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Commentary

Daily Brief For December 28, 2021

Daily commentary for U.S. broad market indices.

Notice: Up to January 3, 2022, any commentaries published will be lighthearted and, generally, shorter in length.

What Happened

Overnight, equity index futures were sideways to higher with most commodities, yields. 

This is as volatility implodes; the CBOE Volatility Index, from December 20, went as low as 17.55 this week [down 9.84 (35.93%)]. This coincides with a compression in the VIX’s term structure, and that has so-called bullish/supportive implications.

Ahead is data on the S&P Case-Shiller U.S. home price index (9:00 AM ET).

Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /ES open is above 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 lackluster breadth and divergent market liquidity metrics, the S&P 500 continues to auction away from intraday value, the levels at which participants found it most favorable to transact.

Moreover, given the persistence of mechanical responses to technical levels, visually-driven, weaker-handed participants (which seldom bear the wherewithal to defend retests) likely carry a heavier hand in recent price discovery.

Via volume profile analysis, we see a plethora of low-volume pockets – voids, if you will – that likely hold virgin tests. 

As stated over the past few days, successful penetration often portends follow-through as the participants that were most active at those levels (quickly run for the exits when wrong).

Context: Recall that a collapse in implied volatility, coupled with relentless, seasonally-aligned passive buying would bring in positive flows that would bolster any attempt higher.

At the same time “options selling strategies [became] attractive,” according to Goldman Sachs Group Inc (NYSE: GS); the commitment of capital to options strikes at higher prices implies participants are pushing up their bets on S&P 500 movement. That’s bullish.

Graphic: Shift Search S&P 500 data (excluding weeklies) suggests participants are likely initiating box spreads and rolling their call exposure out in time (as much as 6 months).

According to SpotGamma, “[s]ince, customers are thought to be net short calls (short-delta), as the index moves toward the high activity $4,800.00 strike, they become longer delta.”

Why? When a position’s delta rises with stock or index price rises, gamma – the expected change in delta given movement in the underlying – is added to delta. 

“As participants keep adding to their bets at $4,800.00, the dealer only takes on more exposure to positive gamma, which they hedge by selling futures and adding liquidity to the market.”

The commitment of capital on lower volatility ups the dealers’ exposure to positive gamma; this will be offset through a supply of liquidity (via short futures), which weighs on price discovery.

Taking into account this positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed, albeit less so than before.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Going forward, coming into Friday’s weighty options expirations, at the index level, hedging pressures ought to be sticky and weigh on the upside. 

Thereafter, positive fundamental forces and dealers’ covering of hedges to remaining “put-heavy” positioning could bolster any seasonally-aligned price rise into the very first interest rate hikes.

Graphic: Per The Market Ear, “January typically sees 134% of inflows (the rest of the 11 months -34%). And with every private wealth manager in the world right now pitching increased allocations into equities (out of cash and out of bonds), Goldman calculates that keeping 2021 pace, This would be $125BN worth of inflows quickly in January.”

Moody’s Corporation’s (NYSE: MCO) forecast is in agreement: “the Dow Jones Industrial Average increases this quarter and peaks in early 2022, … [followed by] steady decline through 2022.”

Graphic: S&P 500 performance before and after rate hikes.

Expectations: As of 7:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, just outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Gap Scenarios: Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,771.00 untested point of control (VPOC) puts in play the $4,784.25 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,797.25 overnight high (ONH) and $4,803.75 extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,771.00 VPOC puts in play the $4,732.50 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,717.25 low volume area (LVNode) and $4,690.25 micro composite point of control (MCPOC), 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.

Definitions

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.

POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and 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.

Volume-Weighted Average Prices (VWAPs): A metric highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

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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