Daily Brief For July 26, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!

Fundamental

What’s the theme?

It’s that policymakers are seeking to curb further escalation in inflation expectations so, per Bloomberg, “companies and workers [don’t] act in ways that would push prices ever higher.”

Adding, despite the potential that the economy is already in recession (bolstered by supply chokepoints, which are “not in the central banking playbook”), per Damped Spring’s Andy Constan, risk premiums, which are the return on investments in excess of the risk-free rate, have expanded substantially on the anticipation of tightening.

Interest rates have risen and are expected to continue rising. Quantitative tightening (QT), which is more of a direct flow of capital to capital markets, on the other hand, just began.

In a write-up, Constan puts forth that “the obvious question is whether the frontrunning of QT has fully priced in?” 

“When looking at the sheer magnitude of the balance sheet reduction both in total reduction amounts and pace the immediate answer and one that we believe is consensus is [NO].” 

Further risk premium expansion is inevitable and, with inflation entrenched, the odds are against central banks. Notwithstanding, with the Fed planning “most of its balance sheet reduction to be run-off,” which is opting to “not reinvest the proceeds from maturing assets they own,” as well as the Treasury’s halving of “the amount of coupon issuance that the market must absorb,” Constan puts forth that the “Fed is done for the summer.”

“Our expectation is that the Fed will continue to validate the current path. That will result in less surprise and falling asset volatility” as investors realize “they are now under-risked,” which may drive a “risk premium contraction over the near term.”

Adding, on the topic of earnings, operating leverage may “provide some buffer for input costs to inflate more than revenue without hitting margin growth.” This factors into Constan’s optimism.

Positioning

As of 5:00 AM ET, Tuesday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.25%. Net gamma exposures remain positive and may continue to promote tighter ranges.

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of short-dated complex options structures (e.g., low-cost call ratios).

The reason why? 

In short, per Kai Volatility’s Cem Karsan, the “tail risks are building” and no longer is volatility likely to be pinned by sentiment and positioning, as well as the hedging on the equity volatility.

For more, the very detailed Daily Brief for July 21, 2022, explained it best. Check that out, here.

Technical

As of 5:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to 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 higher.

Any activity above the $3,965.00 VPOC puts into play the $3,997.00 VPOC. Initiative trade beyond the $3,997.00 VPOC could reach as high as the $4,016.25 HVNode and $4,055.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,965.00 VPOC puts into play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,909.25 MCPOC and $3,867.25 LVNode, 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: The market is in balance.

This is rotational trade that denotes current prices offer favorable entry and exit. Balance areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

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.

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.

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, 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, ex-Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

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.