Categories
Commentary

Daily Brief For June 22, 2022

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

What Happened

Overnight, equity index and commodity futures were sideways to lower all the while bonds and volatility were bid. 

This is after participants, based on metrics included later in the letter, took the advance as an opportunity to sell at higher prices. Demanded was protection, and this bid implied volatility.

Big headlines include China sending warplanes near Taiwan after the U.S. rejected its strait claims. The Taiwanese Foreign Minister Joseph Wu wrote that the threat was “more serious than ever.” This is, also, ahead of Taiwan and U.S. officials talking about arms sales.

In other news, Congress was called on to pass a $0.184 per gallon gasoline tax holiday. Growth in job postings slowed as Q2 GDP forecasts have been revised lower, Chinese manufacturing orders declined by 20-30%, U.K. inflation hit a 40-year record, and sellers of homes are cutting prices in some of the hottest markets while the demand for adjustable-rate mortgages surges.

Ahead, the Federal Reserve’s (Fed) Patrick Harker speaks at 9:00 AM ET. Then, Jerome Powell testifies to the Senate Banking Committee at 9:30 AM ET. Later, Charles Evans speaks at 12:50 PM ET, followed by Harker and Barkin, again, at 1:30 PM ET.

Graphic updated 6:30 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: For what it is worth when it comes to talking of theory and the economy, ARK Invest’s Cathie Wood has been spot on, in many ways.

Somewhat pursuant to our detailed analysis on May 18, 2022, which talked about the impact of reduced liquidity and credit on the real economy and asset prices, Wood explained that the U.S. fell into a recession during the first quarter.

Read: Daily brief for May 18, 2022.

“If massive inventor[ies] bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year,” she said. Last year, though badly timed, Wood said that inflation would be on its way out due in part to excess inventory which would be reflected in commodity prices.

Read: Walmart Inc’s (NYSE: WMT) inventory glut to reduce in a “couple of quarters” and how Target Corporation’s (NYSE: TGT) oversupply problem should scare all retailers.

Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”

“If inventories and stock prices are leading indicators for employment and wages, … then fears of cost-push inflation a la 1970’s should disappear during the next six months.”

To put it briefly, as we’ve talked about in the past, the recent market rout is a recession and the direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s sentiment and reducing demand for goods, among other things, reflect this.

And, with that, after a period during which capital was misallocated, the Fed is not in a position to control price stability “without bringing down the markets,” per Kai Volatility’s Cem Karsan.

Read: Kris Abdelmessih’s Moontower #148 on prevailing macroeconomic perspectives.

In light of these efforts to control price stability, to remain is a continued reach for cash (or bank deposits) and the sale of non-cash assets.

Graphic: Via Redfin Corporation (NASDAQ: RDFN).

“Bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang, who was a trader at the Fed, puts it.

Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”

Graphic: Per Bloomberg, “[E]very $1 trillion of QT will equate to a decline of roughly 10% in stocks over the next 12 months or so.”

If it provides any solace, per comments by Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, the Fed, which “can only deal with nominal [and] not real chokepoints,” is likely to change course.

This is as “nominal balance sheet and liquidity trends will, at some point, clash with the realities of a garden variety of supply chain issues.”

Likewise, Andreas Steno Larsen explains that bond yields remain governed by demographics, and this is good news for stocks, in general.

“Just look at the growth rate of the working-age population (10 years forward) versus the term premium of US Treasury bonds. The current bond bear market is not standing on structural pillars.”

Graphic: Via Andreas Steno Larsen. “Bond yields remain governed by demographics over the medium-term. Low(er) for longer.”

Positioning: To preface, I encourage everyone to check out the Daily Brief for June 17, 2022.

Moving on. So, last week, we had a large monthly options expiration (OPEX). After this, liquidity providers’ re-hedging flows supported the market.

Over the weekend, into Tuesday’s U.S. close, equities, then, traded higher. The rally, however, was not confidence-inspiring and was indicative of short-covering.

Per SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, participants took the relief rally “as an opportunity to hedge/sell,” as I wrote for SpotGamma, yesterday.

Graphic: SpotGamma’s combined HIRO reading for the S&P 500 (INDEX: SPX) and SPDR S&P 500 ETF Trust (NYSE: SPY). Trade was responsive (i.e., buy dip, sell rip) up until 2:00 PM ET when demand for negative delta (i.e., put buying, call selling) outweighed that for positive delta.

This ultimately showed up in broad measures of implied volatility. As The Ambrus Group’s Kris Sidial said: “[I]n the final hour, spot [and] vol up.”

This plays into decreased odds for a far-reaching rally. Participants are positioned out in strikes that are lower and the activity in those strikes plays into a change in tone with respect to the non-linearity and strength of volatility and skew with respect to linear changes in asset prices.

As Karsan spoke to, last week, the spikes in short-dated -sticky skew – the “first we’ve seen since [the] secular decline began” – hints at a “critical change in dealer positioning.”

“We’re transitioning to a fat left tail, right-based distribution,” Karsan adds

So why does any of this matter?

There still appears to be a heavy supply of options, particularly those with less time to maturity, and skew remains poor-performing (hence comments in prior letters on the benefit of buying into implied skew convexity should volatility reprice).

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. Note historical or realized volatility (RVOL) versus that which is implied (IVOL).

Basically, participants are hedged and volatility remains well-supplied. 

If there was to be forced selling or demand for protection by a greater share of the market in ways not recently seen, then the repricing of the aforementioned structures would be a boon for those who own them.

Graphic: Via Banco Santander SA (NYSE: SAN) research.

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” as Mohamed Bouzoubaa et al explain well in the book Exotic Options and Hybrids.

“ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.”

In other words, by owning that protection – e.g., butterfly and back spreads – you are positioned to monetize on a continued non-linear repricing of volatility. The difficult part is cutting the decay of those spreads when nothing happens.

Read: Trading Volatility, Correlation, Term Structure and Skew by Colin Bennett et al. Originally sourced via Academia.edu.

As an aside, despite the bearish tilt in positioning, there has been a notable uptick in index call buying per UBS Group AG (NYSE: UBS), presumably so that participants don’t miss out on a vicious reversal, should one transpire.

Graphic: Via UBS Group AG.

Adding, the “high starting point” in IVOL makes it possible to put on zero- and low-cost bets that deliver asymmetric payouts in case of violent and short-lived reversals. 

Read: Daily Brief for May 13, 2022.

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 (the inverse of a back spread).

Technical: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a 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 $3,696.00 low volume area (LVNode) puts in play the $3,722.50 LVNode. Initiative trade beyond the LVNodes could reach as high as the $3,735.75 and $3,770.75 high volume areas (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,696.00 LVNode puts in play the $3,675.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,639.00 RTH Low and $3,610.75 HVNode, 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: Gap scenarios are in play, today.

Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

Definitions

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.

About

After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.

Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For June 9, 2022

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

What Happened

U.S. markets were weighed by action abroad before recovering late in the overnight session. 

This was ahead of a European Central Bank (ECB) decision that likely results in a tightening of monetary policies in that region of the world. The expectation is that the ECB will end its bond purchases this month. Then, hike rates in July and September. 

At home, in the U.S., the Securities and Exchange Commission (SEC) is looking to change the business model of wholesalers. In consideration is a model in which different firms compete with each other to fill investors’ trades. Some suggest this would increase trading costs.

Elsewhere, one of the largest U.S. export plants of liquified natural gas (LNG) is to shut down due to a facility explosion, raising the risk of shortages in Europe, according to Reuters.

Ahead is data on jobless claims (8:30 AM ET), as well as real household net worth and domestic financial debt (12:00 PM ET).

Graphic updated 6:40 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

In the past week, a narrative on bearish bets in funds such as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSE: HYG) surfaced.

The ETF saw some of the largest volumes since March of 2020, presumably as traders looked to hedge for low cost, the Federal Reserve’s (FED) hawkishness. 

Graphic: Via Bloomberg. “Given that HYG’s realized volatility is still relatively low, it’s an inexpensive way to hedge the impact of tightening monetary policy on corporate credit.”

According to The Ambrus Group’s Kris Sidial, “a lot of banks continue to push credit vol[atility] as a cheap hedge. Every month, at least four banks push the theme on that trade because of ‘value.’”

This is “also, another reason why every month you see HYG put spreads hit the tape with big size, relatively speaking,” he adds.

Adding, Bridgewater Associates, which was founded by Ray Dalio in 1975, is betting on the sale of corporate bonds via credit default swaps (CDS), which are used to transfer and hedge credit exposure on fixed income products.

Bridgewater’s Co-Chief Investment Officer Greg Jensen explained their bet against corporate bonds is based on inflation remaining stubborn, resulting in the Fed to “tighten in a very strong way, which would then crack the economy and probably crack the weaker [companies].”

Here’s why that matters. 

The firms facing challenges, “are creations of easy credit,” according to Bloomberg and, now, for some of them, their time is running short as they “aren’t earning enough to cover their interest expenses, let alone turn a profit.” 

“When interest rates are at or close to zero, it’s very easy to get credit, and under those circumstances, the difference between a good company and a bad company is narrow,” said Komal Sri-Kumar of Sri-Kumar Global Strategies. 

“It’s only when the tide runs out that you figure out who is swimming naked.”

Graphic: Via Bloomberg.

Despite many of these companies having debt that could last them “months, even years,” Vincent Reinhart explains that “[a]s rates rise, it pushes more of those firms into distress, and amplifies the tightening by the Fed of financial conditions and credit availability.”

As stated yesterday, financial conditions are “the mechanism through which the Fed [impacts] the economy,” and “if the data doesn’t slow, financial conditions will need to tighten more,” potentially feeding into a freezing of credit and a harder hit on still-frothy areas of the market “with the greatest systemic risk.”

As we quoted Simplify Asset Management’s Mike Green explaining in early May, we’re more than halfway through a dot-com type collapse that’s happened “underneath the surface of the indices.” 

That’s noteworthy since still-strong passive flows continue to support the largest stocks within the index.

That said, with bonds “not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” per Joseph Wang, who was a trader at the Fed, “[i]nvestors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.”

How to think about trades?

As explained, yesterday, the marginal impact of further volatility compression is likely to do less to bolster equity market upside. Heading into the Federal Open Market Committee (FOMC) event, next week, according to SpotGamma, short-dated, pre-event volatility is likely to get sold (further promoting market consolidation) while that which is farter-dated is likely to be bought.

To capitalize on a resolution of the index-level pinning, participants, too, could sell short-dated volatility (which capitalizes on pinning and the rapid decay of soon-to-expire options) and use those proceeds to fund farther dated options. 

Such a structure would assist in lower the cost of directional exposure.

Graphic: The risk profile of a long put calendar spread, via Fidelity.

Alternatively, if bearish on volatility, one could buy a butterfly (short two times at the money and long above and below out of the money options). 

Graphic: The risk profile of a long call butterfly spread, via Fidelity.

In such a case, the trader becomes long implied skew convexity. This is a play on the comments above, coupled with the fact that the Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), dropped off largely, too, in comparison to the VIX, itself.

Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading.

Technical: As of 6:40 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,129.25 low volume area (LVNode) puts in play the $4,149.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,164.25 regular trade high (RTH High) and $4,189.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,129.25 LVNode puts in play the $4,101.25 LVNode. Initiative trade beyond the LVNodes could reach as low as the $4,073.25 weak high/low and $4,055.75 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.

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.

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For April 1, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to higher after their late-day liquidation and break from a multi-day consolidation area on technical factors (e.g., options expirations) among other things, potentially, like the increase in personal consumption expenditures.

Broadly speaking, the narrative that investors are showing some concern over the economic outlook, with respect to geopolitical tension and monetary policy, continues to emanate. 

U.S. high-grade bonds shed over 5%, booking the worst quarterly performance since the ‘80s. This is as recession risks have risen more than two-fold. 

Notwithstanding, the Federal Reserve’s (Fed) favorite yield curve metric remains steep; per a Bloomberg commentary, “the gap between the three-month bill rates and 10-year yields is the ‘most useful term spread for forecasting recessions,’ … [and] it currently stands at 186 basis points, versus negative 2 basis points on 2s10s.”

In terms of news, the U.K. will join the U.S. in releasing oil from its reserves to lower prices and reduce its reliance on external partners. This helped ease futures calendar spreads on oil, Reuters’ John Kemp said in a newsletter to followers; the “six-month spread [narrowing] to a backwardation of $9 per barrel, the lowest since before Russia’s invasion of Ukraine.”

Ahead is data on nonfarm payrolls, the unemployment rate and average hourly earnings, as well as labor-force participation (8:30 AM ET). Thereafter, the Chicago Fed’s Charles Evans is scheduled to speak (9:05 AM ET). 

Later is Markit manufacturing PMI (9:45 AM ET), as well as ISM manufacturing index and consumer spending data (10:00 AM 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: The S&P 500 bagged its first quarterly loss in two years as recession probabilities, implied by some yield curves, have risen.

Graphic: Via Barclays. Taken from The Market Ear. “[T]he 1y ahead recession probability implied by the 3m10y curve rises to about 40% a year from now (so for an early 2024 recession), slightly higher than implied by other curves.”

This is as the stock performance, relative to bonds against the lagged spread of 10- and 2-year bond yields, is expected to be weak, according to insights by Pictet Asset Management.

Graphic; Via Pictet Asset Management Ltd. Taken from Bloomberg. “On this basis, stocks’ great outperformance this quarter may end up looking like a head-fake.”

Pictet’s narrative further validates some of the theses shared by institutions like Brevan Howard Asset Management, which is having one of its best years, Morgan Stanley (NYSE: MS), Goldman Sachs Group Inc (NYSE: GS), and Bank of America Corporation (NYSE: BAC).

Adding to the prospects for weaker earnings amid higher costs, among other things, some of these institutions see the potential for the Fed’s terminal rate to reach between 3% and 3.25%.

Graphic: Via Andreas Steno Larsen. “The Fed is now priced to hike to levels above 3% by Dec-2023, … which is the main reason why we have seen a sell-off in all assets with an intensive duration profile over the past 12-15 months … [and has] duration intensive assets … starting to look attractive again from a risk/reward perspective.”

This would hit valuations as higher yields both reduce the present value of future earnings and “hurt those carrying the highest leverage,” potentially playing into a slowdown or recession. 

Graphic: Via S&P Global Inc (NYSE: SPGI) “expects the economic damage [of geopolitics and pricing pressures] to lower U.S. GDP growth to 3.2% this year, matching its preliminary forecast in early March but a full 70 bps lower than its November forecast of 3.9%.”

“Now rates volatility can drive growth volatility and that actually becomes a vicious cycle between the two,” said Christian Mueller-Glissmann of Goldman Sachs. 

“That’s a big difference to the last cycle where growth volatility drove rates volatility.”

Graphic: Via Vanda. Taken from The Market Ear. “The bond market is pricing the 2022 cycle to be remarkably fast. Macro Alf: ‘Remember: sharp changes in borrowing conditions often cause non-linear reactions in a highly leveraged system.’”

However, this is as the dominance of rate-sensitive tech stocks is set to shrink next year amid sector reclassifications, as well as still-stimulative policy and beats of economic expectations that may feed into earnings surprises, later.

JPMorgan’s Marko Kolanoivc explains that (1) “both equity and credit markets have historically fared well at the start of monetary tightening cycles,” (2) “the real policy rate is extremely negative and thus stimulative,” and (3) “not all central banks are tightening.”

Morgan Stanley’s Michael Wilson vehemently disagrees suggesting the recent equity market turnaround “was nothing more than a vicious bear market rally,” and offers participants a clear opportunity to sell at better prices.

Taking all of the above comments and perspectives together, one thing is for certain: this period in history is like no other. It makes sense to pick a timeframe and stick with it. 

Positioning: In the past weeks, according to JPMorgan Chase & Co’s Nikolaos Panigirtzoglou, the supportive “rebalancing flows away from bonds into equities” are no more and, therefore, equities are subject to increased vulnerabilities “if bond yields continue to rise.”

This is after measures of equity implied volatility were crushed heading through the mid-March FOMC and monthly options expiry (OPEX) events, and the options hedging impact of this, at least, was very supportive, as we’ve talked about many times in this newsletter.

Graphic: Via Bloomberg. “The CBOE-VIX index, measuring stock volatility from the options market, unsurprisingly spiked immediately after Russia’s attack. It reached another high three weeks ago. Then the VIX started to fall, and in the two weeks since the Fed unveiled its first rate hike in years, the decline has been almost linear. The ‘fear gauge,’ as it is often known, is now significantly lower than it was a week before the invasion, when markets were priced on the assumption that there would be no war.”

On the contrary, measures of volatility for other assets, like the Merrill Lynch Options Volatility Estimate (INDEX: MOVE), a useful measure of bond market sentiment, are doing the opposite. 

We discussed early last month, what we saw was an increased supply of equity market volatility, as a potential reason for some of these divergences. 

As Bloomberg’s John Authers explained well, it, too, could have been “an aggressive central bank” that prompted a move out of bonds and into equities, and subdued target-date fund rebalancing flows which usually sell stocks and buy bonds.

Graphic: Via Bloomberg.

“[I]t looks as though the contradictions that had built up in the market over the last two years, and in the decade before that, are being put under extreme stress by the double whammy of a newly aggressive Federal Reserve, and the worst geopolitical shock in decades,” Authers adds.

Still, realized volatility continues to trend down which ought to force those (e.g., computer-driven traders) who position (and size equity exposure) based on underlying volatility to load up, again.

Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott explains that “volatility-targeting funds and trend-following commodity trading advisers, purchased” billions of equity futures which bolstered the price rise of the last weeks.

From a positioning versus buying support perspective, the forward returns distribution is skewed positive but not by a lot; a lot of the supportive options exposure is rolling-off and this could free up (i.e., unpin) indexes for the next leg up or down.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options Indicator shows negative delta trade in the S&P 500 SPY ETF, and this pressured the underlying index.

Technical: As of 6:30 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively 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 $4,546.00 spike base puts in play the $4,573.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,583.00 untested point of control (VPOC) and $4,611.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,546.00 spike base puts in play the $4,526.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,515.25 and $4,489.75 LVNodes, or lower.

Considerations: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) occurred.

Continue to monitor for acceptance outside of the balance area. Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance. See the below graphic for more.

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.

What People Are Saying

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.

Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.

POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.

Options Expiration (OPEX): Marks change in dealer gamma exposure. 

Volume-Weighted Average Prices (VWAPs): A metric highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

About

After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.

Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 29, 2021

Notice: Given travel commitments, commentaries will be suspended until January 3, 2022. 

As an aside, I’m sincerely honored to have you as a subscriber. 

This newsletter began as a tool to hold myself accountable for objectively assessing dominant narratives and market-generated information. 

Since launching, this commentary has grown. Content and engagement have improved.

Now, with many of the 200 or so of you that are reading this actively, I have spoken with via email, and the like, regarding trader development, among many other things.

When it comes to markets, at the end of the day, whether you’re at a bank (as some of you are) or at home, we’re all alone. The implications of this are staggering.

How are we to objectively assess and act on what the market is signaling to us with no framework or community to work off of?

That’s the problem and I hope to make a bigger impact, going forward.

Wishing you good health and success next year and beyond!

Best, 

Renato

What Happened

In the face of a “stealth correction,” and an “off-loading of risk” by professionals, the S&P 500 remains strong further bolstered by options selling and volatility compression.

This is as less heavily-weighted constituents remain volatile; with hedging pressures sticky at the index level, the only reconciliation can be a decline in correlation. 

As liquidity remains “holiday-thinned,” so to speak, coming into Friday’s weighty “Quarterlys” options expiration, positioning metrics suggest indices ought to stick at higher prices.

Thereafter, expect increased movement.

Moreover, ahead is data on trade in goods (8:30 AM ET) and pending home sales (10:00 AM 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

Given the persistence of responses to technical levels, weaker-handed participants (which seldom bear the wherewithal to defend retests) carry a heavier hand in recent price discovery.

Via volume profile analysis, we see a plethora of low-volume pockets – voids, if you will – that likely hold virgin tests. Successful penetration often portends follow-through as the participants that were most active at those levels (quickly run for the exits when wrong).

Context: In the face of market internals that look weaker than at any time since March of last year, the S&P 500 remains strong, relative to its counterparts.

As alluded to in a prior section, the commitment of capital on lower volatility is upping the dealers’ addition of liquidity, which supports high prices but may limit further price discovery.

Why? When a position’s delta rises with stock or index price rises, gamma – the expected change in delta given movement in the underlying – is added to delta. 

According to SpotGamma, “[a]s participants keep adding to their bets at $4,800.00, the dealer only takes on more exposure to positive gamma.”

Graphic: Via SpotGamma. “Based on the fact that we are at the S&P Call Wall and are approaching this large OPEX, we look for a pause and some consolidation in markets here.”

So, with liquidity “holiday-thinned,” so to speak, and participants’ concentration of activity in near-the-money options strikes, coming into this week’s “Quarterlys” options expiration, indices are to remain pinned.

After Friday, the market is more susceptible to fundamental forces as, according to SpotGamma, there will be “a decrease in sticky gamma hedging.”

Couple current options positioning and buying pressure – via short sales or liquidity provision on the market-making side – metrics suggest middling returns 1-month out, or so.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Moreover, the expectation is that positive fundamental forces and dealers’ covering of hedges to remaining “put-heavy” positioning bolster seasonally-aligned price rise in January.

Graphic: Per The Market Ear, “January typically sees 134% of inflows (the rest of the 11 months -34%). And with every private wealth manager in the world right now pitching increased allocations into equities (out of cash and out of bonds), Goldman calculates that keeping 2021 pace, This would be $125BN worth of inflows quickly in January.”

In anticipation of higher prices, low cost, complex options structures like call-side calendars, butterflies, and ratio spreads are still top of mind. 

After a fast move higher over the past week or so, with positioning metrics as they are, it does not make sense to commit massive debits to static or variable long-delta trades. Cost matters.

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.

Expectations: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Spike Rules In Play: Spike’s mark the beginning of a break from value. Spikes higher (lower) are validated by trade at or above (below) the spike base (i.e., the origin of the spike). 

The spike base is $4,776.00. Below bearish (change in tone). Above bullish (status quo).

In the best case, the S&P 500 trades sideways or higher; activity above the $4,781.75 high volume area (HVNode) puts in play the $4,798.00 minimal excess. Initiative trade beyond the minimal excess could reach as high as the $4,805.50 and $4,815.00 extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,781.75 HVNode puts in play the $4,770.50 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,732.50 HVNode and $4,717.25 low volume area (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. Learn about the profile.

What People Are Saying

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.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

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, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 16, 2021

What Happened

After the Federal Reserve (Fed) announced it would accelerate its taper to bond-buying, clearing the way for interest-rate hikes, the equity market rallied, broadly. 

With all major U.S. equity index futures trading higher, overnight, it appears that participants’ fears regarding monetary policy have been assuaged

As forecasted, a collapse in event-related implied volatility brought in positive flows that ought to support the market into this week’s weighty “quad-witching” derivatives expiry.

Ahead is data on jobless claims, building permits, housing starts, and manufacturing (8:30 AM ET). Then, there are releases on industrial production, capacity utilization (9:15 AM ET), as well as Markit manufacturing and services PMI (9:45 AM ET). 

Graphic updated 6:15 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. 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

Market hammered out a low, yesterday. 

This was after, to start the week, customers had been increasing their exposure to short-delta (call selling and put buying). The counterparty inventorying the opposite (long-delta) exposure sold (bought) futures into price discovery higher (lower).

Graphic: Customers increased their exposure to short-delta call exposure. “Last week was about selling index calls,” SpotGamma’s Brent Kochuba said on Twitter. “This is likely why the $SPX stopped at $4,700.00.”

This dynamic had the effect of pinning the market; was the S&P 500 to remain in consolidation, customers’ (dealers’) short-delta (long-delta) would have risen which would have made for even more pinning.

That didn’t happen, though.

Into Wednesday’s FOMC event, demand for protection expanded (as evidenced by a higher CBOE Volatility Index reading). That knocked most of the major indexes out of sideways trade.

However, as revealed Tuesday by SpotGamma’s (beta) Hedging Impact of Real-Time Options (HIRO) indicator, “participants saw lower prices as an opportunity to express their opinion of lower volatility into Wednesday’s Federal Open Market Committee (FOMC) update.”

From there on, as Ambrus Group’s Kris Sidial best explained, “vols were static in anticipation of the fed talk,” taking away from supportive flows (as a result of options sliding down their term structure [vanna]) and promoting sideways trade.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, which is pink in color, was sideways to higher. This suggests positive options delta trades likely had dealers buying stock/futures into the close.

Context: Wednesday’s commentary really hit the nail on the head, so to speak. 

Therefore, I offer some light updates.

As expected, per Nordea, the Fed will “accelerate its tapering process, and is now set to conclude net purchases already by mid-March vs mid-June with the earlier pace.”

“The dot plot was revised significantly higher, and the plot now shows three hikes for next year, a further three for 2023 and another two for 2024.”

Graphic: “[T]he terminal rate being priced in by financial markets is closer to 1.5% vs. 2.5% for the Fed,” Nordea explained. “The market is now pricing that rate hikes could start already in the mid-March 2022 meeting.”

That said, today’s rates support validations better than in the ‘90s.

At the same time, equity markets tend to rally into the first hike; Moody’s Corporation’s (NYSE: MCO) forecast aligns with that – “the Dow Jones Industrial Average increases this quarter and peaks in early 2022, … [followed by] steady decline through 2022.”

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

This positive take is in the face of what has been markedly divergent breadth and extreme relative weakness, especially in rate-sensitive names. 

Why? Rising rates, among other factors, have the potential to decrease the present value of future earnings, thereby making stocks, especially those that are high growth, less attractive. 

Graphic: As U.S. stocks’ inflation-adjusted earnings yield turns negative, as seen near the peak of the tech bubble, via Bloomberg, “Investors in the Nasdaq increasingly seem to think that only a few companies have much of a chance. With a growing possibility of more aggressive attempts to prosecute antitrust issues, that’s a riskier position than it appears.”

With the equity market moving higher, here, into the end of the week, we ought to not discount participants’ increasing exposure to leveraged products.

This increases the speed with which volatility is realized and was cited as a risk in one of Moody’s recent commentaries.

So, despite having seasonally-aligned “passive buying support” and supportive positioning metrics, as well as expectations of “the strongest quarterly nominal [economic] growth in more than three decades,” offsides positioning ought to exacerbate underlying price movements.

So what? As stated, yesterday, the market is in a positive-gamma environment wherein the counterparties to customer options trades add market liquidity and temper realized volatility.

With participants’ fears surrounding monetary policy assuaged, there are positive flows that ought to support the market into this week’s weighty “quad-witching” derivatives expiry.

Graphic: VIX term shifts inward; as short-dated protection quickly was monetized or expired, volatility collapsed and dealers’ exposure to positive delta declined which meant they would cover their short futures hedges. This “vanna” flow bolstered an SPX rally into the end-of-day.

Into the end of the week, the expectation is that participants continue to step in and commit increased capital on lower directional volatility (as they had into this week).

With activity concentrated in shorter-dated tenors, counterparties will take on more exposure to positive gamma which they will offset by supplying the market with more liquidity, thereby pressuring the price discovery process.

Graphic: Via SpotGamma data, the above model’s tilt suggests dealers will increasingly sell into strength and buy into weakness, pressuring any price discovery into the end of this week.

Moreover, the decrease in dealer supply (short delta) post-OPEX, via the covering of short stock/futures hedges to put-heavy positioning, ought to bolster any attempt higher.

Below: Though book depth “in isolation is not the correct method to gauge liquidity,” it can help in assessing participants’ demand/supply as volatility (and stress, by that token) increases.

Graphic: Analysis of book depth for the E-mini S&P 500 futures contract, via CME Group Inc’s (NASDAQ: CME) Liquidity Tool. For more on the implications of participants’ options positioning and dealer hedging, read here.

In anticipation of higher prices, low cost, complex options structures like call-side calendars, butterflies, and ratio spreads are top of mind.

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.

Expectations: As of 6:15 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. 

Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator. 

Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,712.00 balance area boundary (BAH) puts in play the $4,732.50 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,740.50 minimal excess high and $4,767.00 extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,712.00 BAH puts in play the $4,690.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,674.25 HVNode and $4,657.00 balance low (BAL), 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. Learn about the profile.
Graphic: V-pattern recovery in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, portends continuation. The red, black, and yellow-colored lines are anchored volume-weighted average price levels (VWAPs), 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.

Definitions

V-Pattern: A pattern that forms after a market establishes a high, retests some support, and then breaks above said high. In most cases, this pattern portends continuation.

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.

Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.

Vanna: The rate at which the delta of an option changes with respect to volatility.

Charm: The rate at which the delta of an option changes with respect to time.

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.

Price Discovery (One-Timeframe Or Trend): Elongation and range expansion denotes a market seeking new prices to establish value, or acceptance (i.e., more than 30-minutes of trade at a particular price level). 

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 8, 2021

Editor’s Note: The purpose of these commentaries is to align ourselves better for the day ahead. Seldom, however, do we step away to align ourselves with trade across larger time horizons. 

Given the proximity to the new year, I shall be placing more attention on planning.

How do we model a trading plan? Here is one link on things to consider.

What Happened

Overnight, equity index futures were divergent; the Russell 2000 and Dow Jones Industrial Averaged traded weak relative to their peers the S&P 500 and Nasdaq 100. 

This is as scientists discovered a harder-to-detect version of omicron that may be countered with an extra dose of vaccine.

In other news, the U.K. was set to impose new COVID-19 restrictions, the House passed a bill opening the way to a quick debt ceiling increase, and the list of Chinese developers warning they may not be able to meet upcoming financial obligations grew.

Ahead is data on job openings and quits (10:00 AM 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

On strong intraday breadth and divergent market liquidity metrics, the best case outcome occurred, yesterday, evidenced by an upside gap, expansion of range, and separation of value.

Similar to Tuesday’s commentary, though this activity marks participants’ willingness to change the trend, the structure is poor. As a result, there is technical instability.

Specifically, both Monday and Tuesday’s sessions left gaps and p-shaped emotional, multiple-distribution profile structures (i.e., old-money shorts covering).

As said before, participants will look to revisit, repair, and strengthen – build out areas of high volume (HVNodes) via the cave-fill process – these areas of low volume (LVNodes).

Graphic: Divergent delta (i.e., non-committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is attempting to balance).

Context: Has anything really changed since the November monthly options expiration (OPEX)?

Sure, we had some news with respect to COVID-19, China, and U.S. growth, but any associated fears were fast assuaged. 

In the span of four days, the S&P 500 rose nearly 5.00%. That’s just over 200 points!

Much of what we’re seeing is the direct result of changing market structure; participants are more exposed to leveraged products, among other things, which increases the speed with which volatility is realized.

Participants went from being exuberant and underexposed to protection – in the face of weakening breadth/fundamentals – to generating destabilizing demand for protection.

Alongside that demand of (shorter-dated) protection (where options sensitivity to direction is higher) was the market’s entry into short-gamma. In such an environment, counterparties to customers’ options trades exacerbate underlying volatility through hedging. 

Note all that movement in the front-end of the VIX futures term structure, below. Wow!

In the face of all the fear was “natural, passive buying support,” however, and expectations that short-dated protection (if realized volatility was to not be expressed to the downside) would either roll off the table (expire) or be monetized, resulting in counterparties reversing their hedges (initially short stock/futures) and supporting the market (buying to cover).

As said on December 6, and many commentaries before that, this “flow is stabilizing and may play into a seasonally-aligned rally into Christmas as participants see defenses rolled out against the new COVID-19 variant,” and so on.

Based on this week’s trade, thus far, it seems that the bull thesis is playing out. 

So you’re telling me to buy every S&P 500 call under the sun, right? NO!

There has yet to be a notable strengthening in overall market breadth and volatility remains rich in the face of the fast-approaching December OPEX and December 15-16 Federal Open Market Committee (FOMC) meeting.

Traders are antsy and have already started pricing in potential rate overshoots; Federal Reserve Chair Jerome Powell went from being uber dovish to increasingly hawkish on the topic of taper and interest rate expansion.

Though today’s rates and earnings support validations better than in the ‘90s, an intent to moderate stimulus serves as a headwind; the U.S. may realize the swiftest tightening in financial conditions since 2005 if the Fed was to hike rates three times next year. Yikes!

So, we have to be careful here. 

Despite the S&P rallying into the first hike, historically, dynamics with respect to market structure introduce a lot of noise. Therefore, we ought to be looking at structures that have little to lose in episodes where stress surfaces and volatility is expressed to the downside. 

Graphic: UBS Group AG (NYSE: UBS) research on S&P performance into rate hikes.

Examples of low-cost options structures include call-side calendars, butterflies, and ratio spreads.

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.

If opportune (and well-capitalized), there are opportunities to finance debits on the call side with structures on the put side. 

This, above, is no recommendation. It’s more so how I’m looking at the current market.

In summation, the return distribution is skewed positive, still, at this juncture, but a lot of the opportunity (based on how participants were positioned just a weak ago) has disappeared.

That’s not to say we can’t go higher; upon a smooth passage of the December FOMC and OPEX there may be an unwind of “structural positioning that naturally drives markets higher as long as volatility is compressed.”

Expectations: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,691.25 HVNode puts in play the $4,705.75 LVNode and overnight high (ONH). Initiative trade beyond the latter could reach as high as the $4,716.75 LVNode/ONH and $4,740.50 minimal excess high, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,691.25 HVNode puts in play the $4,674.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,647.25 and $4,618.75 HVNode, 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. Learn about the profile.

What People Are Saying

Definitions

Cave-Fill Process: Widened the area deemed favorable to transact at by an increased share of participants. This is a good development.

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: 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.

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For November 18, 2021

What Happened

Overnight, equity indices auctioned sideways to higher as the bellwether S&P 500 continues to encounter difficulty in overcoming the forces associated with the large derivatives expiry, Friday.

One headline worth mentioning concerns JPMorgan Chase & Co’s (NYSE: JPM) prediction the Federal Reserve (Fed) will raise interest rates next September, earlier than expected. 

Ahead is data on jobless claims and the Philadelphia Fed manufacturing index (8:30 AM ET), leading economic indicators (10:00 AM ET), as well as Fed-speak scattered throughout the day.

Graphic updated 6:00 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. 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

On lackluster intraday breadth and market liquidity metrics, the best case outcome occurred, evidenced by a Gaussian profile, as well as the balance and overlap of value in the S&P 500.

This activity, which denotes participants positioning themselves for directional resolve, is adding structure, a technically stabilizing dynamic, in short.

Graphic: Lackluster delta (i.e., non-committed buying/selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: Amidst a rather large monthly options expiration (OPEX) this Friday, participants are having difficulty directionally resolving the S&P 500.

This is most visible by the S&P 500’s failure to move away from the $4,695.25 high volume area (HVNode), a level at which there is concentrated participation in the options market. 

As noted before, according to SqueezeMetrics, this level ought to be a magnet given hedging.

“As realized volatility falls from its peak around a year ago, more sold SPX options cluster at strikes nearer to spot. And as implied volatility falls with it, the gamma of those options increases. More dealer long gamma means more liquidity. More liquidity means less movement.”

Moreover, yesterday, there was a note about the market’s reaction to what SpotGamma labels a Call Wall, the strike with the largest net positive gamma in the underlying stock. 

This Call Wall is a reflection of participants’ commitment to higher prices. Should that level continue to move up, then that confirms a willingness to do business, higher, so to speak. 

Since participants were able to roll their exposure to positive options gamma, higher in price and out in time, dealers have to hedge. This maintains that positive (stabilizing) dealer flow we talk so often about, which has bolstered this equity bull market.

Graphic: Via SHIFT, we see participants rolling call exposures to strikes out in time.

That leads us to a dynamic I briefly mentioned last week. After being brought to my attention again, yesterday, there is obviously more to unpack there. However, in keeping it short, I’ll hit on the basics.

The bond market’s pricing of risk, according to Bloomberg, based on an “erratic … handling [of] large transfers of risk” – as evidenced by the Merrill Lynch Option Volatility Estimate (INDEX: MOVE) – has diverged from the pricing of equity market risk via the CBOE Volatility Index (INDEX: VIX).

Fear in one market tends to feed into the fear in another; regardless of the cause, equity and bond market participants are not on the same page.

What does that mean?

At its core, the fear is in tandem with “broad uncertainty about the direction of the economy and monetary policy amid surging prices, labor shortages and yields that are holding well below the rate of inflation,” according to Bloomberg.

In combating high inflation, policymakers ought to raise rates, right? 

Well, that’s at least what economists at institutions like JPM believe may happen as soon as next September, earlier than once forecasted.

Rising rates, among other factors, have the potential to decrease the present value of future earnings, thereby making stocks, especially those that are high growth, less attractive to own.

As the market is a forward-looking mechanism, the implications of this seem staggering. 

Prevailing monetary frameworks and max liquidity promoted a large divergence in price from fundamentals. The growth of passive investing – the effect of increased moneyness among nonmonetary assets – and derivatives trading imply a lot of left-tail risks.

As Kai Volatility’s Cem Karsan once told me: “There’s this constant structural positioning that naturally drives markets higher as long as volatility is compressed,” or there is supply.

“At the end of the day, though, the higher you go, the further off the ground you are and the more tail risk.”

Eventually, fear on the part of bond market participants may feed into equity market positioning.

Graphic: Via The Market Ear, in spite of earnings growth, buybacks, and seasonality, among other factors, Bank of America Corp (NYSE: BAC) sees large tech outflows. Fade as big tech starts to look relatively cheap?

Expectations: As of 6:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, just outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Gap Scenarios: Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,695.25 high volume area (HVNode) puts in play the $4,711.75 regular-trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,735.25 and $4,765.25 Fibonacci, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,695.25 HVNode puts in play the $4,674.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,647.25 HVNode and $4,619.00 untested point of control (VPOC), or lower.

Click here to load today’s updated 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. Learn about the profile.

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.

VPOCs: 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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Significance Of Prior ATHs, ATLs: Prices often encounter resistance (support) at prior highs (lows) due to the supply (demand) of old business. These areas take time to resolve. Breaking and establishing value (i.e., trading more than 30-minutes beyond this level) portends continuation.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.

Categories
Commentary

Daily Brief For November 17, 2021

What Happened

Overnight, equity index futures were divergent. This comes as there were no significant news catalysts and there is a weighty CBOE Volatility Index (INDEX: VIX) expiration today.

Ahead is data on building permits and housing starts (8:30 AM ET). Numerous Federal Reserve members are scheduled to speak today.

Graphic updated 5:45 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

When analyzing the composite (i.e., overnight and day time frame) volume profile, yesterday’s double distribution suggests participants initiated from one area of acceptance to another.

Amidst divergent intraday breadth and market liquidity metrics, the S&P 500 came back into range and participants defended the $4,695.25 high volume area (HVNode). This level corresponds with what options analysis provider SpotGamma says is a Call Wall.

Given an implosion in volatility over the past sessions, the Call Wall is a near-term magnet due to associated hedging.

“As realized volatility falls from its peak around a year ago, more sold SPX options cluster at strikes nearer to spot. And as implied volatility falls with it, the gamma of those options increases. More dealer long gamma means more liquidity. More liquidity means less movement.” – SqueezeMetrics

Graphic: Divergent delta (i.e., non-committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: The aforementioned trade is happening in the context of what Goldman Sachs Group Inc’s (NYSE: GS) CEO David Solomon says is a market environment dominated by greed. 

“[T]here have been periods of time when greed has far outpaced fear — we are in one of those periods,” he said. “My experience says those periods aren’t long-lived. Something will rebalance it and bring a little bit more perspective.”

This comes as markets surge alongside historic amounts of stimulus, improvements in fundamentals (i.e., earnings), supply chain demand/supply imbalances, inflation, and more. 

Further, as stated over the past few commentaries, economic structures are different and we are not in the 1970s. That said, there are a few big dynamics that are of concern.

The first is that we see supply pressures beginning to ease as at-home inventory build-ups are expected to take away from consumption during the holidays (for which businesses are scrambling to stock). Ultimately, this may pressure commodity inflation.

Graphic: Via The Market Ear, Bridgewater shows supply returning to pre-COVID-19 levels as demand explodes, “creating an imbalance of a magnitude that we haven’t seen since the 1970s. What happened in the ’70s truly was a supply shock: supply collapsed, and demand stayed relatively steady. Today, demand is surging, and supply is also growing, but it just can’t keep up with demand.”

The second is this concept of the velocity of money slowing as participants extend moneyness to nonmonetary assets. This is primarily because of monetary policies and an environment of debt and leverage that ultimately cuts into asset price volatility. Overall, this dynamic adds to the prevailing risks of carry when volatility does rise and the demand for money pushes deflation.

Solomon adds: “Chances are interest rates will move up, and if interest rates move up that in of itself will take some of the exuberance out of certain markets.”

With prevailing monetary frameworks and max liquidity promoting a divergence in price from fundamentals, as well as the growth of passive investing and derivatives trading, we ought to have some concern for pending monetary evolution, so to speak. 

As Kai Volatility’s Cem Karsan once told me: “A lot of the processes that enforce these bubbles are embedded in the volatility market.”

“There’s this constant structural positioning that naturally drives markets higher as long as volatility is compressed, or there’s a supply of volatility.” However, “At the end of the day, though, the higher you go, the further off the ground you are and the more tail risk.”

Note: This structural positioning in the S&P 500 can be construed as customer long equity, long put, short call. This sort of positioning tends to leave the market in long-gamma whereby dealers buy into weakness and sell into strength. Amidst the decay in protection, dealers are to unwind their hedges (supply less liquidity), and this is a force that bolsters market price rises.

Even the slightest reduction in liquidity has the potential to prick the bubble, prompting a reaction that exacerbates underlying price movements; the response by customers, as well as the dynamics of dealers’ risk exposure to direction and volatility, ought to cut into liquidity and aid in an unraveling.

“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.”

Case in point, the market’s reaction to prices near SpotGamma’s Call Wall. If participants were unable to roll that exposure to positive options gamma higher in price and out in time, dealers would not have to hedge. This cuts into dealers’ need to unwind hedges to customers’ options positions. This removes one positive (stabilizing) flow that has bolstered this equity bull market.
Graphic: Via SHIFT, we see participants potentially rolling call exposures.

We have seasonally-aligned inflows and earnings growth, among other things, bolstering the most recent rally to new highs. With this week’s implosion in implied volatility most noticeable at the front end of the VIX futures term structure, given the decay in shorter-dated customer protection, it may be an opportune time to hedge.

As The Market Ear stated yesterday, “Playing the term structure (i.e., [buying the] short end of the curve vs [selling] the longer part of the term structure curve) is becoming a rather cheap way to hedge some risks here.”

Expectations: As of 5:45 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Balance-Break Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) may occur.

We shall monitor for acceptance (i.e., more than 1-hour of trade) outside of the prior day’s balance area (i.e., the price levels at which 70% of the day’s volume occurred). Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,695.25 high volume area (HVNode) puts in play the $4,711.75 regular-trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,735.25 and $4,765.25 Fibonacci, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,695.25 HVNode puts in play the $4,674.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,647.25 HVNode and $4,619.00 untested point of control (VPOC), or lower.

Click here to load today’s updated 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. Note that the S&P 500 is pinning at $4,695.25 amid what looks to be a cave-fill (i.e., the widening of the area deemed favorable to transact in by an increased share of participants). Learn about the profile.

What People Are Saying

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Significance Of Prior ATHs, ATLs: Prices often encounter resistance (support) at prior highs (lows) due to the supply (demand) of old business. These areas take time to resolve. Breaking and establishing value (i.e., trading more than 30-minutes beyond this level) portends continuation.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.

Categories
Commentary

Daily Brief For November 16, 2021

What Happened

Equity index futures auctioned sideways alongside no new fundamental catalysts.

Ahead is data on retail sales and import prices (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), the NAHB home builders’ index, and business inventories (10:00 AM ET), as well as Fed-speak at 12:00 and 2:30 PM ET.

Graphic updated 6:10 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

On minimally divergent intraday breadth and unsupportive market liquidity metrics, the best case outcome occurred, evidenced by the balance and overlap of value areas in the S&P 500.

This activity, which marks a potential willingness to continue balance, is adding strength to poor structure, a dynamic that is helping clear the market of technical instabilities.

Graphic: Divergent delta (i.e., non-committed selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: According to Morgan Stanley (NYSE: MS), the S&P 500 ought to be weighed down by slower earnings growth and rising yields. The firm’s chief U.S. equity strategist explains that risk and reward for broad indices look unattractive.

“[W]e think 2022 will finally bring the multiple compression we incorrectly forecasted for 2H 2021. Our 12-month target P/E of 18x is 15% below current levels but in line with the 5-year average and the top quintile for the past 30 years.” 

“The risk of de-rating has been deferred, not avoided, and makes our 12-month S&P 500 Bear/Base/Bull targets of 3900/4400/5000 unexciting.”

This comes alongside expectations that inflation – a product of strong demand – is likely to worsen but not disrupt deflationary trends, such as increased moneyness of nonmonetary assets, innovation, and the like. 

Graphic: Inflation ought to worsen before it cools, via The Market Ear.

Moreover, in terms of positioning, the CBOE Volatility Index (INDEX: VIX) was a touch higher, while demand came in across the front area of the VIX futures term structure. 

Obviously, the tone has changed a bit since last week; customer demand and exposure to very short-dated put protection declined. This was most noticeable in how the VIX term structure behaved over the past sessions. After shifting outward (mostly) in the front, a sign of demand for short-dated protection, the curve shifted back down, late last week.

So, while the initial pop (and hedging on the part of those dealers that warehouse customer options orders) was destabilizing, the term structure slid back into line and the removal of that short-dated protection had the effect of leading dealers to buy back short stock/futures hedges.

This stabilized the market. 

Thereafter, the market drifted back up to the level at which positive options gamma is highest, ahead of a fast-approaching monthly options expiration (OPEX). Into OPEX, dealers’ positive exposure to the risks of price movement, based on predominant positioning in the S&P, ought to increase. In hedging this exposure, dealers ought to supply the market with liquidity (i.e., sell stock/futures) which ought to dampen upside volatility.

So, presently, we’re in a bind and things ought to loosen after OPEX, allowing fundamental catalysts to play a bigger role in price discovery.

A way to play this dynamic is to structure some sort of options spread that applies the proceeds from a short option (which capitalizes on pinning and the rapid decay of soon-to-expire options) toward a long option further out in time. Learn about basic Calendar Spreads or see below.
Graphic: The risk profile of a long put calendar spread, via Fidelity.

Expectations: As of 6:00 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 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 sideways or higher; activity above the $4,674.25 micro composite point of control (MCPOC) puts in play the $4,695.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,711.75 all-time high and $4,735.25 Fibonacci, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,674.25 MCPOC puts in play the $4,647.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,619.00 VPOC and $4,590.00 balance area boundary (BAH), or lower.

As an aside, participants reclaimed the volume-weighted average price (VWAP) anchored from the all-time high and recent Federal Open Market Committee (FOMC) meeting.

This is 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.

Further, given that this development suggests the average buyer, since the all-time high, is in a winning position, who does this dynamic embolden? The buyer or seller?

Click here to load today’s updated 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. Learn about the profile.

A Quick Guide To 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 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 direction (delta), time (theta), and volatility (vega). 

  • Negative (positive) delta = synthetic short (long). 
  • Negative (positive) theta = time decay hurts (helps).
  • Negative (positive) vega = volatility hurts (helps).

What People Are Saying

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.

Significance Of Prior ATHs, ATLs: Prices often encounter resistance (support) at prior highs (lows) due to the supply (demand) of old business. These areas take time to resolve. Breaking and establishing value (i.e., trading more than 30-minutes beyond this level) portends continuation.

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.