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Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /MES open is above the prior day’s range. Click here for the latest levels. /MES levels are derived from the profile graphic at the bottom of this letter. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
The newsletter format needs to evolve a bit. Feedback is welcomed! If you are looking for the link to the daily chart, see the caption below the graphic above. Take care!
Positioning
Fear of contagion prompted demands for protection. Measures of implied volatility or IVOL rose, and consequently, these demands for protection pressured markets.
Previously, this letter explained for protection to keep its value, there would have to be a shift higher in realized volatility or RVOL. Well, RVOL did not come back in a big way at the index level, as many expected.
Thus, the positive effects of the bank-related stimulation and traders’ pulling forward their timeline for easing were compounded by the unwinding of hedging strategies.
Graphic: Retrieved from Bloomberg via SpotGamma. “This drop in 5-day realized vol (orange) is pretty sharp, given it occurred from such a low relative level. ‘Can’t short it, don’t want to buy it.’ This vol decline comes as SPX put open interest was cleared with March OPEX, and big VIX call interest expired last week.”
Previously depressed products like the Nasdaq 100 or NDX, which are generally very sensitive to monetary tightening, have performed well.
Graphic: Retrieved from Callum Thomas’ Topdown Charts.
As we near month-end, there is a quarterly derivatives expiry. Above current S&P 500 or SPX levels is a significant concentration of soon-to-roll-off open interest held short by investors. This means the counterparties are dynamically hedging a call they own; they’re selling strength and buying weakness, albeit in a less and less meaningful way, as those options near this expiration and their probability of paying out (i.e., delta or exposure to direction) falls.
Some would allege that volatility compression and time decay would have solicited a more meaningful response from options counterparties at those strike prices above; the absence of downside follow-through had traders supplying previously demanded downside put protection and catalyzing a rally. However, there are not many things for the market to rally on, and so much time has passed that the charm effects (i.e., the impact of time passing on an options delta) have lessened dramatically, some explain.
Graphic: Retrieved from Bloomberg via Liz Young. “The Nasdaq’s Cumulative Advance-Decline line has parted ways with index direction in recent days. In other words, the index has rallied despite weak breadth (more stocks falling than rising), the two lines are likely to find their way back together somehow…”
Therefore, it’s probably likely that the market remains contained through month-end. After, movement may increase. This letter acknowledged RVOL might come back in a big way, particularly with the bank intervention doing more to thwart credit creation.
The caveat is that markets can trade spiritedly for far longer. There is a potential for the markets to move into a far “more combustible” position. With call skews far up meaningfully steep, still-present low- and zero-cost call structures this letter has talked about in the past remain attractive.
Graphic: Retrieved from Charles Schwab Corporation-owned (NYSE: SCHW) thinkorswim.
If the market falls apart, your costs are low, and losses are minimal. If markets move higher into that “more combustible” position, wherein “volatility is sticky into a rally,” you may monetize your call structures and roll some of those profits into bear put spreads (i.e., buy put and sell another at a lower strike).
The signs of a “more combustible situation” would likely show when “volatility is sticky into a rally,” explains Kai Volatility’s Cem Karsan. To gauge combustibility, look to the options market.
Remember, calls trade at a lower IVOL than puts. As the market trades higher, it slides to a lower IVOL, reflected by broad IVOL measures. If broad IVOL measures are sticky/bid, “that’s an easy way to say that fixed-strike volatility is coming up and, if that can happen for days, that can unpin volatility and create a situation where dealers themselves are no longer [own] a ton of volatility; they start thinning out on volatility themselves, and that creates a more combustible situation.”
To explain the “thinning out” part of the last paragraph, recall participants often opt to own equity and downside (put) protection financed, in part, with sales of upside (call) protection. More demand for calls will result in counterparties taking on more exposure against movement (i.e., negative gamma) hedged via purchases of the underlying. Once that exposure expires and/or decays, that dealer-based support will be withdrawn. If the assumption is that equity markets are expensive now, then, after another rally, there may be more room to fall, all else equal (a simplistic way to look at this), hence the increased precariousness and combustibility.
Graphic: Retrieved from Callum Thomas’ Topdown charts.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice; all content is for informational purposes. Capelj and Physik Invest are non-professional advisors managing their own capital. They will never openly solicit others for capital or manage others’ capital to collect fees and disbursements.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 7:00 AM ET. Sentiment Neutral if expected /MES open is inside of the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
Time for something inspiring! Separate from his work at Physik Invest, founder Renato Leonard Capelj is a journalist interviewing global leaders in business, government, and finance. In his desire to learn and apply the methods of those others who are far more experienced, Capelj has a long list of interviews you may find helpful in strengthening your understanding of markets. Check out some recent ones!
Capelj spoke with Simplify Asset Management’s Michael Green about cutting investors’ portfolio volatility while amplifying profit potential.
In response to uncertainty, Green says investors can park cash in short-term near-risk-free bonds yielding 5% or more, as well as allocate some capital to volatility “to introduce a degree of convexity,” risking only the premium paid. Alternatively, investors can take a more optimistic long view and position in innovations like artificial intelligence or next-generation energy production.
Capelj spoke with The Ambrus Group’s Kris Sidial about his market perspectives.
Naive measures like the VVIX, which is the volatility of the VIX or the volatility of the S&P 500’s volatility, are printing at levels last seen in 2017, Sidial explains, noting this would suggest “we can get cheap exposure to convexity while a lot of people are worried.”
“Even if inflation continues, the rate at which it rises won’t be the same. Due to this, CTA exposures likely will not perform as well as they did in 2022, and that’s why you may see more opportunities in the volatility space.”
Capelj spoke with Damped Spring Advisors’ Andy Constan about what investors should focus on and how he creates trades that lose him less money.
Constan’s trades are constructed around two- to four-month time horizons and are structured long and short using defined-risk options trades like debit or credit spreads, depending on whether volatility is cheap or expensive.
“I want deltas and leverage. My macro indicators give me an edge on price and in the worst case, the loss is limited to 10%, if everything has to go against me all at once. I can be 100% invested and only risk 10%.”
Capelj spoke with 42 Macro’s Darius Dale about his Wall Street story and perspectives on life and markets.
“We’re tracking at an above-potential level of output in terms of the growth rate of output. We’re also slowing and the pace of that deceleration is likely to pick up steam in the coming quarters.”
By 2023, that process is likely to “catalyze pressure on asset markets through the lens of corporate earnings and valuations you assign to a lower level of growth.”
Floor traders, according to Reznicek, had low capital requirements. As a result, they could put on strategies like the 1×2 ratio — a debit spread with an extra short option — for a low cost.
(See parts 1, 2, and 3 of ShadowTrader’s how-to series on ratio spreads.)
“On the floor, it is either go big or go home,” he chuckled, remarking that ratio spreads were the way of the casino. “You either get rich or they take your house. So, why would you put on any other spread?”
The next big turning point was Jim Dalton, who’s been a member of the Chicago Board of Trade, as well as a member of the Chicago Board Options Exchange (CBOE) and senior executive vice president of the CBOE during its formative years.
“I’m still in touch with him on a regular basis and I consider him a friend,” Reznicek said in a discussion on Dalton’s works like Mind Over Markets and Markets in Profile, as well as his use of WindoTrader Market Profile software. “I went to Chicago twice to see him teach live … and I came home from those seminars with five, six, 10 pages of notes. The nuances of profile continue to mold me.”
Capelj spoke with Kai Volatility Advisors’ Cem Karsan about the implications of record valuations and the growth of derivatives markets on policy, the economy, and financial markets.
“It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration. These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”
Capelj spoke with The Ambrus Group’s Kris Sidial to understand how to capitalize on volatility dislocations.
Unlike standard tail-risk funds which systematically buy equity puts, Ambrus’ approach is bespoke, cutting down on negative dynamics like decay with respect to time.
Given dislocations across single stock skew, term structure, and volatility risk premium, Ambrus will position itself in options with less time to maturity, buying protection up to six weeks out.
“The market will underestimate the distribution,” Sidial said in a conversation on Ambrus’ internal models that spot positional imbalances to determine who is off-sides and in what single asset. “We’re buying things that have happened before and we’re looking for it to carry a heavier beta when the sell-off happens.”
So, by analyzing flow, as well as using internal models to assess the probabilities of deleveraging in a risk-off event, Ambrus is able to venture into individual stocks where there may be excess fragility; “I know if stock XYZ goes down five percent, it’s going to go down 10% because this fund needs to deleverage.”
To aid the cost to carry, Ambrus utilizes defined-risk, short-volatility, absolute return strategies.
“I’m basically giving you a free put on the market – with a ton of convexity – with something that offers a payout that’s just more than a regular put,” Sidial summarized. “If the market doesn’t do anything, and we do an amazing job, we’re flat and you made money on all your long-only equity exposure.”
Capelj spoke with The Ambrus Group’s Kris Sidial about the meme stock debacle of 2021.
“You have distressed debt hedge funds that focus on shorting these types of companies. Melvin Capital is the one that is singled out due to the media, but they aren’t the only ones.”
Market participants added to the crash-up dynamics. Retail investors aggressively bought stock and short-term call options, while institutional investors further took advantage of the momentum and dislocations.
“You have this dynamic in the derivatives market where there is a gamma squeeze when people are buying way far out-of-the-money calls, and dealers reflexively have to hedge off their risk,” Sidial said.
“It causes a cascading reaction, moving the stock price up because dealers are short calls and they have to buy stock when the delta moves a specific way.”
The participation in the stock on the institutional side has not received much attention, he said.
“We’ve noticed that some of the flow is more institutional,” he said in reference to activity on the level two and three order books, which are electronic lists of buy and sell orders for a particular security.
“You have certain prop guys and other hedge funds that understand what’s going on, and they’re trying to take advantage of it, as well.”
This institutional activity disrupted traditional correlations and caused shares of distressed debt assets like GameStop, BlackBerry Ltd, and AMC Entertainment Holdings Inc to trade in-line with each other.
“This was not some WallStreetBet user, … if you look at how some of these things were moving premarket, you would see GME drop like 2%, BB’s best bid would drop and AMC’s best bid would drop. That’s an algo.”
The takeaway: although the WallStreetBets crowd is getting most of the blame, institutions are also at fault for the volatility.
Technical
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 lower part of a balanced overnight inventory, inside the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,003.25.
Key levels to the upside include $4,026.75, $4,038.75, and $4,049.75.
Key levels to the downside include $3,980.75, $3,955.00, and $3,937.00.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold, barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
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: Markets will build on areas of high-volume (HVNodes). Should the market trend for some time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for some time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
Separate from his work at Physik Invest, founder Renato Leonard Capelj is an accredited journalist interviewing prestigious global leaders in business, government, and finance.
In his desire to learn and apply the methods of those others who are far more experienced, Capelj has a long list of interviews you may find helpful in strengthening your understanding of markets.
Capelj spoke with Simplify Asset Management’s Michael Green about cutting investors’ portfolio volatility while amplifying profit potential.
In response to uncertainty, Green says investors can park cash in short-term near-risk-free bonds yielding 5% or more, as well as allocate some capital to volatility “to introduce a degree of convexity,” risking only the premium paid. Alternatively, investors can take a more optimistic long view and position in innovations like artificial intelligence or next-generation energy production.
Capelj spoke with The Ambrus Group’s Kris Sidial about his market perspectives.
Naive measures like the VVIX, which is the volatility of the VIX or the volatility of the S&P 500’s volatility, are printing at levels last seen in 2017, Sidial explains, noting this would suggest “we can get cheap exposure to convexity while a lot of people are worried.”
“Even if inflation continues, the rate at which it rises won’t be the same. Due to this, CTA exposures likely will not perform as well as they did in 2022, and that’s why you may see more opportunities in the volatility space.”
Capelj spoke with Damped Spring Advisors’ Andy Constan about what investors should focus on and how he creates trades that lose him less money.
Constan’s trades are constructed around two- to four-month time horizons and are structured long and short using defined-risk options trades like debit or credit spreads, depending on whether volatility is cheap or expensive.
“I want deltas and leverage. My macro indicators give me an edge on price and in the worst case, the loss is limited to 10%, if everything has to go against me all at once. I can be 100% invested and only risk 10%.”
Capelj spoke with 42 Macro’s Darius Dale about his Wall Street story and perspectives on life and markets.
“We’re tracking at an above-potential level of output in terms of the growth rate of output. We’re also slowing and the pace of that deceleration is likely to pick up steam in the coming quarters.”
By 2023, that process is likely to “catalyze pressure on asset markets through the lens of corporate earnings and valuations you assign to a lower level of growth.”
Floor traders, according to Reznicek, had low capital requirements. As a result, they could put on strategies like the 1×2 ratio — a debit spread with an extra short option — for a low cost.
(See parts 1, 2, and 3 of ShadowTrader’s how-to series on ratio spreads.)
“On the floor, it is either go big or go home,” he chuckled, remarking that ratio spreads were the way of the casino. “You either get rich or they take your house. So, why would you put on any other spread?”
The next big turning point was Jim Dalton, who’s been a member of the Chicago Board of Trade, as well as a member of the Chicago Board Options Exchange (CBOE) and senior executive vice president of the CBOE during its formative years.
“I’m still in touch with him on a regular basis and I consider him a friend,” Reznicek said in a discussion on Dalton’s works like Mind Over Markets and Markets in Profile, as well as his use of WindoTrader Market Profile software. “I went to Chicago twice to see him teach live … and I came home from those seminars with five, six, 10 pages of notes. The nuances of profile continue to mold me.”
Capelj spoke with Kai Volatility Advisors’ Cem Karsan about the implications of record valuations and the growth of derivatives markets on policy, the economy, and financial markets.
“It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration. These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”
Capelj spoke with The Ambrus Group’s Kris Sidial to understand how to capitalize on volatility dislocations.
Unlike standard tail-risk funds which systematically buy equity puts, Ambrus’ approach is bespoke, cutting down on negative dynamics like decay with respect to time.
Given dislocations across single stock skew, term structure, and volatility risk premium, Ambrus will position itself in options with less time to maturity, buying protection up to six weeks out.
“The market will underestimate the distribution,” Sidial said in a conversation on Ambrus’ internal models that spot positional imbalances to determine who is off-sides and in what single asset. “We’re buying things that have happened before and we’re looking for it to carry a heavier beta when the sell-off happens.”
So, by analyzing flow, as well as using internal models to assess the probabilities of deleveraging in a risk-off event, Ambrus is able to venture into individual stocks where there may be excess fragility; “I know if stock XYZ goes down five percent, it’s going to go down 10% because this fund needs to deleverage.”
To aid the cost to carry, Ambrus utilizes defined-risk, short-volatility, absolute return strategies.
“I’m basically giving you a free put on the market – with a ton of convexity – with something that offers a payout that’s just more than a regular put,” Sidial summarized. “If the market doesn’t do anything, and we do an amazing job, we’re flat and you made money on all your long-only equity exposure.”
Capelj spoke with The Ambrus Group’s Kris Sidial about the meme stock debacle of 2021.
“You have distressed debt hedge funds that focus on shorting these types of companies. Melvin Capital is the one that is singled out due to the media, but they aren’t the only ones.”
Market participants added to the crash-up dynamics. Retail investors aggressively bought stock and short-term call options, while institutional investors further took advantage of the momentum and dislocations.
“You have this dynamic in the derivatives market where there is a gamma squeeze when people are buying way far out-of-the-money calls, and dealers reflexively have to hedge off their risk,” Sidial said.
“It causes a cascading reaction, moving the stock price up because dealers are short calls and they have to buy stock when the delta moves a specific way.”
The participation in the stock on the institutional side has not received much attention, he said.
“We’ve noticed that some of the flow is more institutional,” he said in reference to activity on the level two and three order books, which are electronic lists of buy and sell orders for a particular security.
“You have certain prop guys and other hedge funds that understand what’s going on, and they’re trying to take advantage of it, as well.”
This institutional activity disrupted traditional correlations and caused shares of distressed debt assets like GameStop, BlackBerry Ltd, and AMC Entertainment Holdings Inc to trade in-line with each other.
“This was not some WallStreetBet user, … if you look at how some of these things were moving premarket, you would see GME drop like 2%, BB’s best bid would drop and AMC’s best bid would drop. That’s an algo.”
The takeaway: although the WallStreetBets crowd is getting most of the blame, institutions are also at fault for the volatility.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 8:50 AM ET. Sentiment Neutral if expected /MES open is inside of the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Fundamental
Higher asset prices boosted household wealth and demand; consumers’ increased ability to spend more wealth pushed up inflation. If policymakers use their tools to lower household wealth and demand, this should cut down on inflation.
Kai Volatility’s Cem Karsan says the latter was a policy objective and recent financial institution failures are a sign of follow-through; excesses and speculation are being removed, as policymakers desired.
Put your bracket aside, it’s time for some fresh crumbs 🥐🥐🥐@jam_croissant breaks down how he's looking at volatility trends ahead of the next Fed action with @OJRenick: https://t.co/Aj1piKmJXS
Policymakers don’t want liquidations, however. They want lower asset prices. Recent events put policymakers in an odd position after raising rates non-stop. In the Federal Reserve’s (Fed) case, and we paraphrase Karsan, policy/rates moved very quickly with little pause. With there being a lag, the Fed may want to pause and assess. However, they have to telegraph this carefully so that the market does not read it as a pivot. If the market rallies, that “makes things hotter,” Karsan says.
Before BTFP. Fire sale of assets from bank experiencing a run. Bank getting new deposit already has desired equity risk and no need to lever
After BTFP 1 year to sell assets of losing bank Bank getting new deposit already has desired equity risk and no need to lever
There’s already been an overreaction in the bond market, he adds, which is not ideal. The Fed does not want the long end of the yield curve to fall, as it has on the back of the turmoil and intervention, as well as data including housing starts which show more supply coming onto the market, likely a mortgage application booster in the near term.
Even at the front end, there’s been lots of movement. This has “forc[ed] widespread risk liquidation,” Bloomberg says. Take a look at the Three-Month SOFR (FUTURE: /SR3), a tool used to hedge USD short-term interest rates.
Graphic: Retrieved from Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s thinkorswim platform.
The consensus, which Karsan agrees with, is that the Fed moves forward with a 25 basis point hike while telegraphing it wants the long end of the curve to rise or higher for longer as it is colloquially referred to.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
It is possible for the US policymakers to adopt a meeting-by-meeting stance, as their counterparts have in Europe, letting uncertainties regarding the likes of Credit Suisse Group AG (which just received a ~$54 billion or so liquidity backstop and is mulling a combination with other lenders), SVB Financial Group (NASDAQ: SVB) and First Republic Bank (NYSE: FRC) pan out.
Graphic: Retrieved from Bloomberg. “[T]he credit extended through the two backstops show a banking system that is still fragile and dealing with deposit migration in the wake of the failure of Silicon Valley Bank of California and Signature Bank of New York last week.” Per John Authers: the phenomenal borrowing from the Fed’s discount window suggests that if these are just liquidity problems, they are widespread and serious. Further, the point of the exercise is to slow down the economy, which will in time tend to put pressure on banks’ solvency.”
Pausing, or intending to pause explicitly, could raise inflation expectations or “boost the odds of a recession by spooking consumers and companies into believing that the economy is worse off than they thought,” Bloomberg explains, noting: “All told, the emergency loans reversed around half of the balance-sheet shrinkage that the Fed has achieved since it began so-called quantitative tightening — allowing its portfolio of assets to run down — in June last year.”
Graphic: Compiled by Physik Invest.Per Jefferies Financial Group Inc’s (NYSE: JEF) Christopher Wood: “2022 was the year when US equities suffered multiple contraction from monetary tightening. This year will be the year when earnings downgrades hit the stock market if the US recession forecast proves to be accurate. This is now the key issue in world financial markets. Then 2024 will be the year when markets will have to deal with the emerging credit problems in the private space.”
Positioning
Heading into this most recent market decline, investors foresaw increased volatility and were positioned for it as indicated by the pricing of tail risk and performance of implied volatility or IVOL (as investors continued to demand protection during this window of non-strength), said Laya Royer of Citadel Securities.
Recall that Kris Sidial warned us of this. Options, colloquially referred to as volatility, would serve as the only hedge in an environment wherein commodities, stocks, and bonds don’t combine or balance each other as well as they did in 2022.
Now, there are options expirations (OpEx) nearing (March 16 and 31); monetization of profitable options structures, as well as volatility compression and options decay, have counterparties buying back their short stock and/or futures hedges (to the short put positions they have on), boosting the market (particularly the depressed and rate-sensitive Nasdaq 100) through this OpEx/triple witching window.
Graphic: Retrieved from Cboe Global Markets (BATS: CBOE).
Following this period, the “rollover” of existing positions may result in “price swings” that last, Bloomberg puts forth. “This quarterly expiry may help unpin the market.”
Structures proposed in the Daily Brief for March 14 may work in reducing portfolio downside while allowing you to participate directionally at less cost.
Technical
As of 8:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,970.75.
Key levels to the upside include $4,004.75, $4,037.00, and $4,059.25.
Key levels to the downside include $3,946.75, $3,921.25, and $3,891.00.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 (FUTURE: /MES) at the middle bottom.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: 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.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 850+ that read this report daily, below!
Graphic updated 8:00 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. 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.
Fundamental
As much as it may be a so-called chart crime to overlap past market environments and project or forecast what may happen, it’s quite eerie that today’s path of returns appears similar to that of 1394-1937, 2005-2008, and 1997-2001, for example.
Graphic: Retrieved from Deutsche Bank AG (NYSE: DB).
Moreover, this time around, it’s the case that markets have fallen on participants’ pricing of higher interest rates and quantitative tightening (QT).
Graphic: Retrieved from The Market Ear. Via Guggenheim Partners.
Some argue there is more to go on the pricing of a potential economic slowing happening here, in the U.S., abroad in China, and beyond.
Graphic: Retrieved from Bloomberg. “Earnings are related to the economic cycle, but not tightly, and expectations for next year are intertwined with macroeconomic concerns.”
Notwithstanding, and we will end the fundamental section with this, today, Credit Suisse Group AG’s (NYSE: CS) Jonathan Golub puts forth the following:
“Although revisions are negative, projected EPS growth rates remain positive for the remainder of 2022-23. While 3Q growth has fallen to 4.7%, EPS should expand 9-10%, assuming similar beats as experienced in 2Q. Historically, earnings hold up best when inflation is elevated. Many investors are interpreting the recent decline in estimates as a harbinger to recession. Our work shows that in high inflationary periods (1973, 1980, 1981) earnings peak just 2 months prior to a recession’s onset. With EPS growth projections still positive, revisions would have to fall much more to signal an economic contraction.”
Positioning
Referring traders to a recent case study (HERE) on how to play this market environment, as well as the impacts of implied volatility (IVOL) compression September 8 (HERE).
After a period of sideways-to-lower, markets are rebounding, boosted by IVOL compression and traders’ re-positioning ahead of potential including inflation and monetary policy updates.
Notwithstanding, as Kai Volatility’s Cem Karsan well explained to Charles Schwab Corporation’s (NYSE: SCHW) TD Ameritrade Network, traders must look out for the “window of real risk.”
The energy for a downside move “is significant” after this year’s decimation of “skew and volatility,” he said. “Hedging for convexity is in the 5th percentile.”
This is because participants hedged heading into the decline, and sold skew as the markets explored lower. After the current period of volatility supply passes, Karsan added, and markets were to trade lower, there is the risk of a reach for protection and a fatter tail.
Graphic: Merrill Lynch Options Volatility Estimate (INDEX: MOVE), a measure of volatility for the US Treasury market, versus the Cboe Volatility Index (INDEX: VIX), a measure of volatility for the equity market, diverged this year. This is, in part, due to the supply of volatility in equities.
Should nothing happen, then the unwind of the recent speculation amongst “family offices and institutions front-running the speculative hedges that are more than 50 units,” will add support.
Graphic: Retrieved from SentimenTrader on September 7, 2022.
Technical
As of 6:40 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $4,069.25 HVNode puts into play the $4,107.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,136.75 MCPOC and $4,189.25 LVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $4,069.25 HVNode puts into play the $4,018.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,991.00 VPOC and $3,952.75 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.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Graphic: Updated 9/8/2022. The daily chart of the SPDR S&P 500 ETF Trust (NYSE: SPY).
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.
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.
Editor’s Note: 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!
Overnight, equity index futures auctioned sideways to lower with commodities and bonds.
There are no overnight fundamental catalysts to make note of. However, it bears mentioning that implied volatility metrics – via the Cboe Volatility Index (INDEX: VIX) – are back to levels seen before Russia’s invasion of Ukraine. One may conclude that concerns are easing.
Ahead is data on the Chicago Fed national activity index (8:30 AM ET) and Fed-speak by Chair Jerome Powell (12:00 PM 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
Fundamental: In spite of uncertainties with respect to economic growth and the implications of tighter monetary policy to rein in inflation, as well as geopolitical conflicts abroad, the pricing of equity market risk – via the VIX – is back at levels before Russia’s invasion of Ukraine.
That leads us to question whether the de-rate (or pricing in of uncertainties) has played out?
Potentially. With greater clarity on the Federal Reserve’s commitment to raising borrowing costs (as discussed March 17 in detail), strategists like JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic suggest it is time to add risk in beaten-down, high-beta positions.
“While the commodity supercycle will persist,” Kolanovic said, “the correction in bubble sectors is now likely finished, and geopolitical risk will likely start abating in a few weeks’ time (while a comprehensive resolution may take a few months).”
Graphic: Via Bloomberg. “Officials on the Federal Open Market Committee voted 8-1 [] to lift the target range for their main policy rate to 0.25%-0.5% and forecast a sequence of increases that would raise it to 1.75%-2% by year-end. The projections, known as the dot plot, also showed that almost half of the 16 current policymakers wanted to move faster.”
Complicating Kolanovic’s outlook is uncertainty with respect to the Fed’s decision to hike and taper asset purchases faster, as some Fed members say they are “very open to.”
At a high level, higher rates make borrowing more costly (i.e., higher rates on mortgages and business loans, as well as credit cards, among other things, disincentivize borrowing, and this funnels into less growth and inflation).
These higher rates compound the challenges of limited supply, for instance, in housing.
Graphic: Via Bloomberg. “The slide in sales reflects a market still constrained by a lack of inventory, which in February was the second-lowest on record. Buyers are bidding up prices on the few homes available. Meantime, affordability is showing signs of worsening, especially among first-time buyers … [which] accounted for 29% of sales last month, down from 31% a year earlier. [A]t current rates, monthly mortgage payments are up 28% from February last year.”
There’s also the topic of using quantitative tightening (QT) to fight inflation, too.
Recall that quantitative easing (QE) is a policy to expand the Federal Reserve’s balance sheet “to provide monetary accommodation, typically when interest rates are at a zero-lower bound (when nominal interest rates are at, or near, zero),” as JH Investment Management explains.
With QT, central banks remove assets (e.g., government bonds they bought from the private sector) from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities.”
With that, we note that when bonds rise in value, their yields decline; “when the Fed embarks on bond-buying program[s] to support the U.S. economy, … [it nudges] the prices of these assets higher while pushing yields lower, which also has the effect of driving yield-hungry investors into relatively riskier asset categories that promise high returns.”
As a result, participants’ demand for risk assets prompts their divergence from fundamentals. As liquidity is removed and funding costs increase, this may prompt risk assets to converge with fundamentals.
This is as, for investors to take on additional risk for return, they must receive in excess of the risk-free rate (as provided by the Treasury). This excess is the risk premium.
At present, according to commentary by Damped Spring’s Andy Constan, “Additional risk premium expansion pressures from these levels is not likely from news emanating from” Fed meetings.
“However, if, in the unlikely event, details of QT do emerge suggesting a start of QT before June and at a greater size than expected, we would no longer be willing to hold [risk] assets as that would cause an end to any risk premium contraction possibilities.”
Positioning: According to Morgan Stanley’s (NYSE: MS) trade desk, institutions (e.g., volatility targeting funds and trend following commodity-trading advisers) dumped nearly $200 billion in global equities over the first two months of 2022.
Hedge funds’ net leverage, too, “fell 7.5 percentage points over the two weeks through March 11, the largest decrease over any comparable period since at least January 2016,” according to Goldman Sachs Group Inc (NYSE: GS).
“Institutional traders, major money managers, asset managers, and hedge funds, their moves have to do with the current market conditions — a lot of volatility, a lot of uncertainty, inflation concerns, geopolitical concerns,” says Bloomberg’s Jackson Gutenplan.
“As the market continues to downtrend, institutions selling out of positions are overwhelming any retail buying pressure.”
Given this, as mentioned in the prior fundamentals section, strategists like JPM’s Kolanovic suggest these are some of the reasons to boost risk.
“Current risk positioning is very light. This is a result of high and persistent volatility, and risk aversion caused by global geopolitical developments,” Kolanovic says. “And for this reason, risks are skewed to the upside.”
And so, alongside the buying of futures and stock to offset the decay of counterparty positive delta (post-FOMC and through OPEX), retail investor buying remained undeterred last week.
But, as Zephyr’s Ryan Nauman says, “even though retail has gained a lot of momentum over the past two years, institutional money still outweighs the retail money, and it’s still going to move markets.”
Graphic: Via TD Ameritrade. Taken from Bloomberg. “There’s a little bit of what I think is a retrenchment going on, where they weren’t just buying everything across the board,” Shawn Cruz, senior market strategist at TD Ameritrade Inc said. “As much as there is some pulling back, and there’s a lot of volatility going on, you’re seeing some selling in the more highly valued areas and the buying is very targeted.”
That is in the face of lackluster options activity. According to SpotGamma, call-buying, a feature of sustained bull markets “was at lows going back to 2020,” last week.
Graphic: Via SpotGamma. “Here’s options data from the OCC. These plots show the premium per trade aggregated each week, with calls in blue and puts in orange. This is only customer flow (i.e. retail, hedge funds). Starting with equities, call buying this past week was at LOWS going back to ’20 (top right).”
“Maybe you get to an extreme bearishness, and that’s usually where you bottom out,” adds Liz Young of SoFi Technologies Inc (NASDAQ: SOFI) in a statement on mom-and-pop investors eventually following institutional selling trends.
As this commentary has said before, a way to participate in the upside (while lowering debit risk) is through complex options structures, such as the ratio spread. Note, ratio spreads may carry margin risk, depending on the structure, resulting in undefined losses, potentially.
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.
Technical: As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed 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; activity above the $4,438.25 high volume area (HVNode) puts in play the $4,466.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,499.00 untested point of control (VPOC) and $4,526.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,438.25 HVNode puts in play the $4,409.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,395.25 HVNode and $4,355.00 VPOC, or lower.
Considerations: Push-and-pull, as well as responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
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.
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.
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.
