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Overnight, equity index futures were steady alongside commodities and bonds. This is ahead of the release of minutes from a Federal Reserve (Fed) policy meeting.
In the news were advertising and social media firms. Snap Inc (NYSE: SNAP) warned of slower growth and deterioration in the macro-environment. Its peers Meta Platforms Inc (NASDAQ: FB), Alphabet Inc (NASDAQ: GOOGL), and Twitter Inc (NYSE: TWTR) also saw weakness.
China’s COVID Zero commitment likely nudges it off a path to achieve economic targets “by a large margin for the first time ever,” as Bloomberg explains.
This is as China and Russia have conducted one of their largest joint air drills “to send their own political, economic and military message to the international community,” much of which is at Davos, Switzerland doing thought exercises.
In a recent podcast, Pippa Malmgren, who is a former White House adviser and economist, well said, particularly in reference to some of the tension abroad, that “autocracy is not working well,” and “[y]ou go to war because … you have a domestic objective.”
Thought it was interesting. Give it a listen, here.
And, finally, Michael Burry of the “Big Short” sent a cryptic tweet alluding to what is likely the risk of another financial collapse.
Moreover, ahead is data on durable goods and core capital equipment orders (8:30 AM ET). Later, the Fed publishes the minutes of its last policy meeting (2:00 PM ET).
What To Expect
Fundamental: The Fed will issue policy meeting minutes that may provide clarity with respect to its intent to hike and reduce the size of its balance sheet.
In focus, per ex-Fed insider Ellen Meade, is “the rate path, the expected economic conditions, and what policymakers want to see from the data before they slow the pace of tightening.”
“The minutes may tell us they see the tightening in conditions this time around as greater than in earlier cycles. If that’s the case, then they may judge that they don’t need to raise the funds rate by as much this time around.”
John Authers notes, however, that “inflation tends to move in waves” and it doesn’t, usually, “plateau and stay there.”
“That suggests that even though the focus is already shifting to whether there is evidence of a growth slowdown,” he added, in a statement echoed by Meade who is betting on slower “GDP growth, below its longer-run rate, and a rise in the unemployment rate, perhaps to its longer-run median rate or slightly above.”
Pursuant to those last remarks, the Fed’s Raphael Bostic is already floating a pause to rate hikes near September if inflation falls more than expected over the summer.
As Diane Swonk of Grant Thorton explains, “Policy works with a lag. The Fed wants to catch up but not outrun the market in its effort to tighten credit market conditions.”
Futures First analyst Rishi Mishra, who is also the author of the “On Another Note” newsletter, suggests the Federal Open Market Committee may, rather, hone in on monthly changes with annual inflation still elevated.
“This brings down inflation expectations into a range where the Fed feels comfortable about de-anchoring risks,” Mishra said.
JPM’s Marko Kolanovic adds: “We have gone from a situation where both stocks and bonds were sold on the back of de-leveraging, to a situation where bonds rallied as stocks fell, nudging stock/bond correlations toward a more normal (negative) level.”
“We do indeed think this is where things could be gradually heading, but we acknowledge this is not likely to play out in a linear way.”
Positioning: In yesterday’s in-depth write-up, we talked about the underperformance of implied volatility (IVOL), relative to that which is realized (RVOL).
Dennis Davitt of Millbank Dartmoor Portsmouth had explained that the “RVOL of the underlying S&P 500 is above 27% … with IVOL of options trading between 24%-27%,” which translates to a VIX at 30%.
So, essentially, it makes more sense to have exposure to underlying markets, synthetically (i.e., own options).
This, though, merits a bit more clarification (as I do not want it to be construed as if I was buying, systemically, bets on the downside). The opposite, actually.
Moreover, this was stated in the context of a market that is “(1) stretched and (2) near a critical inflection which we see at $3,700.00 SPX,” per SpotGamma. Separately, investors are bidding “skew on the call side” amid their “fear of missing on the upside.”
That’s when it makes sense to buy closer to at-the-money (ATM) and sell farther from ATM, or out-of-the-money (OTM). For instance, a margin intensive but low cost call +1 [ATM] x -2 [OTM] ratio spread.
Note, however, that width and timing are everything. Too much time or too narrow may result in asymmetric losses when the demand for upside bets further out in price and time bids the skew that you’re short, relative to the at-the-money volatility you own. I’m willing to talk through this via email, if interested. Ping me at firstname.lastname@example.org. I’m mindful that if I do post actual trade ideas, people may take them without knowing how to size and manage them, accordingly. Big yikes!
Goldman validates this thesis: “Even though the VIX’s reaction to recent spot downside has been mild, its high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”
Further, though SpotGamma assigns an edge to lower prices until the June FOMC and OPEX, “markets (which are already ‘fully loaded’ with puts) [are likely] pressured by liquidity providers’ hedging [at most] down to $3,700.00,” the area where that added pressure from hedging cools.
Technical: As of 6:15 AM ET, Wednesday’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 overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,969.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,917.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,863.25 LVNode and $3,831.00 VPOC, 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.
Considerations: Push-and-pull, as well as responsiveness near key-technical areas (discernable visually on a chart), suggests technically-driven traders with shorter time horizons are very active.
Such traders often lack the wherewithal to defend retests.
Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.
Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.
Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.
Overnight Highs And Lows (ONH and ONL): 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 value tests as they offer favorable entry and exit.
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 also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.
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.
2 replies on “Daily Brief For May 25, 2022”
[…] As was suggested could happen in Wednesday’s pre-market letter, the Federal Reserve (Fed) indicated potential policy flexibility, later this […]
[…] Malmgren, who is a former White House adviser and economist we wrote on earlier this week, discussed more of this decoupling and coordination among Eastern and Western […]