Tag: Cem Karsan

Categories
Commentary

Daily Brief For May 17, 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!

Subscribe

What Happened

Overnight, equity index futures were higher. The S&P 500, in particular, probed the high end of the low-volume (gap) area it broke into on May 9, 2022.

The key is to monitor whether the S&P 500 is able to sustain the prices it discovered overnight. If so, then the odds that participants are, indeed, hammering out a bottom are heightened.

Ahead is data on retail sales (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).

Fed-speak is scattered. At 9:15 AM ET, the Philadelphia Fed’s Patrick Harker speaks on health care. At 2:00 PM ET, Fed Chair Jerome Powell is interviewed by the WSJ. At 2:30 PM ET, the Cleveland Fed’s Loretta Mester talks at an inflation conference. And, lastly, at 6:45 PM ET, the Chicago Fed’s Charles Evans speaks.

Graphic updated 6:50 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

Fundamental: Out of all the news, it was noteworthy when Elon Musk broke with the prevailing opinion to declare the U.S. was facing a tough recession that would last up to 18 months. 

This is on the heels of a large “misallocation of capital,” he says, caused by the government printing “a zillion amount of more money than it had.”

Musk cautioned companies to watch their costs and cash flows, the latter of which we talked on the importance of in cycles where monetary conditions are tighter and there is less money to be had for corporates who are taking “the long view” and “competing on eyeballs and growth,” per Kai Volatility’s Cem Karsan who this letter’s writer spoke with last summer.

As Karsan puts it, over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted deflation, ultimately creating “a disinterest and unimportance to cash flows.”

“Monetary policy has a velocity of almost zero, it goes directly to ‘Planet Palo Alto,’ and Palo Alto creates new technologies,” Moontower’s Kris Abdelmesih puts well in a summary of Karsan’s macro thesis.

“They’re sophisticated, futuristic people. They provide new self-driving cars and things getting delivered to your doorstep. They create supply … [and] does not increase demand. And so it is deflationary.”

Over the last years, in light of talk to address increasing inequality, money was sent to labor, so to speak, and that promoted inflation.

Moreover, today’s contractionary monetary policy is a blunt tool and is not equipped to “address the main problem which is a lack of supply to absorb the demand.”

Please read Moontower’s full write-up, here.

That’s sort of in accordance with comments we quoted Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar making, yesterday. Essentially, “the Fed is pursuing demand destruction through negative wealth effects,” as the “central banks can only deal with nominal” chokepoints.

By that token, we must “[c]onsider at least the possibility that the extreme volatility and lack of liquidity [we] see in markets is by design, and the Fed will not be deterred by it, but rather that it will be emboldened by it in its singular pursuit of price stability.”

With even President Biden endorsing the closure of the “wealth window,” Karsan believes corporations will have to worry about making money again.

“These cycles are a lot shorter than the monetary supply-side cycles but they tend to be very bad for multiples and great for economic growth.”

With that in mind, there is no escape. Even the traditional bond-stock relationship – the 60/40 framework – is at risk of being upended.

Graphic: Via Andy Constan of Damped Spring Advisors. “Zero rate hikes in 2023. Clearly, a recession is being priced in.” Per Bloomberg, a Bank of America Corporation (NYSE: BAC) survey puts the Fed put (a pivot) at $3,529.00 in the S&P 500.

Positioning: Measures of implied volatility came in. That’s significant since participants have a lot of exposure to put options.

Further, we see liquidity providers being short those puts. As volatility continues to come in, the exposure of those options to direction (delta) compresses. 

As a result, liquidity providers will taper some of their negative delta short stock and futures hedges to that positive delta put position.

Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”

Those delta hedging flows with respect to changes in volatility (vanna) are on top of what has historically been a front-running of the bullish flow associated with the delta decay of options, particularly with respect to time (charm), into options expirations (OPEX). 

Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

Notwithstanding, though proxies for buying and this hedging of existing options positioning, at the surface, appear to point to positively (skewed) forward returns, we have concern over the level at which from implied volatility is dropping from, and the general divergence between the volatility realized and implied, talked about yesterday.

Basically, as SpotGamma says, there’s not as much “stored energy to catalyze a rally.” 

SqueezeMetrics adds: 

The Cboe Volatility Index (INDEX: VIX) compressing, while dealer gamma exposure is “more negative than it’s been in years is not how you get sustained rallies–it’s how you get energy for bigger downside moves.”

Therefore, we continue to focus on participating in upside with as little debit risk as possible, via the use of complex strategies, further validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Technical: As of 6:30 AM ET, Tuesday’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.

In the best case, the S&P 500 trades higher; activity above the $4,083.75 overnight high (ONH) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,148.25 and $4,184.25 high volume nodes (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,083.75 ONH puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,013.25 micro composite point of control (MCPOC) and $3,978.50 LVNode, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Considerations: A push-and-pull between the largest of S&P 500 weights.

For instance, Apple Inc (NASDAQ: AAPL) is clinging to its prior trend.

Graphic: Via Bloomberg.

All the while products like Amazon Inc (NASDAQ: AMZN), are trading into key supports.

Graphic: Via Bloomberg.

We continue to monitor our market internals and (large) changes in positioning (e.g., open interest builds at higher prices further out in time) that will provide further validation to this most recent S&P 500 reversal.

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Current reads of breadth (top charts), in particular, are uninspiring. An advance you do not short has an advance-decline line that’s pegged at +2,000, coupled with a Tick (bottom left) that has trouble closing below 0 for nearly the entirety of a session. Caution.

What People Are Saying

Definitions

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

Volume Areas: 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.

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 May 16, 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!

Subscribe

What Happened

Overnight, equity index futures auctioned lower after a failed attempt to solicit strong buying on a break of Friday’s regular trade high. 

Coincidentally, after a test of an anchored volume-weighted average price level, some measures from China had traders concerned about global growth, and that fed into a risk-off sentiment and probe further into Friday’s range.

Moreover, ahead is data on Empire State Manufacturing (8:30 AM ET).

Today, we add light context to our narratives with an aim to elaborate further in letters later this week. Take care!

Graphic updated 6:45 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

Fundamental: Data from China shows contraction in light of COVID-19 troubles.

Graphic: Via Bloomberg. 

Bloomberg’s John Authers explains that a contracting China “would be a deflationary force for the rest of the world.”

Graphic: Via Stenos Signals. “China imports vs. Commodities – the most important macro chart in the world right now.”

Andreas Steno Larsen, of the Stenos Signals letter, recently talked about this “lack of economic activity in China,” as well as “slowing demand in the West,” both of which are to “lead inflation expectations lower.”

Graphic: Via CrossBorder Capital. “Latest weekly Fed liquidity injections and the S&P 500. Bigger the bull, the harder they fall? Fed trying to crash [the] economy to kill inflation [and] Wall Street is the victim.”

Notwithstanding, the Federal Reserve (Fed) remains on track “to deliver substantial QT and rate hiking,” all the while investors “hold a relatively risk-friendly position in equities and credits.”

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear.

Steno Larsen explains: “That disconnect [between sentiment and exposure to risk] will have to wane before I truly dare to re-add risk asset exposure to my list of recommendations.”

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

Pursuant to that remark, Authers notes that the latest Chinese data emboldens the risks of a recession which Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar explains is not enough.

“[T]he risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects, and signs of a recession might not mean immediate rate cuts to ramp demand back up.”

“Rallies could beget more forceful pushback from the Fed – the new game.”

Graphic: Via @TheBondFreak. “2/10s spread has delivered its message. The long end is beginning to trend lower. NOW…it’s time to start watching the 3m/10yr spread, which will likely invert as the Fed continues with its rate hikes to kill demand, cause a recession, but “us” from inflation.”

Per Goldman Sachs Group Inc (NYSE: GS), baseline forecasts assume “no recession” and imply the S&P 500’s P/E ends unchanged at 17x. 

“A recession would see the index fall by 11% to $3,600.00 as the P/E drops to 15x.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear. A recession brings S&P 500 to $3,600.00.

Positioning: Early on Friday morning, we approached trade too optimistically but, to our credit, we focused on participating with as little risk as possible, via the use of complex strategies, as validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Heading into Monday’s regular trade, little has changed and indexes are holding well, relative to some constituents.

This is as participants are hedged and volatility markets remain well-supplied, due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

Kai Volatility’s Cem Karsan hypothesizes: “If a meaningful [volatility] event has happened within the last year, participants are more likely to be prepared for the move. So the ‘2nd event’ dramatically underperforms [implied volatility] skew expectations.”

“Take Jan/Feb 2016, Oct-Dec 2018, &…Sep 2020? All these ‘2nd Events’ ended up being as meaningful as their 1st events, if not more, for markets, but were much more orderly [and] accompanied by poor [volatility] performance.”

Graphic: Via Bloomberg. “For all the recent declines — the S&P 500 is down more than 13% from its high on March 29 — stress indicators also aren’t at levels seen during comparable slumps. Fewer than 30% of the benchmark’s members have hit a one-year low, compared with nearly 50% during the growth scare in 2018 and 82% during the global financial crisis in 2008.”

Given the aforementioned supply and demand dynamic, we continue to observe “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says. 

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

For “divergences in volatility realized and implied to resolve, it would likely take forced selling. Liquidity providers’ response to demand for protection would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

All else equal, SpotGamma adds, there is no catalyst to rally until the May 20, 2022 options expiration (OPEX). Till then, rallies are subject to failure.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

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

In the best case, the S&P 500 trades higher; activity above the $4,013.25 micro composite point of control (MCPOC) puts in play the $4,036.00 regular trade high (RTH High). Initiative trade beyond the $4,069.25 high volume area (HVNode) could reach as high as the HVNode and $4,119.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,013.25 MCPOC puts in play the $4,3978.50 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,943.25 HVNode and $3,899.00 VPOC, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
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.

MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, 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 May 6, 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!

Subscribe

What Happened

Overnight, equity index futures auctioned weak, inside of the prior day’s large trading range.

Yesterday, the equity indexes, bonds, and crypto (which many saw as a hedge against equities) were sold, aggressively. The selling came one day after the Federal Reserve hiked 0.50 basis points and outlined its balance sheet reduction timeline.

Notable was ten-year Treasury yields breaking the 3.00% barrier.

Despite a more dovish tone (i.e., Fed assuaging participants of a 0.75 basis point hike in the coming meetings), the near-vertical price rise (which we discussed was a function of “structural buyback” in yesterday’s morning letter) was taken back in a fire sale across all sectors.

Today is data on nonfarm payrolls, unemployment rates, average hourly earnings, and labor force participation (8:30 AM ET). Later, consumer credit data is released (3:00 PM ET).

Speaking today is the Fed’s John Williams (9:15 AM ET), Raphael Bostic (3:20 PM ET), James Bullard and Chris Waller (7:15 PM ET), as well as Mary Daly (8:00 PM ET).

Graphic updated 6:45 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

Positioning: In yesterday’s detailed letter, we talked about the implications of participants’ hedging heading into and after the Federal Open Market Committee (FOMC) event.

Mainly, markets were stretched and participants were demanding protection in size. As said:

“Barring a worst-case scenario, if markets do not perform to the downside (i.e., do not trade lower), those highly-priced (often very short-dated) bets on direction will quickly decay, and hedging flows with respect to time and volatility may bolster sharp rallies.” 

After that “structural buyback,” as Kai Volatility’s Cem Karsan explained clearly, it was highly likely the bear trend would hold. Participants not shifting their bets on direction (via options) to higher prices, further out in time, further suggested very little change in sentiment.

Toggle, which is an AI and machine learning research firm tracking 35,000 securities globally, sent us, yesterday, their post-Fed analysis. According to them, “during the first week after the Fed’s 50 bps hike markets broadly headed lower.”

“In fact, 1 in 5 times the drop reached more than 5%.”

Graphic: Via Toggle.

The firm’s CEO and founder – Jan Szilagyi – said, in response to the market action that “market bulls should root for stocks to go down first.”

That’s actually a powerful statement. For markets to break (rally), they sometimes need to rally (break). Said another way, at times the market is stretched. Sellers (buyers) are either too short (or too long), if we will.

In order to trade lower, for instance, that short inventory (which in and of itself is a support mechanism as it is a bunch of buy orders sitting at lower prices) must be cleared (i.e., covered).

After that support is removed, the market can succumb to whatever fundamental weaknesses it was trying to price in. 

In this case, “the incremental effects on liquidity (QE/QT),” as Karsan says.

Moreover, what’s interesting, and this is something others have picked up on, is the difference between the level of volatility that is realized and implied by activity in the derivatives market.

Another time we saw such divergences was during the 2020 Coronacrisis sell-off.

Graphic: Via @HalfersPower. On March 2, 2020, “VIX-30 day realized vol go from 99 percentile yesterday to inverted and 9 percentile today lol. (left vs. right).

Let’s unpack. So, the Cboe Volatility Index (INDEX: VIX), as described by Cboe Global Markets Inc (BATS: CBOE), is a “constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500 Index (INDEX: SPX) call and put options.”

Essentially, to make it simple, VIX is the equity market’s pricing of risk or insurance and it has a strong inverse relationship with the SPX. If SPX is lower, the VIX higher, basically.

Then, just as we have metrics to measure the change in an option’s sensitivity to the underlying direction (delta) or gamma, we have the sensitivity of an option to changes in volatility (vega) or volga.

Volga has different names. Vomma. The convexity of vega (i.e., change in vega based on change in volatility implied by market participants’ activity). The volatility of volatility. And so on.

The volatility of volatility can naively be measured through the Cboe VVIX Index (INDEX: VVIX) which, according to Cboe, “represents a volatility of volatility in the sense that it measures the expected volatility of the 30-day forward price of VIX.”

Historically, the gauge has a mean somewhere beneath 100 and a high correlation with the VIX at times of heightened stress (e.g., Coronacrisis).

Graphic: The VVIX via Physik Invest.

What’s going on is there is really negative sentiment and emotion, both of which are playing into market weaknesses and realized volatility. However, that realized volatility is not priced in.

In other words, the volatility of volatility – VVIX – is low relative to the volatility realized (and implied) and that, as I take it, essentially means that the market is not pricing up protection.

Graphic: Via The Ambrus Group’s Kris Sidial. “Trotting out the good old VVIX/VIX (trader heuristic) to compare SPX skew to VIX Vol. Negative sentiment but lack of fear continues.”

Why does this matter? Well, when you think there is to be an outsized move, relative to what is priced, you buy options (positive exposure to gamma) so that you may have gains that are potentially amplified in case of directional movement.

You also buy can buy options for positive exposure to volga. This is so that you may have gains that are potentially amplified in case of movement (repricing) in implied volatility.

Graphic: Via @Alpha_Ex_LLC. “Here’s 10-day realized vs VVIX on a scatter. The ‘white star’ is 40 realized but only 117 VVIX. When realized this high, VVIX typically closer to 150.”

With back-to-back daily price changes sometimes in excess of 2%, this essentially suggests to us the potential for the pricing of equity market risk to “catch up.”

Graphic: Via Bloomberg. The realized volatility for the SPX versus the VIX.

Per SpotGamma, much of this has to do with market participants being “well-hedged.”

“From an options perspective, participants would have to demand en masse protection (buy puts, sell calls) for liquidity providers to further take from market liquidity (sell into weakness) and that volatility skew to, essentially, blowout (e.g., Corona crisis, Meme mania, and the like).”

The Ambrus Group’s Kris Sidial, who felt that the liquidation was likely large desks de-risking their book, explains, well, too: 

“Vol is mainly used as a source of hedging. We are coming off of a big FOMC meeting where vol was slightly elevated. Think about this for a second, although SPX had a nasty day today, we are still right where we were at Tuesday… what does that tell you?”

“That means there wasn’t really a NEED to rehedge that same exposure. Volatility didn’t compress much after FOMC and when the market gave it all back it brought us right back to where we started. Put yourself in the shoes of an institution.”

Graphic: SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO) for SPY shows light put selling and call buying. Participants are (likely) hedged and are not demanding protection in size amid lower prices.

Pursuant to those remarks, SpotGamma sees markets reaching a lower limit near the $4,000.00 SPX area. At that juncture, the rate at which liquidity providers add pressure in their hedging activities flattens as they, too, have hedges.

Graphic: Via SpotGamma. Updated April 27, 2022.

“In turn, dealers may be able to advantageously reduce delta hedging (sell less), and supply markets with more liquidity (buy more stock). This could serve to reduce volatility.”

So, what do you do with this information? The idea is that volatility implied may reprice to reflect what is realized. In such a case, you’d want positive exposure to volga (i.e., don’t sell volatility).

This is more of a view on volatility rather than direction, at this juncture.

Directionally speaking, the returns distribution is skewed positive. This is from an overlay of proxies for buying and naive gamma exposure.

Here’s one model using similar data we often look at in this letter.

Graphic: Via nextSignals. “When SPX and [gamma exposure] nosedive after an extended selloff while dark pools’ buying sharply diverges to the upside … buy the S&P 500.”

Technical: As of 6:45 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,148.25 high volume area (HVNode) puts in play the $4,184.25 HVNode. Initiative trade beyond the $4,184.25 HVNode could reach as high as the $4,212.25 micro composite point of control (MCPOC) and $4,303.00 weak high (obvious breakout level), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,148.25 HVNode puts in play the $4,099.25 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,055.75 low volume area (LVNode) and $3,978.50 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

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.

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.

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 May 5, 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!

Subscribe

What Happened

Overnight, equity index futures took back a small chunk of Wednesday’s post-Federal Open Market Committee (FOMC) advance. Both bonds and equity indexes were lower while most commodities and the dollar were bid.

The Federal Reserve hiked interest rates by 50 basis points while knocking the odds of a larger hike (~0.75 or above) later this year, all else equal. The Fed’s holdings of U.S. Treasuries (UST) and mortgage-backed securities (MBS) are set to fall starting June 1.

As expected, the Fed will cut $95 billion a month from its holdings, split between $60 billion of USTs and $35 billion of MBS, per Reuters, in the span of three months.

Heading into the FOMC event, markets were sold and protection, particularly that which is shorter-dated, was demanded. This was evidenced via metrics like the VIX’s term structure which had short- and mid-term VIX futures prices higher than those that are longer-term.

The compression of implied volatility after the event affecting existing concentrations of options positioning, particularly at the short-end, coupled with lackluster options buying and selling at the index level, has us questioning the rally’s sustainability.

Ahead is data on jobless claims, productivity, and unit labor costs (8:30 AM 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

Fundamental: The Fed is raising rates and reducing the size of its balance sheet in light of the economy’s “strong underlying momentum,” as Nordea Bank (OTC: NRDBY) research puts it, a hot labor market and elevated inflation.

During a press conference after the release of meeting statements, the Fed’s Jerome Powell assuaged participants of their fears regarding a 75 basis point hike in later meetings.

Instead, it’s likely the fed tightens twice more by 50 basis points before scaling back to 25 basis point hikes, helping bring inflation down to the 2% target.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, “roughly double the maximum pace of $50 billion a month targeted in the 2017-2019 cycle.”

With QT, central banks remove assets from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities,” as JH Investment Management explains. 

Since March, the Fed’s balance sheet was at $9 trillion, steadied by the reinvestment of proceeds from maturing securities. After a small run-up, starting in September, the Fed will allow for a maximum of $95 billion to roll off without reinvestment.

Per MarketWatch, “In this cycle, one key to markets is when the Fed might actually sell some of its holdings of mortgages $2.7 trillion. This will ripple out through U.S. debt markets.”

This, however, “would be announced well in advance,” enabling “suitable progress toward a longer-run … portfolio composed primarily of Treasury securities.”

When bonds fall in value, their yields rise. This may have the effect of driving yield-hungry investors into relatively less risky asset categories.

Graphic: Via Reuters.

Positioning: There was a large squeeze, post-FOMC. 

The prevailing narrative is that participants’ fears, with respect to how aggressive the Fed would tighten, were assuaged.

Per Standard Chartered’s (OTC: SCBFY) Steve Englander, at its core, “it is fair to say that positioning and excess pessimism reflect a big part of the market reaction.” ​​

“Overall, the tone was much more balanced than at the January and March FOMC meetings.”

As discussed in the past few letters, markets were stretched and participants were demanding protection in size. To quote the May 2 letter:

“Barring a worst-case scenario, if markets do not perform to the downside (i.e., do not trade lower), those highly-priced (often very short-dated) bets on direction will quickly decay, and hedging flows with respect to time and volatility may bolster sharp rallies.” 

Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”

That’s precisely what happened. The question now is whether there’s a sustained reversal. 

Based on SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO), participants’ reaction to the FOMC was lackluster and capital was not committed to bets further out in price and time at higher or lower prices. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. Capital was not committed to bets further out in price and time at higher or lower prices. 

If participants start to concentrate their bets at higher prices, further out in time, that confirms the odds of sustained follow-through. If not, it’s likely that indexes, after a short-term relief, will succumb to fundamental weaknesses.

According to Kai Volatility’s Cem Karsan, the rally was purely a function of “structural buyback” and the baseline is that the bear trend holds.

This is because Fed is expected to continue withdrawing liquidity, and this will prompt risk assets to converge with fundamentals as “QT is a direct flow of capital to capital markets.”

https://twitter.com/TDANetwork/status/1521940372787716099?s=20&t=niBUbjcqo_pSuG_d4KjCOw

Technical: As of 6:30 AM ET, Thursday’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 $4,260.25 overnight low (ONL) puts in play the $4,303.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,260.25 ONL puts in play the $4,177.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,142.75 RTH Low and $4,123.00 VPOC, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures. Please note that some levels have been adjusted since this graphic was made.

Considerations: Strong advance, yesterday, characterized by very supportive breadth.

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).

The weaker of the indexes we monitor – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – just retook a major VWAP anchored from the lows of March 2020. 

That indicator denotes the level at which the average buyer/seller is in. In other words, that’s the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called supply zone, the level ought to, again, be looked at as a demand area. 

What’s next? Looks like there are some key areas where supply is likely to show. Mainly the $340.00 and $360.00 areas in the QQQ are of significance. In the SPY, those areas include $435.00 and $445.00.

Graphic: Invesco QQQ Trust Series 1 (NASDAQ: QQQ) with anchored VWAPs.

Definitions

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

Volume Areas: 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.

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 May 4, 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!

Subscribe

What Happened

Overnight, equity index futures were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

A check on some naive measures suggests we’re in for an expansion of range (i.e., heightened realized volatility) in the coming session(s). Key, today, are Federal Open Market Committee (FOMC) updates (2:00 PM ET) and a news conference (2:30 PM ET). 

The expectation is a 50 basis point hike and balance sheet contraction with run-off caps of $95 billion. If the action is in line with expectations (priced in), the reaction is likely to be positive.

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (10:00 AM ET). 

Graphic updated 7:00 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: Expected is front-loaded tightening, by the Federal Reserve (Fed), today.

The consensus is anchored around a 50 basis-point hike in May and no adjustments to the Reverse Repo Rate (RRP) or Interest on Reserve Balances (IORB), says Nordea Bank (OTC: NRDBY) research. The Fed may opt, also, to initiate a 75 basis-point hike in June.

“We believe that after the FOMC hikes by a half-point in May and presents a detailed plan to reduce the Fed balance sheet,” imminently, says Anna Wong, Yelena Shulyatyeva, Andrew Husby, and Eliza Winger of Bloomberg. 

“Powell will avoid definitive guidance about the size of future hikes, as policymakers assess how the runoff is affecting the economy in coming months.”

Graphic: Via Nordea research. Heightened inflation, exacerbated by sticky supply pressures and the conflict in Ukraine, and trends in demand have played into a tough talk on monetary policies.

As noted before, the key (risk) is the statements on the Fed’s balance sheet and the (imminent) process to shrink it through quantitative tightening (QT).

Graphic: Via Mish Talk. “The Fed expanded QE aggressively for years. But nearly all of that expansion was longer-dated securities as the [] chart shows. If the Fed had short-term securities it could reduce its balance sheet simply by runoff. Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

Per Nordea, QT is likely to consist of a 3-month phase-in period and run-off caps of $95 billion (i.e., $60 billion on U.S. Treasuries [USTs] and $35 billion in mortgage-backed securities [MBSs]), effectively lowering the Fed’s balance sheet by $670 billion by year-end.

Graphic: Via Bloomberg and Mitsubishi UFJ Financial Group Inc (NYSE: MUFG) U.S. Macro Strategy.

This is alongside the realization that “1Q may be the last good quarter of earnings as higher costs and increased recession risks weigh on future growth,” Morgan Stanley’s (NYSE: MS) Mike Wilson explains.

Graphic: Via Royal Bank of Canada (NYSE: RY) U.S. Equity Strategy and Bloomberg.

Market weakness in the past weeks was the result of “growing evidence that growth is slowing faster than most investors believe,” Wilson adds, and “the market is currently so oversold, any good news [such as Fed action being as expected] could lead to a vicious bear market rally.”

“We can’t rule anything out in the short term but we want to make it clear this bear market is far from complete.”

Positioning: Borrowing from yesterday’s letter, as little has changed, bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and highly sensitive to changes in implied volatility and direction.

Graphic: SqueezeMetrics on “how IV, direction, and moneyness cause option dealers to buy or sell the underlying.”

This exposure’s roll-off and compression in volatility ought to coincide with liquidity provider support to markets (i.e., relief of pressure from hedges to concentrated options positioning).

Per Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Validation of the latter (move) ought to be confirmed by participants’ new concentration of bets. In other words, if participants start to concentrate their bets at higher prices, further out in time, that confirms (changing sentiment) and (improves) the odds of sustained follow-through.

If not, it’s likely that prices, after a short-term relief, will succumb to fundamental weaknesses.

Technical: As of 7:00 AM ET, Wednesday’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, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,157.00 VPOC puts in play the $4,123.00 VPOC. Initiative trade beyond the $4,123.00 VPOC could reach as low as the $4,055.75 and $3,978.50 low volume areas (LVNodes), 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.

What People Are Saying

Definitions

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

Volume Areas: 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.

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 April 28, 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!

Subscribe

What Happened

Overnight, equity index futures auctioned sideways-to-higher alongside some upbeat earnings announcements.

Meta Platforms Inc (NASDAQ: FB) surged post-market, yesterday, after its main social network Facebook added more users than expected. 

PayPal Holdings Inc (NYSE: PYPL) vowed to rein in costs and boost profits while Qualcomm Inc (NASDAQ: QCOM) rose on an upbeat forecast.

There’s a strong push-and-pull between what’s good and bad. File Deutsche Bank’s (NYSE: DB) recent comments on a pending recession under what’s bad.

The bank sees the Fed Target Rate reaching up to 6% which “will push the economy into a significant recession by late next year.”

Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. 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: Divergences across different assets and markets continue.

For instance, the equity market’s pricing of risk which we can take as being reflected by the CBOE Volatility Index [INDEX: VIX]) is not moving lock-step with that of measures elsewhere.

Graphic: Via Bloomberg.

The fear in one market tends to spread to others. Regardless of the cause, it seems that equity and bond market participants are not on the same page.

Is that really true, though? Not necessarily. 

If we look at some single stocks, Netflix Inc (NASDAQ: NFLX), among others (all the while S&P 500 earnings have been revised up) has suffered through a substantial de-rate and volatility as participants priced the implications of policy evolution, slower economic growth, and beyond.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear.

That has us returning to pinning at the index level, relative to what the constituents are doing.

As well explained in Physik Invest’s March 3, 2022 commentary, this is more so a function of positioning and structural flows, or supply of liquidity.

Absent some exogenous event, participants are well-hedged for what is known (e.g., rate hikes and quantitative tightening (QT), COVID resurgences, Russia and Ukraine, among other things).

The caveat is that the Federal Reserve is far more aggressive than expected, ramping up QT, “a direct flow of capital to capital markets or flow out of,” per Kai Volatility’s Cem Karsan. 

For context, it is the intention to take from the max liquidity (which pushed participants out of the risk curve and promoted a divergence from fundamentals) markets were supplied with, and this has the effect of removing market excesses, some of which have fed into volatility markets.

In part, some of the QT has been reflected in bond prices, JPMorgan Chase & Co (NYSE: JPM) explains. However, should there be far more aggressive monetary action, as Deutsche research suggests, coupled with a worsening of the geopolitical and/or economic situation abroad (e.g., Russian default), markets are likely to succumb.

“Using the balance sheet as a tightening tool represents a large change in the Fed’s attitude, and IS NOT priced into the market,” MacroTourist’s Kevin Muir adds.

“An increase in the pace of tightening of QT should mean lower stocks, wider credit spreads, and a slight reduction in the need for front-end hikes.”

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. The “Nasdaq has underperformed the S&P 500 but by less than what the move in real yields would suggest.”

Positioning: Volatility to continue as markets have traded lower and participants have priced up the cost of insurance – particularly at the short-end – on underlying equity exposure.

Graphic: SPX volatility term structure via Refinitiv. Taken from The Market Ear.

This is due to options delta (exposure to direction) being far more sensitive (gamma) across shorter time horizons (i.e., the range across which options deltas shift from “near-zero to near-100% becomes very narrow.”)

Yesterday, markets were pinned after exploring lower in the days prior. The activity was concentrated in short-dated bets at those levels, and that’s in part a result of some of the hedging that went on.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options Indicator.

If markets do not perform to the downside (i.e., do not trade lower), those short-dated bets on direction will quickly decay, and hedging flows with respect to time (charm) and volatility (vanna) may bolster sharp rallies.

Whether those price rises have legs depends on what the fundamental situation is, then. Regardless, the returns distribution, based on implied volatility metrics alone, is skewed positive, albeit there are some large negative outliers.

Graphic: Via @HalfersPower. “In backwardation via $VIX: $VIX3M next month [realized volatility] is highest amongst the deciles (d10 >1) ~43% subsequent realized volatility.”

Technical: As of 7:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,236.25 regular trade high (RTH High) puts in play the $4,267.75 RTH High. Initiative trade beyond the $4,267.75 RTH High could reach as high as the $4,303.75 overnight high (ONH) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,236.25 RTH High puts in play the $4,191.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,136.00 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), 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: Markets are higher after testing some key levels outlined in prior letters.

The Invesco QQQ Trust Series 1 (NASDAQ: QQQ), one of the weakest products this letter monitors, just tested a major VWAP, yesterday, anchored from the lows of March 2020. 

Graphic: Invesco QQQ Trust Series 1 (NASDAQ: QQQ) with anchored VWAPs.

The Nasdaq has led the market down. It may lead the market higher on reversals. We’ll continue to monitor market breadth, among other metrics, for signs of strength.

Definitions

Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

Volume Areas: 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.

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.

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 April 25, 2022

Editor’s Note: Wow, what a month! Looks like there was a ton of volatility we weren’t able to navigate together.

I’m back now and will be making changes to both the quantity and quality of notes sent. In total transparency, I took on way too much work, and quality suffered a tad. I look forward to making things a bit more sustainable and am grateful for your interest in remaining a subscriber.

Interested in getting this free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 200+ that read this report daily, below, today!

Subscribe

What Happened

Overnight, the equity index and most commodity futures explored lower. Bonds and implied volatility metrics were bid.

This is alongside news that China’s reaction to a local COVID-19 outbreak may feed into global slowdowns just as supply pressures, among other things, are pushing the Federal Reserve (Fed) to adopt a more hawkish policy stance.

Notable is the pace at which China’s yuan is falling. 

Per TD Securities, it suggests “the PBOC is utilizing the yuan as another tool to provide stimulus to the economy at a time when they are showing restraint on the monetary policy front.” 

Ahead, there are no important economic events scheduled. See who is reporting earnings, here.

Graphic updated 7:30 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: A push-and-pull, continues.

At a high level, it was surmised that many of the responses to geopolitical tension and inflation were priced in. The economy, since early pandemic disruptions, has strengthened and the need for ultra-accommodative policies is no more.

Graphic: Via S&P Global Inc (NYSE: SPGI).

That means low rates and quantitative easing (QE) – easy money so to speak – are on the way out, at least for the time being.

Recall that QE is a policy to expand the Federal Reserve’s balance sheet “to provide monetary accommodation, typically when interest rates are at a zero-lower bound (when nominal interest rates are at, or near, zero),” as JH Investment Management explains.

With QT, central banks remove assets (e.g., government bonds they bought from the private sector) from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities.”

With that, we note that when bonds rise in value, their yields decline; “when the Fed embarks on bond-buying program[s] to support the U.S. economy, … [it nudges] the prices of these assets higher while pushing yields lower, which also has the effect of driving yield-hungry investors into relatively riskier asset categories that promise high returns.”

Graphic: Via ICI. Taken from The Market Ear.

As a result, participants’ demand for risk assets prompts their divergence from fundamentals. As liquidity is removed and funding costs increase, this may prompt risk assets to converge with fundamentals.

This is because, for investors to take on additional risk for return, they must receive in excess of the risk-free rate (as provided by the Treasury). This excess is the risk premium.

Previously, as the Damped Spring’s Andy Constan had previously commented, “[a]dditional risk premium expansion pressures from these levels is not likely.”

“However, if, in the unlikely event, details of QT do emerge suggesting a start of QT before June and at a greater size than expected, we would no longer be willing to hold [risk] assets as that would cause an end to any risk premium contraction possibilities.”

Well, that’s what happened in early April when Fed members said their debt holdings would be reduced “at a rapid pace” as soon as May, as well as hike rates, faster. 

“Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery,” the Fed’s Lael Brainard said. 

The Fed may even raise “caps” on the pace of QT.

Graphic: Via The Market Ear. Goldman Sachs Group Inc (NYSE: GS) sees the balance sheet shrinking “to an equilibrium size of just over $6tn by early- or mid-2025, though there is substantial uncertainty about its terminal size.”

Per CME Group Inc’s (NASDAQ: CME) FedWatch Tool, market participants are pricing a near-100% probability that the Fed will move the target rate to 75-100 bps (+50 or +75 bps).

Graphic: Via CME Group Inc. FedWatch Tool suggests a near-100% chance of a Fed hike that moves the target rate between 75 and 100 bps.

At a high-level, rates hikes take time to flow through to the economy while “QT is a direct flow of capital to capital markets or flow out of,” according to statements by Kai Volatility’s Cem Karsan. 

“An increase in the pace of tightening of QT should mean lower stocks, wider credit spreads and a slight reduction in the need for front-end hikes,” explains Kevin Muir of the MacroTourist.

“Using the balance sheet as a tightening tool represents a large change in the Fed’s attitude, and IS NOT priced into the market.”

Graphic: Bloomberg. “Everyone bearish, but redemptions just starting,” said BofA strategists led by Michael Hartnett, adding that the environment of “extreme inflation” and rates shock is just setting in, as the Federal Reserve tightens monetary policy. “75 basis points is the new 25 basis points,” Hartnett said, referring to the scope of future interest-rate hikes.

As an aside, adding to earlier comments on the yuan’s fall, Bob Parker, a senior adviser at Credit Suisse Group AG (NYSE: CS) explains that “When Chinese investors lose confidence in their own economy/markets, capital outflows from China accelerate, … [and] this, then, leads to a central bank which has to prop up the currency by selling some of the country’s huge reserve piles.” 

“Part of their reserves will have been/are in U.S. equities so as the reserves fall, they are natural sellers of the S&P.”

Graphic: Via Refinitiv. Taken from The Market Ear. CNH versus SPX.

Positioning: In a comparison of options positioning and passive buying support, the returns distribution is skewed positive and points to building support for a potential short-term bounce.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

The most recent liquidation resulted in participants reaching for protection and this exacerbated movement to the downside amidst the reflexive hedging.

As this short-dated exposure decays, the counterparts’ hedges are to be tapered and this may assist in the market hammering out a bottom or rallying. 

On the contrary, however, as SpotGamma explained in a recent note, “[t]op of mind as we head into new trade on Monday is the likelihood traders will not aggressively sell volatility (i.e., if they sell volatility -> that drives volatility lower -> resulting in hedging flows that support the market) until the FOMC (5/4) and/or some resolution on the geopolitical front.”

“Therefore, [] expect larger trading ranges this upcoming week.”

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

In the best case, the S&P 500 trades higher; activity above the $4,247.75 regular trade low (RTH Low) puts in play the $4,274.50 spike base. Initiative trade beyond the spike base could reach as high as the $4,314.75 high volume area (HVNode) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,247.75 RTH Low puts in play the $4,227.75 HVNode. Initiative trade beyond the $4,227.75 HVNode could reach as low as the $4,177.25 HVNode and $4,129.50 overnight low (ONL), or lower.

Considerations: Spikes 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).

In a spike up (down) situation, trade below (above) the spike base, negates the buying (selling).

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

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.

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 March 18, 2022

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

Subscribe

What Happened

Ahead of Friday’s triple witching derivatives expiry, the equity index and most commodity futures auctioned sideways to lower.

Ahead is data on existing home sales and leading economic indicators (10:00 AM ET), as well as Fed-speak by Tom Barkin (1:20 PM ET).

Graphic updated 6:45 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

Fundamental: Today’s focus is on market positioning. Therefore, the fundamental section is (more) lighthearted.

Equity markets rose in the context of a sharp multi-month drawdown. This is, in part, masking the concern over Russia’s economic situation, a slowing in the flow of U.S. credit, supply and demand imbalances, the impact of COVID-19, and other things.

Graphic: Via Bloomberg.

Further, in spite of the Federal Reserve’s (Fed) comments on the strength of the economy and its likely resilience in the face of tighter policies, Goldman Sachs Group Inc (NYSE: GS) said the odds of a recession were “broadly in line with the 20-35% odds currently implied by models based on the slope of the yield curve.”

Graphic: Via Bloomberg. “Whenever the yield curve inverts, it tends to function as an early warning for a recession, suggesting that in the medium-term rates will have to fall.”

The forecast “implies below potential growth in 2022 Q1 and 2022 Q2 and potential growth for 2022 overall.”

With the Fed now eyeing about six more rate hikes in 2022 – putting the policy rate at ~2.8% before 2024 – commentators were quick to point out the “central bank’s patchy record on not tipping the economy into recession.”

Graphic: Via Bloomberg.

Alhambra Investments’ Jeffrey Snider, however, made an interesting point.

“To believe the Fed is behind all this or can do something useful about it, like the rate hikes you would have to be” born yesterday, he said.

“On the contrary, bond curve recession probabilities are more attuned to why production levels have struggled despite prices, having more to do with global conditions and the lack of actual volume expansion. Consumer, producer, and commodity prices have obscured, to some substantial extent, the true underlying economic situation.”

Moreover, Goldman forecasts the S&P 500 (INDEX: SPX) to end 2022 near $4,700.00 (down from $4,000.00), ~6% higher than today’s prices.

“The S&P 500 has dropped about 24% from peak-to-trough around past recessions (based on the median),” Goldman said in one newsletter. 

“But when the U.S. economy avoids a sustained contraction after a 10% market correction, the index has returned 15% over the next 12 months.”

Positioning: Friday marks the quarterly triple witching options expiry and index rebalancing.

Through this event, ~$3.5 trillion in options are set to expire, according to Goldman, with “more near-the-money options are maturing than at any time since 2019.”

Graphic: Via Goldman Sachs Group Inc.

In terms of the index rebalance, according to Howard Silverblatt of S&P Global Inc’s (NYSE: SPGI) Dow Jones Indices, “the rebalance in the index alone could spur $33 billion of stock trades.”

This newsletter has talked about the implications of derivatives and their expirations, too, ad nauseam.

Mainly, stock moves and options activity is more correlated and this is the result of participants’ increased exposure to derivatives products (particularly those with less time to expiration).

The demand for this derivatives exposure is transmitted to underlying stocks, via the risk management of counterparties; with option volumes heightened, related hedging flows may represent an increased share of volume in underlying stocks.

As I talked about this in conversations with the Ambrus Group’s Kris Sidial and Kai Volatility’s Cem Karsan, among others, the counterparties’ response to this options trading is impactful (and often predictable).

“Moreover, heading into Wednesday’s FOMC, we saw the market well-hedged,” SpotGamma, an options modeling and analysis service explained. “Participants’ demand for protection is concentrated in options with little time to expiry (given the monthly options expiration and roll-off a significant size of S&P delta).”

“Adding, the compression of volatility [post-FOMC and into OPEX], coupled with trade higher, solicits less counterparty hedging of put protection … [and] less positive delta = less selling to hedge = less pressure.”

Graphic: Implied volatility term structure shifts inward. This solicits positive hedging (vanna) flows as counterparty exposure to positive delta declines. In other words, short stock and futures hedges (against options) are bought back.

So, at a high level, this week’s events (a ”rally [that’s] been fueled by dealers covering short positions to balance exposures while demand for stock hedges is elevated”) have bolstered positive price action. 

Graphic: Via Bloomberg.

What’s interesting, also, is the S&P 500’s response to the $4,400.00, level. At this level is a concentration of call exposure.

Graphic: Via Goldman Sachs Group Inc. SPX resistance at $4,400.00.

As noted before, the dominant customer positioning, at least at the index level, is short call and long put (i.e., finance downside insurance by selling upside to hedge equity exposure).

The counterparty, in such a case, is short downside and long upside protection; when volatility contracts and underlying prices move higher, the put side, as noted above, solicits less active hedging whilst the call side solicits more active hedging.

In other words, the counterparty has less exposure to negative gamma (from puts) and more exposure to positive gamma (from calls), meaning gains are multiplied to the upside).

Graphic: Via SqueezeMetrics. Market gamma turns positive.

Knowing that “the range of spot prices across which option deltas shift from near-zero to near-100% becomes very narrow as options approach maturity (and at maturity, options on one side of the settlement value have zero delta and the other side have 100% delta),” trading into that concentration of calls (which have increased sensitivity to direction or gamma) quickly adds to counterparty positive delta exposure.

This must be offset with counterparty negative delta in the underlying (selling futures and stock to hedge). If there are enough “contracts sitting close to the spot price this time around,” that leads to more frenetic hedging as participants “actively trade around those positions,” and pressure upside, even.

Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from ZeroHedge. “SPX / SPY currently “pinning” btwn 4400 strike ($4.1B $Gamma), 4350 ($2.5B), 4300 ($2.4B); currently see ~43% of the $Gamma dropping-off for Friday’s expiration; currently at “Zero Gamma” level, “Max Short Gamma” at 4125 and -$17B per 1% move.”

Ultimately, this post-FOMC price rise may put the market in an underhedged position. In such a case, as talked about yesterday, new demand for protection would add fuel to weakness (later). 

“I’ve never seen an environment where you’ve had so many potential overhangs in the market that can not be controlled,” said David Wagner, a portfolio manager at Aptus Capital Advisors. “We’ll see if people can see to redeploy their puts.”

SpotGamma’s Delta Tilt indicator. Current readings rival that of Dec ’18 and Mar ’20. These expirations can be correlated to sharp rallies in the S&P (red line).

Technical: As of 6:45 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,395.25 high volume area (HVNode) puts in play the $4,418.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,438.25 HVNode and $4,464.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,395.25 HVNode puts in play the $4,355.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as low as the $4,314.75 and $4,285.25 HVNodes, or lower.

Considerations: Push-and-pull, as well as responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active. 

Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

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.

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

Disclaimer

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 January 19, 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!

Subscribe

What Happened

Overnight, equity index futures explored lower and hammered out a low. On that recovery, measures of implied volatility fell, and most commodity products and yields moved higher.

Ahead is data on Building Permits and Housing Starts (8:30 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: Narratives discussed, before, remain valid. 

Mainly, expected is strong economic and earnings growth, as well as cooling inflation.

However, according to a note published by Andy Constan of Damped Spring Advisors, “The lack of additional liquidity provided by Fed purchase will also remove a damper for the market and the economy keeping asset volatility well bid, while also causing asset diversification benefit to fall, generating rising portfolio volatility and the risk demanded to hold assets.”

Graphic: From Goldman Sachs (NYSE: GS). The Market Ear recaps: “Bigger moves in yields eventually spill over to SPX. We basically had the 2 sigma move in rates…and equities are behaving as they should.”

The Ambrus Group’s Kris Sidial made a great point, yesterday, too.

Basically, despite that the market is off about 5% from its highs, the go-to 60/40 portfolio and “diversified funds” are in turmoil.

This newsletter has touched on the “bonds down, equities down” dynamic in the past. 

In short, over the past 40 or so years, monetary policy was used as a crutch to support the economy. This promoted deflation, innovation, and the subsequent rise in valuations.

With rates near zero and lifting, that’s a headwind; coupled with participants’ increased exposure to rate and equity market risk, which can play into cross-market hedging and de-leveraging cascades, 60/40 turns into somewhat of a poor hedge.

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

Putting it all together, per Constan, “If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” Constan adds. 

“These risk premium expansions will generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Morgan Stanley (NYSE: MS) strategists are in agreement.

“With our economic team’s new Fed forecast for the end of QE, 4 rate hikes, and the beginning of balance sheet normalization this year, our call for falling valuations is likely to happen faster and more broadly than our prior forecast.”

Also: “Companies have expedited supplies, they’ve hired a bunch of labor at higher prices and if there’s excess supply now in the first or second quarter, potentially temporarily that could lead to margin compressions.”

Graphic: Via comments made by Morgan Stanley’s (NYSE: MS) U.S. equity strategist Michael Wilson, “Our new Fed forecast simply brings forward our call for lower equity valuations and raises the risk in the first half of the year. The median stock remains expensive even though the most egregiously priced stocks have corrected.”

It’s looking like Ark Invest’s Catherine Wood hit the nail on the head with respect to her comments on inventory build-ups. 

Early in November, as this newsletter highlighted, the CIO said inflation was likely on its way out due to (1) productivity increases, (2) China housing and financial sector turmoil depressing commodity prices, (3) inventory build-ups, and (4) disruptive innovation.

“This is unsustainable,” she had said. “I’m wondering if even the housing market inflation is going to give way, here.”

Positioning: Despite elevated measures of implied volatility like the Cboe Volatility Index (INDEX: VIX) marking higher, the VIX term structure remains upward sloping. 

Graphic: VIX term structure via Vix Central. 

All that means is that we have yet to similar levels of destabilizing demand for protection. 

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. In buying a put, customers indirectly take liquidity as dealers, short the put, sell underlying to hedge. With higher levels of implied volatility, dealers’ exposure to direction increases. They hedge by selling more underlying.

Though conditions could worsen, taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics remain positively skewed, more so than before.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Any expansion in volatility, however, likely coincides with further weakness.

As a result, this, coupled with data that suggests “OPEX week returns peaked in 2016 and have trended lower since,” cautions us on trade into and after this week’s expiration of options on the VIX and equity products.

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 upper part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,574.25 high volume area (HVNode) puts in play the $4,593.00 point of control (POC). Initiative trade beyond the POC could reach as high as the $4,619.00 HVNode and $4,650.75 extended trading hours low (ETH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,574.25 HVNode puts in play the $4,535.50 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,520.00 and $4,492.00 regular trade low (RTH Low), 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

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.

DIX: For every buyer is a seller (usually a market maker). Using DIX — which is derived from short sales (i.e., liquidity provision on the market-making side) — we can measure buying pressure.

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.

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.

Inversion Of VIX Futures Term Structure: Longer-dated VIX expiries are less expensive; is a warning of elevated near-term risks for equity market stability.

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

Disclaimer

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 January 18, 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!

Subscribe

What Happened

Overnight, equity index futures auctioned lower alongside a surge in bond yields. Rate-sensitive sectors were weakest in pre-market trade, in comparison to the value and cyclical names. 

Earnings are now in focus. Participants shall use earnings updates to gauge how companies are performing in spite of omicron, among other challenges.

Ahead is data on the Empire Manufacturing Index (8:30 AM ET) and NAHB Home Builders Index (10:00 AM 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: Ahead of earnings releases from Goldman Sachs Group (NYSE: GS), Morgan Stanley (NYSE: MS), Bank of America (NYSE: BAC), and Netflix (NASDAQ: NFLX), as well as key rate decisions, indices sold heavy. 

The Nasdaq 100 led the decline after holiday-trade, Monday, as yields surged alongside concerns central banks would tighten monetary policy sooner than expected.

This is as higher rates have the potential to decrease the present value of future earnings, making stocks, especially those that are high growth, less attractive. 

“The rationale behind this is the trade-off,” Grit Capital put well in a recent newsletter. 

“Why would I park my money somewhere that is only yielding 1%, when I can invest in riskier assets that can raise my return?”

Graphic: Per Grit Capital, “A common proxy that a lot of people look at is the S&P500’s earnings yield (yellow) vs. the 10yr (white).”

At the same time, narratives around quantitative tightening (i.e., the reduction in the size of the Federal Reserve’s balance sheet) are growing louder.

Graphic: QT mechanics per The Macro Compass.

This is what Andy Constan of Damped Spring Advisors refers to as the QT drumbeat. 

This drumbeat is to intensify in spite of strong economic and earnings growth, as well as a moderation in inflation, Constan says. 

“The lack of additional liquidity provided by Fed purchase will also remove a damper for the market and the economy keeping asset volatility well bid, while also causing asset diversification benefit to fall, generating rising portfolio volatility and the risk demanded to hold assets.”

Note: Check out this Constan’s really interesting story, below!

Graphic: Via The Market Ear, “Temporary relief from Powell – slow reverse QE’ confirmed. Powell says Fed will stop replacing maturing bonds, but will not sell holdings: slow QT.”

“If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” Constan adds. “These risk premium expansions will generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Constan’s comments line up with that of Morgan Stanley’s which sees markets selling down 10-20% during H1 2022, as expectations call for five 25 bp hikes. History is in alignment, below.

Graphic: S&P 500 performance before and after rate hikes, via The Market Ear.

So, despite recent inflows and “light positioning,” taking all of the above comments together, the window for stocks to rally is closing.

Positioning: The coming January 19 expiration of options on the Cboe Volatility Index (INDEX: VIX) and January 21 monthly equity options expiration (OPEX) has major implications.

According to Constan, the “[o]ptions expiration which includes lots of LEAP contracts will be a catalyst for a squeeze rally and a post-OpEx sell-off.”

This is as, according to Kai Volatility’s Cem Karsan, there is a constant structural positioning that naturally drives markets higher.

“I use this analogy of a jet,” he explained, referencing the three factors – the change in the underlying price (gamma), implied volatility (vanna), and time (charm) – that are well known to impact an options exposure to directional risk or delta. 

“[T]he hedging vanna and charm flows, and whatnot will push the markets higher.”

To note, though, with narratives around higher rates and QT strengthening, so to speak, divergences between the S&P 500 and metrics like the Bond Closed-End Fund (CEF) Advance-Decline line have already appeared.

As McClellan Financial Publications explains, “liquidity has suddenly become a problem, and it is affecting the more liquidity-sensitive issues first. That can be a prelude to that same illiquidity coming around and biting the big cap stocks that drive the major averages.”

Graphic: Bond CEF A-D showing liquidity problems, via McClellan Financial Publications.

As an aside, some believe that the Fed’s removal of liquidity has the potential to prick the bubble, prompting a cascading reaction that exacerbates underlying price movements.

“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,” Karsan adds. 

“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.”

Technical: As of 6:30 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, 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 higher; activity above the $4,593.00 point of control (POC) puts in play the $4,624.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,633.00 POC and $4,650.75 regular trade low (RTH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,593.00 POC puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,549.00 VPOC and $4,520.00 RTH Low, or lower.

Considerations: The S&P 500 remains above its 200-day simple moving average. The long-term trend remains up.

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.

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.

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

Disclaimer

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.