? NO!

There has yet to be a notable strengthening in overall market breadth and volatility remains rich in the face of the fast-approaching December OPEX and December 15-16 Federal Open Market Committee (FOMC) meeting.

Traders are antsy and have already started pricing in potential rate overshoots; Federal Reserve Chair Jerome Powell went from being uber dovish to increasingly hawkish on the topic of taper and interest rate expansion.

Though today’s rates and earnings support validations better than in the ‘90s, an intent to moderate stimulus serves as a headwind; the U.S. may realize the swiftest tightening in financial conditions since 2005 if the Fed was to hike rates three times next year. Yikes!

So, we have to be careful here. 

Despite the S&P rallying into the first hike, historically, dynamics with respect to market structure introduce a lot of noise. Therefore, we ought to be looking at structures that have little to lose in episodes where stress surfaces and volatility is expressed to the downside. 

Graphic: UBS Group AG (NYSE: UBS) research on S&P performance into rate hikes.

Examples of low-cost options structures include call-side calendars, butterflies, and ratio spreads.

Graphic: Via Banco Santander SA (NYSE: SAN) research, the return profile, at expiry, of a classic 1×2 (long 1, short 2 further away) ratio spread.

If opportune (and well-capitalized), there are opportunities to finance debits on the call side with structures on the put side. 

This, above, is no recommendation. It’s more so how I’m looking at the current market.

In summation, the return distribution is skewed positive, still, at this juncture, but a lot of the opportunity (based on how participants were positioned just a weak ago) has disappeared.

That’s not to say we can’t go higher; upon a smooth passage of the December FOMC and OPEX there may be an unwind of “structural positioning that naturally drives markets higher as long as volatility is compressed.”

Expectations: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,691.25 HVNode puts in play the $4,705.75 LVNode and overnight high (ONH). Initiative trade beyond the latter could reach as high as the $4,716.75 LVNode/ONH and $4,740.50 minimal excess high, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,691.25 HVNode puts in play the $4,674.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,647.25 and $4,618.75 HVNode, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures. Learn about the profile.

What People Are Saying

Definitions

Cave-Fill Process: Widened the area deemed favorable to transact at by an increased share of participants. This is a good development.

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test. 

If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

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