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Commentary

Daily Brief For January 24, 2022

Daily commentary for U.S. broad market indices.

The Daily Brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 200+ that read this report daily, below!

What Happened

Overnight, equity index futures auctioned sideways to lower while measures of implied volatility expanded, which suggests increased fear and demand for protection.

This is in the context of an environment wherein the equity market, in particular, is positioned for heightened volatility, albeit potential strength, after Friday’s large monthly options expiration.

Ahead is data on Markit Manufacturing and Services PMI (9:45 AM ET).

Graphic updated 6:15 AM ET. Sentiment Risk-Off if expected /ES open is below 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

Fundamental: “The ratio of stocks hitting 52-week lows is at the highest since March 2020,” according to The Market Ear

In fact, in the face of a traditionally bullish period, seasonally, this is the worst January on record for the Nasdaq.

Graphic: Per Bloomberg, “Down almost 12% in January, the Nasdaq 100 is on course for its worst month since the 2008 global financial crisis. On any four-day basis, the current streak of 1% drops was the first since 2018.”

This weakness is in the context of months of divergent breadth by lesser weighted index constituents, geopolitical tensions, the prospects of reduced stimulus to combat high inflation, poor responses to earnings results, and disappointments in real demand and growth.

Graphic: @MacroAlf plots credit impulse as a percent of GDP and SPX year-over-year earnings.

The tone amongst retail participants is changing, too, with outflows starting for the first time since a major rush in account openings. When asked whether the selling is over, JPMorgan Chase & Co’s (NYSE: JPM) prime brokerage data suggests no.

This is in opposition to the typical trend into the start of the Federal Reserve (Fed) hiking cycles.

“U.S. equities have stumbled significantly on their way toward the first hike of this cycle, which is not the norm,” Jefferies Financial Group (NYSE: JEF) explained. “Performance tends to be poor immediately after the first hike, and can be worse if stocks are weakly into the first hike.”

Notwithstanding, Jefferies adds, “the SPX was higher in the 12 months that followed the start of each of the last 7 hike cycles.”

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

With some of that context in mind, what is there to look forward to? The corporate buyback blackout window ended after the close of business, Friday, and equity inflows remain robust.

What is there to be wary of? 

Well, given that “risk is being repriced to fit the world where real rates are a lot higher, and the Fed put [is] much lower thanks to the Fed’s need to fight inflation,” this week’s Federal Open Market Committee (FOMC) meeting shall provide market participants more context as to the “timing and pace of QT” which may assuage fears unless the Fed is all out to “drop QE next week itself.”

The odds of that happening are low.

Graphic: Per Bloomberg, “As Savita Subramanian of Bank of America Corporation (NYSE: BAC) shows in the following chart, expected earnings are far less helpful in explaining market outcomes since 2010 than they were before. Meanwhile, changes in the Fed’s balance sheet, the amount of money it’s making available to markets, have become hugely important.”

As Bloomberg’s John Authers puts it well: “Despite many scares, money has stayed plentiful for the last decade, rates have fallen, and anyone who did much to protect themselves against the risk of a decline would have done badly by it.”

Graphic: As Goldman Sachs Group Inc (NYSE: GS) “shows in this chart, companies are becoming ever more profitable in a way that seems to be sustained.”

Positioning: The major broad market indices – the S&P 500, Nasdaq 100, and Russell 2000 – are in an environment characterized by negative gamma and heightened volumes. 

Graphic: Per Tom McClellan, “Persistently high volume late in QQQ is a sign of overly bearish sentiment worthy of a bottom. Key caveat: just because one notices a sentiment indication which should matter does not mean it has to matter right away.”

The negative gamma – in reference to the options counterparties reaction “when a position’s delta falls (rises) with stock or index price rises (falls)” – is what compounds the selling. 

With measures of implied volatility expanding, as is the case when there is heightened demand for downside put protection (a positive-delta trade for the dealers), protection is bid and the dealer’s exposure to positive delta rises, which solicits more selling in the underlying (addition of short-delta hedges).

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. For instance, in selling a put, customers add liquidity and stabilize the market. How? The market maker long the put will buy (sell) the underlying to neutralize directional risk as price falls (rises).

Moreover, in negative-gamma, dealers are selling weakness and buying strength, taking liquidity. 

That’s destabilizing but it appears that “Friday in the markets did not have abnormal liquidity across S&P500 stocks.”

Graphic: Per @HalfersPower on Twitter, liquidity rankings for S&P 500 components. 

High readings in indicators like the put/call volume ratio, which denotes heightened trade of puts, relative to calls, as well as how calm equity market volatility is relative to rate volatility, could be the result of adequate hedging into the monthly options expiration (OPEX) and this week’s FOMC meeting.

“A very nasty flush out on a key polarized psychological level (S&P 500 $4,500.00) on the highest negative gamma day on an OPEX,” said Kris Sidial of The Ambrus Group on the increased potential for relief as a result of aggressive dip-buying. 

“Aggressive shorts piling in on an already dismantled tech selloff, leading into FOMC meeting after an 8% decline in the market, and Apple Inc (NASDAQ: AAPL) reporting earnings.”

Sidial’s opinion that the market is due for a counter-trend rally, in the face of an environment in which “there does not seem to be a direct hazard,” is aligned with the expectation that removal of put-heavy exposure, post-OPEX, and a reduction in embedded event premiums tied to the approaching FOMC, opens up a window of strength, wherein dealers have less positive delta exposure to sell against.

Technical: As of 6:15 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a balanced skewed overnight inventory, 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 higher; activity above the $4,381.50 regular trade low (RTH Low) puts in play the $4,449.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,486.75 RTH High and $4,526.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,381.50 RTH Low puts in play the $4,349.00 VPOC. Initiative trade beyond the $4,349.00 VPOC could reach as low as the $4,299.00 and $4,233.00 VPOC, or lower.

Considerations: The daily, weekly, and monthly charts are in alignment. 

The loss of trend across higher timeframes suggests a clear change in tone. This does not discount the potential for fast, but short-lived counter-trend rallies.

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.

Definitions

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.

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.

About

After years of self-education, strategy development, mentorship, 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.

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

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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