Last week, we discussed the recent response to the bank issues cutting risks for the S&P 500 (INDEX: SPX). Volatility and correlations fell as time passed, and this helped contain the market. Though last week’s options expiration (OpEx) may free markets up, we maintain that the SPX may stay contained longer before it weakens.
Graphic: Retrieved from SqueezeMetrics. “Monthly OpEx just shaved off nearly $300mm per point in SPX dealer gamma exposure. That means index liquidity has lost quite a bit of depth going into next week.”
Catalysts for weakness include falling earnings growth and a debt-ceiling crisis that’s driven T-bill yields lower from surging demand; a failure by Congress to raise the limit on how much the government can borrow may disrupt funding markets, WSJ reports.
Let’s limit our expectations and focus on low- or zero-cost call structures (e.g., bull call ratio) monetized to finance longer-dated put structures (e.g., bear put vertical) while allocating a chunk of our portfolio to near-risk-free yield-harvesting structures (e.g., box spread), mainly if you are a portfolio margin trader.
As I explained to a subscriber over the weekend, for boxes, the greatest possible loss across a range of prices is negligible. Hence, buying power is unaffected in trading a box. Consequently, using portfolio margin and trading boxes, you have more buying power to allocate to other trades that are margin (and not debit) intensive, such as synthetic long stock (i.e., purchase ATM call and sell ATM put). Using options, among other derivatives, enables us to stack returns on each other.
Here’s one example.
We can trade box spreads expiring at the end of June. We buy the $4,000/$5,000 call spread for $22,365.00 and simultaneously buy the $5,000/$4,000 put spread for $76,620. This trade costs $98,985.00, and by lending this amount (on April 21, 2023), you will receive $1,015.00 upon maturity. Yes, you will have $99,000.00 cash tied up, but you should be able to use $99,000.00 in buying power in other trades if you have that portfolio margin component which is so important.
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See you later!
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Bank of America Corporation (NYSE: BAC) sees allocations to equities versus bonds falling. That’s amid recession fears. Per EPB, “the cyclical economy has just started to shed jobs today, and leading indicators signal the recession is likely underway.”
“To get advanced warning of recessions, you must look at the construction and manufacturing sectors, even though these two sectors are only 13% of the labor market,” EPB adds, noting traditional indicators’ weakening predictability is not so great to ignore the insight. “It’s clear that the composition of traditional leading indicators remains appropriate, and thus, the current resounding recessionary signal should not be ignored.”
BAC strategist Michael Hartnett said, though, that this “consensus lust for recession” must soon be satisfied. Otherwise, the “pain trade” would be even higher yields and stocks; the S&P 500 (INDEX: SPX) is enjoying an accelerated rally which Jefferies Financial Group (NYSE: JEF) strategists think portends a period of flatness, now, over the coming weeks …
Graphic: Retrieved from Jefferies Financial Group (NYSE: JEF) via The Market Ear.
… and through options expiration (OpEx), typically a poor performance period for the SPX.
Beyond the uninspiring fundamentals, the positioning contexts are supportive. Recall our letters published earlier this year. If the market consolidated and failed to break substantially, then falling implied volatility (IVOL) and time passing would bolster markets and, potentially, help build a platform for a rally into mid-year. A check of fixed-strike and top-line measures of IVOL like the Cboe Volatility Index or VIX confirms options activities are keeping markets intact.
Graphic: Retrieved from Danny Kirsch of Piper Sandler (NYSE: PIPR). “SPX May $4,150.00 call volatility, the lack of realized volatility weighing on the market. Volatility low, not cheap.”
Beyond the rotation into shorter-dated options, just one of the factors exacerbating the decimation of longer-dated volatility, traders’ consensus is that markets won’t move a lot and/or they don’t need to hedge over longer time horizons; traders want punchier exposure to realized volatility (RVOL), and that they can get through shorter-dated options that have more gamma (i.e., exposure to changes in movement), not vega (i.e., exposure to changes in implied volatility).
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg.
Consequently, counterparties may be less dangerous to accelerating movement in either direction; hence, the growing likelihood of a period of flatness.
“Despite the collapse in the 1-month realized volatility, we suspect most vol control funds have scaled into using their longer-term realized vols, which by design, lead to less aggressive rebalancing flows,” Tier1Alpha says. “For example, the 3-month rVol, which is currently driving our model, was essentially unchanged yesterday, which means volatility targets were maintained, and very little additional rebalancing had to occur. So even with the decline in the 1-month vol, overall risk exposure remained the same.”
With IVOL at a lower bound, the bullish impacts yielded by its compressing have largely played out. There may be more to be gained by movements higher in IVOL, in addition to the expiry of many call options this OpEx. By owning protection, particularly far from current prices, you are positioned to monetize on the market downside and non-linear repricings of volatility, as this letter has discussed in recent history. The caveat is that volatility can cluster and revert for longer; hence, your structure matters.
“I am concerned that VIX is underpricing the series of events that we know to expect over the coming weeks,” says Interactive Brokers Group Inc’s (NASDAQ: IBKR) Steve Sosnick. “While there is now an 88% implied likelihood of a 25 basis point hike, the likely path of any potential future hikes and assumed cuts should be more clarified at the meeting and in its aftermath. And oh, has anyone ever heard the expression “sell in May and go away?”
Graphic: Retrieved from Interactive Brokers Group Inc (NASDAQ: IBKR).
With call skews far up meaningfully steep in some products, still-present low- and zero-cost call structures this letter has talked about in the past remain attractive. If the market falls apart, your costs are low, and losses are minimal. If markets move higher into a “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). An alternative option is neutral. Own something such as a T-bill or box spread (i.e., buy call and sell put at one strike and sell call and buy put at another higher strike). Some boxes are yielding upwards of 5.4% as of yesterday’s close.
To end, though the short-dated options activity may prompt cascading events in market downturns, the main issue is the reduced use of longer-dated options; a supply and demand imbalance likely resolves itself with an implied volatility repricing of a great size where longer-dated options outperform those that are shorter-dated.
Our locking in of rates or using the profits of call structures to position for a potential IVOL repricing, particularly in the back half of the year when dealer positioning is less clear, buybacks are to fall off of a cliff, rates may fall, and the boost from short-covering has played its course, is an attractive proposition given the context.
Graphic: Retrieved from Bloomberg. “The S&P 500 (white line) is well above its levels from early March, while the yield on the 3m-2y spread remains in a deep inversion, signifying meaningful expectations of cuts in the months ahead.”
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Inflation and employment rates remain high. Additionally, consumers show resilience, and earnings are strong. As a consequence, markets are back to pricing higher rates for longer. This is a pressure on bonds and stocks which appear “overvalued relative to coming bad news on both economic growth and corporate earnings.”
Graphic: Retrieved from Bloomberg via @Marcomadness2. Hedge funds are net short 2Y and SOFR futures.
Morgan Stanley (NYSE: MS) says stocks are at risk of a pullback, accordingly.
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via The Market Ear. The indexes have front-run the pause and pivot; Goldman Sachs Group Inc (NYSE: GS) data suggests a statistically significant disconnect between the Nasdaq 100 (INDEX: NDX) and yield.
With the percentage of stocks outperforming the S&P 500 the lowest on record, MS added, a slump in technology is the big risk if yields continue to rise; the bear market is not yet over. “If there is one thing that can throw cold water on the large mega-cap rally, it’s higher yields due to a Fed that can’t stop hiking.”
Graphic: Retrieved from Morgan Stanley (NYSE: MS) via Bloomberg.
Moody’s Corporation (NYSE: MCO) expects a “0.25-percentage point increase to the fed funds rate when the FOMC reconvenes in early May.” Following this hike, there is likely to be a pause at a 5.00-5.25% terminal rate for a few months.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
From a positioning perspective, Kai Volatility’s Cem Karsan stated that in the past 6-9 months, there has been a significant increase in the volume of options with zero days to expiration (0 DTE), which now accounts for 44% of the total volume. This increase in short-dated options volume has been accompanied by a similarly sized decrease in longer-dated options volume.
Further, the majority of trading activity in these short-dated options is split between hedging and directional trading, as well as yield harvesting via out-of-the-money (OTM) options sales. Though the short-dated activity may prompt cascading events in market downturns, the main issue is the reduced use of longer-dated options; a supply and demand imbalance likely resolves itself with an implied volatility repricing of great size where longer-dated options outperform those that are shorter-dated.
Traders can look to position for a potential IVOL repricing, particularly in the back half of the year when dealer positioning is less clear, buybacks are to fall off of a cliff, and the boost from short-covering has played its course.
Traders can continue to play near-term strength via call spread structures and use those profits to reduce the costs of owning longer-dated bets on markets or rates falling and IVOL increasing. If not interested in directional exposure, traders may allocate funds to T-bills and SPX box spreads which allow traders to create a loan structure similar to a T-bill. If savvy, one could find some structures yielding ~5.5%. Traders can also consider blending T-bills and boxes with directional exposure. This way, they can cut portfolio volatility but still have a bit of leverage potential. Please check out our past letters for trade structure specifics. Have a great day!
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
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 Risk-On if expected /MES open is above 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
Not all doom and gloom. Make sure to read to the end!
Fundamental
In the Daily Brief for 3/20, we summarized the financial industry and policymaker responses that would turn asset fire sales into managed, orderly asset sales.
The net result of the intervention would be a reduction in credit creation, a tightening of financial conditions, as well as a slowing of the economy and inflation while, potentially, setting “a dangerous precedent that simply encourage[s] future irresponsible behavior” (e.g., risky lending/borrowing), the House Freedom Caucus put eloquently. Basically, the fear is in policymakers underwriting the losses of prevailing carry-type strategies and setting the stage for an even bigger unwind or so-called “Minsky moment,” the “sudden crash of markets and economies that are hooked on debt,” Bloomberg reports.
"Regional banks relied on a business model that relied on uninsured deposits," says @Lazard's @porszag. "The government needs to make explicit what a lot of people are assuming: that for the foreseeable future, uninsured deposits don't exist. Everything is insured." pic.twitter.com/GgZ9ZF2f7r
A systemic credit event is among strategists’ biggest fear, indeed. A Bank of America Corporation (NYSE: BAC) survey shows a credit event happening on the heels of a US shadow banking, corporate debt, and developed-market real-estate collapse. Recall this letter writer’s conversation with Simplify Asset Management’s Michael Green who said he sees “cracks in bubbles like commercial real estate” already appearing, too.
Bloomberg adds that JPMorgan Chase & Co (NYSE: JPM) strategists think the inverted yield curve signals recession and the stocks are likely nearing their high point.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
JPM adds that market lows won’t occur until interest rate cuts ensue.
Graphic: Retrieved from BNP Paribas ADR (OTC: BNPQY).
Recall 3/20’s letter citing BAC research that finds selling markets on the last Fed rate hike is a good strategy. The “Minsky moment” comment/fear has others at JPM adding that investors should sell into relief bounces.
Graphic: Retrieved from Bank of American Corporation (NYSE: BAC) via The Market Ear.
Most participants foresee rates continuing to rise by at least 25 basis points, per the CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Following Wednesday’s (expected) hike, the path forward appears uncertain. Yesterday, the terminal/peak rate was at 4.75-5.00%. Today, the peak has shifted higher to 5.00-5.25%.
Graphic: Retrieved from CME Group Inc (NASDAQ: CME).
Financials look ready to fall off a cliff, to add. If they do, the whole market likely goes.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
Positioning
We keep referring back to our Daily Briefs published last week (e.g., 3/13 and 3/14). In those letters, we talked about the growing concern about markets enduring some exogenous shocks.
We opted to take the less extreme side since policymakers’ response was likely to stem (or push into the future) turmoil. Additionally, with participants easing up on their long-equity exposure, equity markets were likely to stay contained, relative to bond markets where the lack of liquidity is an issue, some believe. Anyways, following important events including inflation updates (i.e., CPI) and derivatives expiries, short bursts of strength (particularly in some of the previously depressed products such as the Nasdaq 100 or NDX, as explained 3/17) were likely to ensue heading into the end of this month and next month. Additionally, certain rates trades via options we set forth on 3/14 were ripe for monetization, too.
Rotating into a money market or T-bill fund or box spreads, while allocating some remaining cash to leverage potential by way of some call options structures, appeared attractive. While the T-bill or box spread exposures did not budge much, call options structures as proposed on 3/14 worked (and are likely to continue to work) rather well. The monetization of the rate structures discussed on 3/14 was timely, also.
The potential for coming events including the Federal Reserve’s (Fed) interest rate decision on Wednesday 3/22 to assuage participants’ fears of slowing may, accordingly, prompt fears of missing out on the upside, Bloomberg reports. A response may be FOMO-type demand for call options exposures, coupled with CTAs further “raising their equity exposure” on trend signals and lower volatility, boosting markets into a “more combustible” state as explained on 2/17. This fear of missing out is visible in options volatility skew; traders are hedging those tail outcomes.
Technical
As of 7:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,004.75.
Key levels to the upside include $4,026.75, $4,037.00, and $4,045.25.
Key levels to the downside include $3,994.25, $3,977.00, and $3,959.25.
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
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.
Options Expiration (OPEX): Reduction in dealer Gamma exposure. There may be an increase in volatility after the removal of large options positions and associated hedging.
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
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.
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 6:30 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
A long(er) letter, today. Through the end-of-this week, newsletters may be shorter due to the letter writer’s commitments. Take care!
Fundamental
Yesterday’s letter focused on the SVB Financial Group (NASDAQ: SIVB) failure, albeit with an optimistic tone. In short, the bank could not make good on fast accelerating withdrawals. Read more here.
According to one TechCrunch article, the likes of Founders Fund “reportedly advised their portfolio companies … to withdraw their money, … [and], if everybody is telling each other that SVB is in trouble, that will be a challenge,” as it was.
Graphic: Retrieved from @Citrini7. In the worst-case scenario, it was likely that uninsured depositors at SIVB would have received $0.80 on each dollar barring a bailout.
Authorities later put forth emergency measures guaranteeing all deposits. The effort shored up confidence in the banking system and markets strengthened, though some regional names such as First Republic Bank (NYSE: FRC) continued trading weak. In FRC’s case, the Federal Reserve’s (Fed) new bailout facility does not help. As former Fed trader Joseph Wang explains, “you need Treasuries and Agency MBS to tap the facility, and [FRC] barely owns any.”
Anyways, as yesterday’s letter briefly mentioned, expectations on the path of Fed Funds shifted. Traders put the terminal/peak rate at 5.00-5.25%, down from 5.50-5.75%, while pricing cuts after spring. Previously, no cuts were expected in 2023.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
Measures of US Treasury yield volatility implied by options (i.e., bets or hedges on or against market movement) adjusted higher, accordingly. This is often a harbinger of equity market volatility.
Graphic: Merrill Lynch Option Volatility Estimate retrieved from TradingView
Call options on the three-month Secured Overnight Financing Rate (FUTURE: SOFR) future (i.e., bets on interest rates falling in the future) paid handsomely.
For instance, bull call spreads that expire in December 2023 (e.g., BUY +1 VERTICAL /SR3Z23:XCME 1/2500 DEC 23 /SR3Z23:XCME 96/97 CALL @.0375) increased in value by about 650.00% to $0.33 (i.e., $750.00 per contract).
Graphic: Retrieved via TradingView. Three-month SOFR Future (December 2023). When SOFR is at a lower (higher) number, the market is pricing an increase (decrease) in interest rates. Participants put the December 2023 SOFR rate at 100-96.145 = 3.855%.
In the equity space, some readers may have caught some commentary on spot-vol beta in the VIX complex strengthening like we have not seen in a while, a nod to the harbinger of equity market volatility remark a few paragraphs higher.
Recommended Readings:
Read: The Ambrus Group’s Kris Sidial on two major risks investors should watch out for in 2023. In short, volatility’s sensitivity to underlying prices (spot-vol beta) was low, and Sidial cast blame, in part, on commodity trading advisors and strong volatility supply.
Read: Simplify Asset Management’s Michael Green on using option and bond overlays to hedge big uncertainties facing markets. Following 2022, investors swapped poor-performing long-dated volatility exposures for ones with bounded risk and less time to expiry, hence the increase in 0 DTE trading.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch.
This spot-vol beta remark suggests that (at least some of) the volatility in rates, as well as certain small pockets of the equity and crypto market, manifested demand for crash protection in the S&P 500, “which feeds back into VIX,” one explanation put well.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch. “[Last] week finally got a bit of explosiveness in VIX as fixed strike volatility got bid. This is VIX generic front month future and move in SPX. Last time it really “paid” to have VIX upside was Jan of 2022 (point in upper left corner).”
Notwithstanding, for these options to keep their value and continue to perform well, realized volatility (RVOL) must pick up substantially, which is not likely.
Unlimited’s Bob Elliott comments: “the bond market is pricing a broad-based credit crunch, … [and though] it’s not crazy for the Fed to slow down here given the current uncertainty,” odds are financial problems are contained and the Fed moves forward with its mission to get (and keep) inflation down.
Graphic: Retrieved from Fabian Wintersberger. Just as the “monetary expansion supported the rise in equity and bond prices in January.”
Consequently, “the pricing of Dec23s and 5yr BEIs makes no sense,” Elliott adds. This means the example SOFR trade above is/was ripe for some monetization, and equity volatility must be dealt with carefully (i.e., price movements must be higher than they are now which would be difficult given that authorities/Fed do not want liquidations).
In support of siding with the less extreme take, we paraphrase Kai Volatility’s Cem Karsan who says that for years prior to the 2007-2008 turmoil, macro tourists were calling for a crash.
For markets to crumble, there would have to be an exogenous event far greater in implications than what just transpired with SIVB over the weekend. With odds that such turmoil doesn’t happen soon, coupled with participants easing up on their long-equity exposure (i.e., selling stock and not needing to hedge, hence the statement that owning equity volatility must be dealt with carefully), RVOL is likely to stay contained. That’s not to say that this volatility observed in the rates market can’t persist. It’s also not to say that markets can’t continue to trade lower (in fact, with interest rates rising and processes like quantitative tightening challenging bank liquidity, there is less incentive for investors to reside in lower-yielding equities). It just means that, barring some exogenous event, the market remains intact.
Graphic: Retrieved from Jack Farley. “Silicon Valley Bank owns >$80 Billion of Mortgage-Backed Securities (MBS), a market that is ‘more prone to bouts of volatility’ because ‘small investors & leveraged funds have become the main buyers’ as the Fed & banks step away from market, according to Dec 2022 BIS report.”
Positioning
Following important events like the release of the Consumer Price Index (CPI) today, the compression of implied volatility or IVOL, coupled with the nearing of big options expirations (OpEx), sets the market up for potential short bursts of strength heading into the end of the month and next month.
Graphic: Retrieved from Bloomberg. Inflation has been well within forecasts.
A quick comparison of the Russell 2000 (INDEX: RUT) and Nasdaq 100 (INDEX: NDX) suggests this options-induced strength may help keep the recent re-grossing theme intact. The compression of wound IVOL and passage of OpEx, coupled with the still-live re-grossing theme, may put a floor under equities.
Graphic: Retrieved from TradingView. Orange = RUT. Candles = NDX. Note the weakness in RUT. Note the strength of the Nasdaq relative to the Russell.
To play, one could place a portion of their cash in money market funds or T-bill ETFs or box spreads, for instance, while allocating another portion to leverage potential by way of some call options structures that use one or more short options to help bring down the cost of a long option that is closer to current market prices (e.g., a bull call spread or short ratio call spread). To note, based on options prices as of this writing, it may be too early to enter call structures (i.e., too expensive given the context).
DEFINED OUTCOME INVESTING
-Worried about the prospects of the 60/40 portfolio? -Looking for a strategy that takes advantage of higher interest rates? -Tired of market timing?
A 🧵on how to use exchange-traded options + U.S. Treasurys to define your risk today, for tomorrow.
As of 6:30 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 the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,904.25.
Key levels to the upside include $3,921.75, $3,945.00, and $3,970.75.
Key levels to the downside include $3,884.75, $3,868.25, and $3,847.25.
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
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.
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
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.
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 Risk-On if expected /MES open is above 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
Lots of content today but a bit rushed at the desk. If anything is unclear, we will clarify it in the coming sessions. Have a great weekend! – Renato
Fundamental
Physik Invest’s Daily Brief for March 2 talked about balancing the implications of still-hot inflation and an economy on solid footing. Basically, the probability the economy is in a recession is lower than it was at the end of ‘22. For the probabilities to change markedly, there would have to be a big increase in unemployment, for one.
According to a blog by Unlimited’s Bruce McNevin, if the unemployment rate rises by about 1%, recession odds go up by 29%. If the non-farm payroll employment falls by about 2% or 3 million jobs, recession odds increase by about 74%. After a year or so of tightening, unemployment measures are finally beginning to pick up.
Policymakers, per recent remarks, maintain that more needs to be done, however. For instance, the Federal Reserve’s (Fed) Raphael Bostic, who generally carries an easier stance on monetary policy, mulled whether the Fed should raise interest rates beyond the 5.00-5.25% terminal rate consensus he previously endorsed. This commentary, coupled with newly released economic data, has sent yields surging at the front end.
Graphic: Retrieved from TradingView.
Traders are wildly repricing their terminal rate expectations this week. The terminal rate over the past few days has gone up from 5.25-5.50% to 5.50-5.75%, and back down to 5.25-5.50%.
Graphic: Retrieved from CME Group Inc (NASDAQ: CME).
Positioning
Stocks and bonds performed poorly. Commodity hedges are uninspiring also in that they do not hedge against (rising odds of) recession, per the Daily Brief for March 1.
In navigating this precarious environment, this letter has put forward a few trade ideas including the sale of call options structures to finance put options structures, after the mid-February monthly options expiration (OpEx). Though measures suggest “we can [still] get cheap exposure to convexity while a lot of people are worried,” the location for similar (short call, long put) trades is not optimal. Rather, trades including building your own structured note, now catching the attention of some traders online, appear attractive now with T-bill rates surging.
Such trades reduce portfolio volatility and downside while providing upside exposure comparable to poorly performing traditional portfolio constructions like 60/40.
As an example, per IPS Strategic Capital’s Pat Hennessy, with $1,000,000 to invest and rates at ~5% (i.e., $50,000 is 5% of $1,000,000), one could buy 1000 USTs or S&P 500 (INDEX: SPX) Box Spreads which will have a value of $1 million at maturity for the price of $950,000.
With $50,000 left in cash, one can use options for leveraged exposure to an asset of their choosing, Hennessy explained. Should these options expire worthless, the $50,000 gain from USTs, at maturity, provides “a full return of principal.”
For traders who are focused on short(er)-term movements, one could allocate the cash remaining toward structures that buy and sell call options over very short time horizons (e.g., 0 DTE).
Knowing that the absence of range expansion to the downside, positioning flows may build a platform for the market to rally, one could lean into structures like fixed-width call option butterflies.
For instance, yesterday, Nasdaq 100 (INDEX: NDX) call option butterflies expanded in value ~10 times (i.e., $5 → $50). An example 0 DTE trade is the BUTTERFLY NDX 100 (Weeklys) 2 MAR 23 12000/12100/12200 CALL. Such trade could have been bought near ~$5.00 in debit and, later, sold for much bigger credits (e.g., ~$40.00).
Such trade fits and plays on the narrative described in Physik Invest’s Daily Brief for February 24. That particular letter detailed Bank of America Corporation’s (NYSE: BAC) finding that “volume is uniquely skewed towards the ask early in the day but towards the bid later in the day” for these highly traded ultra-short-dated options.
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg.
Even options insight and data provider SqueezeMetrics agrees: “Buy 0 DTE call.” The typical “day doesn’t end above straddle b/e, but call makes money,” SqueezeMetrics explained. “Dealer and call-buyer both profit. Gap down, repeat.”
Anyways, back to the bigger trends impacted by liquidity coming off the table and increased competition between equities and fixed income.
Graphic: Via Physik Invest. Net Liquidity = Fed Balance Sheet – Treasury General Account – Reverse Repo.
As this letter put forth in the past, if the “market consolidates and doesn’t break,” as we see, the delta buy-back with respect to dropping implied volatility (IVOL) or vanna and buy-back with respect to the passage of time or charm could build a platform for a FOMO-driven call buying rally that ends in a blow-off.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch. Short volatility and short stocks was attractive to trade. As your letter writer put in a recent SpotGamma note: “With IV at already low levels, the bullish impact of it falling further is weak, hence the SPX trending lower all the while IV measures (e.g., VIX term structure) have shifted markedly lower since last week. If IV was at a higher starting point, its falling would work to keep the market in a far more positive/bullish stance.”
Per data by SpotGamma, another options insight and data provider your letter writer used to write for and highly recommends checking out, call buying, particularly over short time horizons, was often tied to market rallies.
“0DTE does not seem to be associated with betting on a large downside movement. Large downside market volatility appears to be driven by larger, longer-dated S&P volume,” SpotGamma founder Brent Kochuba said in the Bloomberg article. “Where 0DTE is currently most impactful is where it seems 0DTE calls are being used to ‘buy the dips’ after large declines. In a way this suppresses volatility.”
Anyways, the signs of a “more combustible situation” would likely show when “volatility is sticky into a rally,” explained Kai Volatiity’s Cem Karsan. To gauge combustibility, look to the Daily Brief for February 17.
Technical
As of 6:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,988.25.
Key levels to the upside include $3,999.25, $4,012.25, and $4,024.75.
Key levels to the downside include $3,975.25, $3,965.25, and $3,947.00.
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
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.
Vanna: The rate at which the Delta of an option changes with respect to implied volatility.
Charm: The rate at which the Delta of an option changes with respect to time.
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.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
Options Expiration (OPEX): Reduction in dealer Gamma exposure. Often, there is an increase in volatility after the removal of large options positions and associated hedging.
Options: Options offer an efficient way to gain directional exposure.
If an option buyer was short (long) stock, he or she could buy a call (put) to hedge upside (downside) exposure. Additionally, one can spread, or buy (+) and sell (-) options together, strategically.
Commonly discussed spreads include credit, debit, ratio, back, and calendar.
Credit: Sell -1 option closer to the money. Buy +1 option farther out of the money.
Debit: Buy +1 option closer to the money. Sell -1 option farther out of the money.
Ratio: Buy +1 option closer to the money. Sell -2 options farther out of the money.
Back: Sell -1 option closer to the money. Buy +2 options farther out of the money.
Calendar: Sell -1 option. Buy +1 option farther out in time, at the same strike.
Typically, if bullish (bearish), sell at-the-money put (call) credit spread and/or buy a call (put) debit/ratio spread structured around the target price. Alternatively, if the expected directional move is great (small), opt for a back spread (calendar spread). Also, if credit spread, capture 50-75% of the premium collected. If debit spread, capture 2-300% of the premium paid.
Be cognizant of risk exposure to the direction (Delta), movement (Gamma), time (Theta), and volatility (Vega).
Negative (positive) Delta = synthetic short (long).
Negative (positive) Gamma = movement hurts (helps).
Negative (positive) Theta = time decay hurts (helps).
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.
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 6:15 AM ET. Sentiment Risk-Off if expected /MES open is below 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
A tight monetary environment resulted in a hesitation to take risks. With inflation high, in the face of exogenous events (e.g., geopolitics disrupting deflationary influences) and beyond, assets were sold.
With inflation still hot and the economy on solid footing (i.e., “stronger growth for longer” per Unlimited’s Bruce McNevin), traders price even “tighter monetary policy and a harder eventual landing to ease inflation pressure.” This is not good for assets.
In fact, for a moment yesterday, traders put the terminal rate at 5.50-5.75%, up from 5.25-5.50% prior to the market opening.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) via The Kobeissi Letter on March 1, 2023, at 10:55 AM.
For the Federal Reserve (Fed) to hit its inflation target, likely in the range of 2-4% per Oaktree Capital Management’s Howard Marks said the real Fed Funds rate has to be positive. This effort puts the economy at risk of recession, said the Federal Reserve’s Neel Kashkari.
“Typically when the Fed raises rates to cool down inflation, it leads to a recession,” Kashkari explained, adding that “getting inflation down is job number one.”
Per Unlimited’s McNevin, the probability the economy is in a recession is lower than it was at the end of last year. For probabilities to change, there would have to be a large increase in unemployment. For instance, if the unemployment rate rises by about 1%, recession odds go up by 29%. If non-farm payroll employment falls by about 2% or 3 million jobs, recession odds jump by 74%.
Per last month’s remarks by Kai Volatility’s Cem Karsan, quoted in Physik Invest’s Daily Brief for February 17, 2023, if the market was to not breakdown sharply after February monthly options expiration (OpEx), as we see today, then options decay could build a platform for a FOMO-driven call buying rally that ends in a blow-off.
Consequently, trades this letter put forth last month (e.g., call verticals sold to finance put verticals expiring months from now) would suffer greatly.
“We’ve had an intraday range of 33.5 [points] thus far. That’s not vol[atility] expansion, which is what I’d want to see if I was short,” volatility trader Darrin John put well. “If the market doesn’t do what you think it should, in a reasonable amount of time, then it’s best to [exit].”
At the same time, with portfolio constructions like 60/40 not as attractive in this macroeconomic environment (i.e., asset headwind from monetary tightening, as well as slowing growth and inflation headwind to bonds and commodities), traders can look to Physik Invest’s Daily Brief for February 28, 2023, for ideas on how to navigate. In that letter, we talked about how traders can participate in the upside by about the same amount they would with a traditional construction (e.g., 60/40) while eliminating their downside risk exposure.
For instance, one can buy enough bonds/box spreads so that, at their maturity, the principal is returned. The cash remaining can be invested in leverage potential.
Ending with a supporting quote from Oaktree’s Howard Marks: “Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets.”
Technical
As of 6:00 AM ET, Thursday’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 negatively skewed overnight inventory, outside of the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,943.25.
Key levels to the upside include $3,965.25, $3,975.25, and $3,988.25.
Key levels to the downside include $3,926.25, $3,908.25, 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 Futures.
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.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and 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.
Options Expiration (OPEX): Reduction in dealer Gamma exposure. There is usually an increase in volatility after the removal of large options positions and associated hedging.
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.
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 6:30 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
A light letter, today.
Check out the Daily Brief for February 27, 2023, for how to take advantage of higher interest rates and define the outcome of your trading.
As an aside, the second to last positioning section paragraph in that letter talks about using short-dated bets like “butterflies, broken-wing butterflies, ratio spreads, back spreads, and beyond.” In the initial version of the letter, your letter writer accidentally wrote box spreads instead of back spreads. Apologies.
Positioning
Yields are ~5.00%, and this is around the S&P 500’s (INDEX: SPX) earnings yield (i.e., the 6-month Treasury yield is about equal to the SPX’s earnings yield of 5.2%).
A nod to rising rates and risk premiums, the likes of Morgan Stanley suggest the S&P 500 (INDEX: SPX) will come under further pressure.
Graphic: Retrieved from Morgan Stanley (NYSE: MS).
Since not all who read the letter are active in the same timeframe, in the interest of expanding the opportunity set if we will, your letter writer detailed ways to express one’s longer-term opinion on the upside or downside in a capital-protected way.
Essentially, traders can create their own structured notes, investing in a manner that returns principal only. The difference between the bond/box spread outlay and cash remaining is invested in leverage potential. At maturity, the worst-case is a return of principal.
Further, through such structures, traders can participate in the upside by about the same amount they would with a traditional construction (e.g., 60/40). However, you cut the downside.
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
Alternatively, traders can bias themselves short or non-directionally. In a short-bias situation, one can buy a put spread (and/or sell a call spread) with an outlay (or max loss) not exceeding the cash remaining after the purchase of a bond or box spread.
Through a short-biased setup, traders may participate in potential downside on the pricing of equity market headwinds.
Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM).
The suggested downside trades are rather attractive now in the absence of hedging demands in longer-dated protection convex in price and volatility. Naive measures like the Cboe VIX Volatility (INDEX: VVIX), as well as the graphic below, allude to the little demands for convexity and a declining sensitivity of the VIX with respect to changes in share prices.
Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR).
Technical
As of 6:30 AM ET, Tuesday’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 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 $3,992.75.
Key levels to the upside include $4,003.25, $4,012.25, and $4,024.75.
Key levels to the downside include $3,979.75, $3,965.25, and $3,949.00.
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
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.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
The author, Renato Leonard Capelj, works in finance and journalism.
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. Separately, Capelj is an options analyst at SpotGamma and an accredited journalist.
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.
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 7:45 AM ET. Sentiment Risk-On if expected /MES open is above 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.
Positioning
In The Second Leg Down: Strategies For Profiting After A Market Sell-Off, there is one passage on the inaccuracy of normal distributions in markets and serial correlation, as well as the underpricing of rare events. In that same passage, Nassim Nicholas Taleb is credited for his advocacy on portfolio allocations to safe short-term government bonds and high-risk speculative bets through which “you could lose no more than your initial investment.”
Naturally, this leads to Exotic Options and Hybrids. Structured notes, to quote chapter two, are “composed of a non-risky asset providing a percentage of protected capital and a risky asset offering leverage potential.”
The structure, as a whole, is not risky in the absence of defaults. The bond, which is bought at a discount, increases in value until maturity. The difference between the initial value to allocate (100% of notional) and the bond purchase price is allocated to the leverage (e.g., options) component of the structure.
Graphic: Retrieved from Exotic Options and Hybrids.
This type of capital-protected structure is particularly attractive right now, given the interest rate environment. That’s because high-interest rates decrease the initial value of the bond. This means we can allocate more to leveraged bets, for example.
During the life of the structured note, the value of the non-risky part increases when interest rates decrease. At maturity, the value of the bond component is equal to 100% of the notional while the value of the riskier part of the note is “non-linear and fluctuates depending on many market parameters such as the underlying’s spot, interest rates, borrowing costs, dividend yield or volatility.”
Graphic: Retrieved from Exotic Options and Hybrids. For illustration only.
Last week, IPS Strategic Capital’s Pat Hennessy wrote a thread on how to apply this information.
Basically, with interest rates near 5% at the front of the yield curve, and traditional portfolio constructions performing poorly, defined-outcome investing is attractive.
With $1,000,000 to invest and rates at ~5% (i.e., $50,000 is 5% of $1,000,000), one could “purchase 1000 USTs [or S&P 500 (INDEX: SPX) Box Spreads] which will have a value of $1 million at maturity for the price of $950,000.”
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
With $50,000 left in cash, one can use options for leveraged exposure to an asset of their choosing, Hennessy explained. Should these options expire worthless, the $50,000 gain from USTs, at maturity, provides “a full return of principal.”
In an example, Hennessy presented a structure providing 60% of the upside gain of the S&P 500 with full principal protection should markets fall. Though “you may initially scoff at 60%, [] keep in mind that historically 60/40 has captured between 60-70% of the upside of equities.”
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
If you’re bearish or unopinionated, Hennessy presented capital-protected structures that make money if the market moves lower (e.g., instead of buying a call option on the SPX, buy put options or a put options spread) or sideways (e.g., sell defined-risk option condor structures).
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
Markets have a tendency to move big and continue moving big in the same direction, over the very short term, hence the “fat tails in the distribution over short horizons,” to quote The Second Leg Down. Given this, your letter writer can use his analyses to capitalize big on underpricing and participate in upside or downside through a series of short-dated options bets (e.g., butterflies, broken-wing butterflies, ratio spreads, back spreads, and beyond) that, in time, may return in excess of ~10 times the initial investment. Should nothing happen, then he walks away with his principal. That’s trading made less stressful.
Have a great day. If you enjoyed today’s letter, consider sharing it with your friends!
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 7:40 AM ET, Monday’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 the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,992.75.
Key levels to the upside include $4,003.25, $4,012.25, and $4,024.75.
Key levels to the downside include $3,979.75, $3,965.25, and $3,949.00.
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
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.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
The author, Renato Leonard Capelj, works in finance and journalism.
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. Separately, Capelj is an options analyst at SpotGamma and an accredited journalist.
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.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
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 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. At the same time, 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.
Positioning
It’s a dynamic this letter has discussed before. Levels quoted in the bottom section of this letter have proved useful in recent trade, marking the bottom and top of rallies precisely. A factor to blame is short-term participation. Let’s explain this further.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
For instance, as SpotGamma said this morning, volumes at options strikes, very close to levels this letter quotes, are very large relative to the open interest changes. These volumes are large enough to add to the movement and result in responses to certain areas, but their impact is not long-lasting. In fact, some suggest the activity is part of “trading for risk positioning” and the impact “can net out” over a longer time horizon.
It is this letter writer’s opinion that the noise is easy to get swept into. Rather, we are interested in participating in the bigger strides, hence the trades we’ve quoted prior.
As your letter writer elaborated in a recent note for SpotGamma, following weakness heading into the January monthly options expiration (OpEx), the window was open for relief. A cross above big inflections like the 200-day simple moving average, a trigger for some to buy stocks, coupled with measures like the Cboe Volatility Index (INDEX: VIX) trending higher, partly the result of the fear of missing out and hedging in a lower liquidity environment, had us leaning optimistic.
Notwithstanding, with measures like the Cboe VIX Volatility (INDEX: VVIX) “at low levels and rebounding” implying “(1) traders are looking to hedge for cheap and (2) convexity remains a good place to be”, we had the interest to limit downside via call structures with long and short options. The short options help us harvest a bit of call skew and lower the cost of the spread, helping it retain “value better through time.”
In short, though “the marginal positivity of further IV compression likely does little to keep stocks on an upward trajectory”, SpotGamma explained, structures we explained recently may enable you to get on the right side of an SPX and VIX up environment (explained by SpotGamma), all the while limiting downside on the eventual turn.
If you’re averse to directional risk, consider trades like the Box Spreads we talked about many letters back, which are now gaining popularity.
Technical
As of 8:00 AM ET, Thursday’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.
Our S&P 500 pivot for today is $4,050.25.
Key levels to the upside include $4,061.75, $4,071.50, and $4,083.75.
Key levels to the downside include $4,028.75, $4,011.75, and $3,998.25.
Click here to load updated key levels into the web-based TradingView platform. 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: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). 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 HVNodes for favorable entry or exit.
POCs: 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
In short, Renato Leonard Capelj is an economics graduate working in finance and journalism.
Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.
Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.
