Categories
Commentary

Daily Brief For November 28, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

Graphic updated 6:50 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 this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

Hope you had a great holiday with your closest!

Fundamental

Minutes from a Federal Open Market Committee (FOMC) meeting dropped last week.

As strategist Rishi Mishra summarized well, “the focus shift[ed] to the terminal rate from the pace of tightening; although the terminal rate would be higher than previously expected, the pace at which we get there will be slower because they want to take lags into account.”

Graphic: Retrieved from Rishi Mishra.

At its core, the economy has not slowed as much as the Fed was expecting, said Ellen Meade, a former Fed Board economist; “[t]hey can’t stop the rate increases until they see some measured evidence that the economy is slowing.”

So, with inflation “still at its highest since the 1980s,” according to Fabian Wintersberger, all the while financial conditions have loosened on easing inflation pressures, markets have yet to face their “most significant problems, [and] … keeping interest rates around 5% will not be a Fed pivot” (which is likely to happen near the middle of 2023, per the consensus analysis).

In short, the Fed must further raise rates and unwind liquidity injections.

To bring the “balance sheet back to [2020 levels], [the Fed] needs to reduce it by 41%.” The balance sheet has only been reduced by 1.5%. Should liquidity keep shrinking, that pulls investors out of risk.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

Positioning

From a volatility perspective, it’s not a terrible time to hedge

An example demonstrates the point, well. As lightly discussed in last week’s letters, in mid-June, a trading partner and I noticed a change in tone in the non-linearity of volatility and skew with respect to linear changes in the price of the market or S&P 500 (INDEX: SPX).

The cost of certain spread structures (e.g., long/short one option near- or at-the-money and short/long two or more further out-of-the-money options) changed by hundreds of percent for only a few basis points of change in the underlying’s price.

Here’s more detail:

The market rose (boosted by a “vol crunch” and “systemic exposure reallocation,” per Nomura Holdings Inc’s [NYSE: NMR] Charlie McElligott) and, though top-line measures of IVOL have declined (e.g., INDEX: VIX), volatility skew is performing well.

Graphic: Retrieved from TradingView. Top, S&P 500 (INDEX: SPX). Middle Nations SkewDex (INDEX: SDEX). Bottom Cboe Volatility Index (INDEX: VIX). According to one paper from Nations Indexes, “SkewDex tells market participants how expensive out-of-the-money options are in relation to at-the-money options and thus, how risk-averse investors are.”

As Kai Volatility’s Cem Karsan once explained, this suggests “a potentially critical change in dealer positioning [and] the distribution of underlying outcomes”.

IVOL is at a lower bound and the bullish impacts yielded by its compressing have, largely, played out.

There is more to be gained by movement higher in IVOL. By owning protection, particularly that which is farther from current prices, you are positioned to monetize on non-linear repricings of volatility (as we saw earlier this year and may still see).

Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR).

Technical

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

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,024.00, $4,051.00, and $4,069.25. 

Key levels to the downside include $3,985.00, $3,965.25, and $3,923.00.

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

Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For November 16, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

Graphic updated 7:15 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 this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

There will be no Daily Brief published on Thursday, November 17, 2022.

Positioning

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to enter into such trades including protective collars (i.e., sell call, buy put), as stated in yesterday’s letter and explicitly discussed by the likes of Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

To quote McElligott: The “legacy ‘short skew’ trade that’s been the key US equities vol theme of 2022 is now at risk of its own ‘regime change’ reversal, too. This is, then, especially interesting when considering that ongoing VIX call [or] call spread buying … generally some pretty ‘tail-y’ stuff that is beginning to get loaded into.”

Graphic: Retrieved from The Ambrus Group’s Kris Sidial. This is “gutter low vol.”

Entering trades that change non-linearly with respect to changes in implied volatility (IVOL) and direction (Delta) exposes participants to convexity (Gamma).

A simple way to think about this is if the market was to shock lower by one, all else equal, the derivative’s value would change in excess of that. On the other hand, if one was short static (not dynamic) Delta, meaning they profit from that movement lower, profits realized would be one for one with the change in the underlying.

Graphic: Retrieved from Banco Santander SA (NYSE: SAN).

So, given the flat skew we mentioned earlier, it is attractive in price to hedge against the downside. Whether that downside materializes, is another story.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS). Equity skew is so depressed in the US that one could buy a multiple of the calls they sold in the S&P 500, elsewhere.

Food For Thought:

This is amidst the responsiveness near key technical areas provided in past letters. It suggests traders with short time horizons are very active and anchoring to key areas, such as $4,000.00 in the S&P 500. These same participants will often lack the wherewithal to defend retests, and big participants (some of whom move by committee) seldom respond to those technical inflections. 

Graphic: Retrieved from SpotGamma.

According to SpotGamma, a provider of data and written analyses on the options market, data shows the “$4,000.00 strike continu[ing] to dominate both in terms of position sizing” with calls, at that level most likely “being sold, which has helped maintain $4,000.00 resistance.”

The sale of IVOL leaves counterparties with long (+Delta) exposure to be hedged through sales (-Delta) of the underlying. As the market trades higher, these options, which are very close to current market prices, have a lot of Gamma, meaning they are very sensitive to changes in the price of the underlying (or convex and non-linear to direction). That means these options can go from having little value to a lot of value, quickly.

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

If the market is below $4,000.00 and trading higher, while at $4,000.00 there is a lot of this trade going on, then the counterparty will sell the underlying to offset gains in their options while the reverse happens if the market is trading down, as SpotGamma data showed, yesterday. When the market traded lower, positive Delta was firing off, which is supportive, hence the mean-reversion back to $4,000.00 into the close.

Graphic: SPY HIRO. Retrieved from SpotGamma’s Twitter. Posted 11/15/2022 at 1:42 PM ET.

A quick check of how sticky these areas may be, look at the level of positive Gamma.

As traders bet against the market movement, counterparties take on more exposure to positive Gamma. In hedging this positive Gamma, the counterparty does more to reduce market movement.

Couple this mean-reversion-type activity with the structural Delta buyback linked to the passage of time (Charm) and compression of volatility (Vanna), these conditions do more to bolster continued relief, as put forth by Goldman Sachs Group Inc.

Another consequence, as picked up by individuals online including Darrin John, the S&P 500’s realized volatility (RVOL) “is so high” with “a basket of 500 of the ‘best’ stocks in the US [wildly] swing[ing] +5% in a single day,” while the S&P 500 is relatively mute, as your letter writer sees it.

In general, something has to give. If there are forces that are pinning the S&P 500, all the while there are arbitrage constraints connecting the components and all, then correlation must break and dispersion must increase. In short, this is a trader’s market; data shows managers tend to “outperform the worst by more during periods of lower correlation,” as does “higher dispersion.”

Should traders continue to hone in on key areas, and add to the interest and volume near those areas, then the market is likely prone to more of the same. Expect pinning and sideways to up. If there were to be a decrease in positive Gamma exposures, that likely opens the door to more movement. Likewise, if traders’ bets are concentrated elsewhere (higher or lower), that can open the door to relief. A catalyst for that may be something fundamental.

The Key Takeaway:

Recent happenings mimic that of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).” 

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

Simple trades to protect (or capitalize on this) include collars, as stated earlier, as well as calendars. If you expect RVOL on the index level, at least, to be mute, then sell short-dated exposure and use those proceeds to purchase farther-dated exposure (e.g., sell weekly put to buy monthly put).

Why? 

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma). When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga). If there’s a large change in direction (RVOL) or IVOL repricing, you may make money. 

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of IVOL to levels where there would be more stored energy to catalyze a rally,” as we saw after elections and CPI … 

Graphic: Commentary published by Kai Volatility.

… alongside the Dollar’s (INDEX: DXY) weakness which is easing the burden on margins and global funding.

Per Morgan Stanley (NYSE: MS), “simple math on S&P 500 earnings from currency is that for every percentage point increase on a YoY basis, it’s [] a 0.5 hit to EPS growth.”

Graphic: Retrieved from Bloomberg.

Technical

As of 7:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,027.00, $4,069.25, and $4,136.75. 

Key levels to the downside include $3,965.25, $3,913.00, and $3,871.25.

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

Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

Volume Areas: 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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For September 22, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 950+ that read this report daily, below!

Graphic updated 8:00 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. 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.

Administrative

An easy read, today. For more complex, see the September 20 and 19 letters. Also, there will not be a letter published for Friday, September 23, 2022. See you next week, team!

Fundamental

Equity markets traded down, yesterday, on the heels of the Federal Reserve’s (Fed) decision to raise interest rates by 0.75% and “keep at it” for longer, eyeing a 1.25% jump, in sum, by 2023.

This puts the current target rate at 3.00-3.25%.

Separately, if the “keep at it” quote sounds familiar, that’s because it is. The Fed Paul Volcker’s memoir is titled “Keeping at It.”

Graphic: CME Group Inc’s (NASDAQ: CME) FedWatch Tool shows higher odds of a 75 to 100 basis point rate hike in November, along the lines of what the futures market was pricing heading into the event.

The Fed Chair Jerome Powell admitted there may be below-trend growth and the potential for unemployment to reach 4.4% next year, up from the current rate of 3.7%. Projected increases, as of yesterday, show interest rates at 4.4% by 2023, and 4.6% in 2023, before moderation in 2024 to 3.9%, as well summarized by Bloomberg.

Graphic: Retrieved from Bloomberg.

Moreover, economists suggest that raising rates to 4.5% would cost the economy nearly 1.7 million jobs while rates at 5% would bring that number to 2 million. A higher savings rate and increased funds at the state level would likely cushion the blow, however.

In response, the likes of Ark Invest’s Cathie Wood, who we quoted recently regarding her thoughts on why the Fed needs to lower the pace of tightening and/or cut, said:

“Most disappointing about the Fed’s decision today was its unanimity. None of those voting on the Federal Reserve is focused on the significant price deflation in the pipeline. The Fed seems to be making decisions based on lagging indicators and analogies.”

She adds that the Fed is setting the stage for deflation:

“The Fed is solving supply chain issues by crushing demand and, in my view, unleashing deflation, setting it up for a major pivot.”

Graphic: Initially retrieved from Bloomberg. Taken from Ophir Gottlieb who concludes costs are dropping, as observed via shipping, gasoline, manufacturing, cars, and rent measures.

Moreover, it’s the case that “[a]s rates rise and debt servicing costs increase, ‘many zombie institutions, zombie households, corporates, banks, shadow banks, and zombie countries are going to die,’” said economist Nouriel Roubini, who predicted the 2008 financial crisis. 

Prior to the Fed event, Roubini forecasted a 75 basis point hike in September, followed by a 50 basis point hike in November. The market is pricing more than what Roubini thought the Fed would probably do after Wednesday’s Fed meeting.

In his opinion, stay “light on equities and have more cash, … [as] equities and other assets can fall by 10%, 20%, 30%.”

Positioning

In short, unexpected was the post-event response. In recent times, post-Fed moves have been positive, driven by the “rebalancing of dealer inventory,” per Kai Volatility’s Cem Karsan.

That didn’t happen and let’s unpack why.

Basically, into the event, traders demanded protection and bid implied volatility (IVOL). The assumption is that counterparties, who are likely on the other end, have exposure to positive Delta and negative Gamma, which they hedge through negative Delta trades in the underlying.

Should fears have been assuaged, the supply of that protection once demanded, would have decreased IVOL (and options Delta), providing the markets a boost.

Graphic: Retrieved from SqueezeMetrics.

That didn’t happen. Instead, traders added protection, as shown by this SpotGamma graphic tracking changes in put open interest on the S&P 500 (INDEX: SPX).

Graphic: Retrieved from SpotGamma. Updated September 22, 2022.

This bid some basic measures of IVOL into the close.

Graphic: Retrieved from VIX Central. Updated September 21, 2022.

That’s as these particular options, which were added at much lower prices, as I explained in a SpotGamma note, recently, “are far more sensitive to changes in direction and IVOL.”

These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly. “If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”

Graphic: Retrieved from SqueezeMetrics.

Notwithstanding, it’s still the case that a “reload on fresh short-dated downside” flows heighten the risk of a “negative Delta squeeze … into month end,” said Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

Therefore, “you have to consider a move up [to] $4,000.00 as part of your distribution of outcomes to the upside,” as that is near where “market makers are ‘long,’” as part of an impactful collar trade many are aware sits.

As an aside, some online conversation was sparked around placing cash into riskless trades for some small, but guaranteed, rates of return. In that conversation, Box Spreads were put forth as a solution to lend cash and earn a competitive interest rate.

For context, “Boxes allow market participants to create a loan structure similar to a Treasury bill. T-bills are ‘discount’ instruments that are purchased at a value less than the stated face value. Upon maturity, bills call for the return of the stated face value.”

“For example, one might buy a $1 million 90-day T-bill for $998,000. Ninety days later, the $1 million face or principal value is returned and the $2,000 discount is earned as interest. One may represent the rate on this transaction as a 0.80% or 80 basis point discount yield [= (360/90) x ($2,000/$1,000,000)]. The effective rate on a box represents a ‘discount yield’ similar to a quoted T-bill rate.”

Graphic: Retrieved from boxtrades.com.

IPS Strategic Capital’s Pat Hennessy explains that SPX boxes “typically yield[] 20-40 bps above [the] corresponding maturity risk-free rate.” Additionally, there are tax advantages to using the S&P 500’s 1256 contracts. 

For easier fills, use the “3K/4K line in an AM settled expiry,” Hennessy noted. “Helps if you know where the broker market is.”

Technical

As of 8:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher.

Any activity above the $3,826.25 HVNode puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as high as the $3,893.00 VPOC and $3,936.25 ONH, or higher.

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

Any activity below the $3,826.25 HVNode puts into play the $3,770.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,722.50 LVNode and $3,688.75 HVNode, or lower.

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

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.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For September 13, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!

Graphic updated 7:45 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Fundamental

Today, traders get inflation updates. These will help drive perceptions regarding monetary policy.

Expected is an 8.1% rise year-over-year (YoY) and 0.1% fall month-over-month (MoM). In July, these numbers were 8.5% and 0.0%, respectively.

Core CPI (which excludes food and energy) is expected to rise by a rate higher than in July, 6.1% YoY and 0.3% MoM, respectively.

Mattering most is core inflation, which the Fed has more control over. If lower than expected, that may warrant some appetite for risk.

Graphic: Retrieved from Bloomberg.

Notwithstanding, prior to July’s release, the average movement in the S&P 500, after CPI, was -1.27%. Still, though, the expectation is that August data will show improvement.

“The market has concluded that both the ECB and even the Fed, despite their protestations otherwise, are both being viewed as data-dependent,” Peter Tchir of Academy Securities said. 

“I cannot see any scenario where the market doesn’t decide that CPI is heading the right direction and … [this] should allow markets to continue to enjoy the strength.”

Graphic: Retrieved from Bloomberg. “Stronger evidence that a wage-price spiral can indeed be avoided came from Monday’s publication of the New York Fed’s latest Survey of Consumer Expectations.”

At this point, in spite of the prospects of inflation continuing to cool, expectations regarding Fed (Federal Reserve) action remain sticky with the fed funds futures pricing a peak in rates of 4%.

Graphic: Retrieved from Bloomberg.

Unchanged, all else equal, this means markets have accounted for the rise in interest rates and their impact on valuations. From hereon, further de-rating is not out of the question, particularly if inflation continues to rise and/or growth fears materialize, as some like Fitch Ratings believe.

Graphic: Retrieved from The Market Ear. Via Morgan Stanley (NYSE: MS). “MS Research thinks the lows for this bear market will likely arrive in the fourth quarter with 3,400 the minimum downside and 3,000 the low if a recession arrives.”

According to Fitch, a decline in corporate profits is likely to speed up in the coming quarters, and this will highlight economic slowing (below-trend GDP growth) that leads to a 2023 recession.

Graphic: Retrieved from Bloomberg, via Bank of America Corporation (NYSE: BAC). “Bank of America … remains ‘fundamentally and patiently bearish.’”

To quote CFO Dive, “Downward revisions to consensus expectations for earnings next year ‘will likely accelerate as monetary tightening continues to reduce inflation and growth slows.’”

Thus far, the economy has shrunk 0.6% in the second quarter, after slumping 1.6% in the first, which is “the common definition of a recession” despite the continued growth of the economy as shown by other metrics like “nonfarm employment, consumer spending, industrial production, and weekly hours worked.”

Positioning

As of 7:45 AM ET, Tuesday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.24%. Net gamma exposures increasing may promote some market stability.

It’s the case that there is this trend in demand for equity downside put options protection. This is evidenced by figures of open interest, volume, as well as bid implied volatility (IVOL) metrics like the Cboe Volatility Index (INDEX: VIX).

Graphic: Retrieved from Bloomberg.

“They’re buying protection against a crash at a pace unlike anything the market has ever seen,” said Jason Goepfert, chief research officer at Sundial. This is as Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott says more traders are taking shots amid “hawkish global central bank escalations,” and tightening measures of liquidity, among other things.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

Goepfert adds that the “massive hedging activity” feels “unsettling.” That has to do with what the reaction to that protection entails should markets drop lower and IVOL increase, accordingly.

Graphic: Retrieved from SqueezeMetrics. Learn the implications of volatility, direction, and moneyness.

Notwithstanding, should nothing bad happen, the activity, which is structured in soon-to-expire options, will quickly fall out of favor (as will the probability of those options paying out). Liquidity providers, on the other side of those trades, will reduce their negative Delta (short futures and stock) hedges which may further add support to markets.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).

The concern is that soon after this big options expiration passes, new fear and demand for protection may feed into another bout of weakness as traders rush to re-protect and liquidity providers add pressure in their hedging, accordingly.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).

Technical

As of 7:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher.

Any activity above the $4,127.00 VPOC puts into play the $4,189.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,231.00 VPOC and $4,253.25 HVNode, or higher.

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

Any activity below the $4,127.00 VPOC puts into play the $4,071.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,018.75 HVNode and $3,991.00 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.

About

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

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

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

Disclaimer

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

Categories
Results

Case Study: How A Bearish S&P 500 Trade Turned Into A Multibagger

Heading into the 2022 equity market decline, institutions repositioned and hedged their downside, even allocating to commodities, which worked well for the first couple of quarters.

Due in part to this, the 2022 equity market decline was like no other experienced during 2021.

Instead, the monetization and counterparty hedging of existing customer options hedges, as well as the sale of short-dated options, particularly in some of the single names where implied volatility (IVOL) was rich, lent to lackluster performance in IVOL.

Eventually, entities were squeezed out of trades not working.

That means participants rotated out of options and commodities, all the while a macro-type re-leveraging ensued on improvements in inflation data, an earnings season that was better than expected, and “crazy tax receipts,” among other things.

The most recent advance climaxed the week of the August monthly options expiration (OPEX).

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE).

Why? Well, heading into that particular week, markets were rising at a fast rate, and call options (i.e., bets on the market upside) were highly demanded.

Graphic: Updated 8/15/2022. Retrieved from SqueezeMetrics.

Those, on the other side of those call option trades (i.e., counterparties), hedged in a manner that was supportive (i.e., counterparties sell calls to customers and buy underlying to hedge exposure).

Eventually, traders’ activity in soon-to-expire options became concentrated at certain strikes – particularly $4,300.00 in the S&P 500 – while IVOL trended lower. The counterparty’s response, then, did more to support prices and reduce movement.

This is because, with the passage of time and declining volatility, options Gamma (i.e., the sensitivity of an option to direction) became more positive and the range of spot prices, across which Delta (i.e., options exposure to direction) shifts rapidly, became a lot smaller.

When options Gamma exposure is more positive, market movements may have a positive impact on the counterparty’s position (i.e., movement is beneficial). If movement is beneficial, and the counterparty is not interested in realizing that benefit, they may hedge in a manner that can stifle market movement.

This is, in part, what happened, in the late stages of the rally. That said, however, soon after the S&P 500 hit $4,300.00, the near-vertical price rise began to sputter and follow-on support, both from a fundamental (e.g., liquidity) and volatility perspective was soon set to worsen.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

Why? There was an OPEX that would trigger “a big shift in market positioning,” Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott explained.

In short, participants’ failure to roll forward their expiring bets on market upside coincided with a message that the Fed would stay tough on inflation. So, it’s the case that after the OPEX, those same bets that were prompting counterparties to stem volatility and bolster equity upside were not rolled forward.

Instead, these bets expired and this is visualized by the drop in Gamma exposures, post-OPEX.

Graphic: Created by Physik Invest. Data by SqueezeMetrics.

Accordingly, this expiration, combined with technical and fundamental contexts that were prompting funds to “reload[] on short sales,” shocked the market into a higher volatility, negative Gamma environment. In this environment, put options, through which the vast majority of participants speculate on lower prices and protect their downside, solicited far more pressure from counterparties.

Adding, if markets were to continue trading lower, traders were likely to continue rotating into those put options that would bolster this pressure from counterparties.

This happened as shown, below.

Graphic: Retrieved from SpotGamma. “There was a huge surge in large trader put buying in the equities space last week as per the OCC data.”

This demand for put options protection was reflected by a bid in IVOL. To hedge against this demand for protection and rising IVOL, counterparties sold underlying, compounding bearish fundamental flows.

Graphic: Retrieved from SqueezeMetrics. Learn the implications of volatility, direction, and moneyness.

In late August, data suggested September would have “a very large options position as it is a quarterly OPEX,” SpotGamma said. With that position being “put heavy,” a slide lower, and an increase in IVOL, was likely to drive continued counterparty “shorting” with little “relief until Jackson Hole.”

In expecting markets to trade lower and more volatile, Physik Invest sought to initiate new trades.

At the time, in mid-August, call option premiums were attractive, in part due to interest rates, all the while IVOL metrics seemingly hit a lower bound.

This was observable via a quick check of skew, a plot of the IVOL levels for options across different strike prices. Usually, skew, on the S&P 500, shows a smirk, not a smile.

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE). Updated August 17, 2022. Skew steepened into $3,700.00 and below $3,500.00 in the S&P 500.

This meant it was likely that short-dated, wide Put Ratio Spreads had little to lose in a sideways-to-higher market environment. Additionally, call Vertical Spreads above the market were relatively more expensive.

Given the above context, the following analysis unpacks how Physik Invest traded options tied to the S&P 500 leading up to and through the August 19 OPEX, into the Jackson Hole Economic Symposium.

Note: Click here to view all transactions for all accounts involved.

Sequence 1: After a skew smile was observed, through August 12, 2022, the following positions were initiated, while the S&P 500 was still trending higher, for a net $7,616.68 credit.

Positions were structured in a way that would potentially net higher credits had the index moved lower.

  • SOLD 10 1/2 BACKRATIO SPX 100 (Weeklys) 26 AUG 22 3700/3500 PUT @ ~$0.13 Credit
  • SOLD 3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL @ ~$25.10 Credit

Sequence 2: While the S&P 500 was trading near $4,300.00 resistance, by 8/19/2022, all aforementioned Ratio Put Spread positions were rolled forward for a $452.26 credit.

The resulting position was as follows:

  • -17 1/2 BACKRATIO SPX 100 (Weeklys) 16 SEP 22 3700/3500 PUT
  • -3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL

From thereon the market declined and, by 9/1/2022, all positions were exited for a $6,963.84 credit.

  • BOT 17 1/2 BACKRATIO SPX 100 (Weeklys) 16 SEP 22 3700/3500 PUT @ ~$4.94 Credit
  • BOT 3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL @ ~$4.57 Debit

Summary: In total, the sequence of trades net a $15,032.78 profit after commissions and fees.

The max loss (minus unforeseen events) sat at ~$6,790.00 if the S&P 500 closed above $4,350.00 in OCT. Because the Ratio Put Spreads were initiated at no cost, any loss, if the market went higher, would have been the result of the trade’s Vertical Spread component. Overall, this trade netted in excess of a 200% return; the trade’s profit was more than two times the initial debit risk, a multi-bagger.

Reflection: Heading into the trade, it was the case that IVOL performed poorly during much of the 2022 decline. This was likely to remain the case on a subsequent drop, hence the wide and short-dated Ratio Put Spread.

Still, in spite of the Ratio Put Spread exposing the position to negative Delta and positive Gamma (i.e., the trade makes money if the market moves lower, all else equal), if implied skew became more convex (i.e., implied volatilities grow more rapidly as strike prices decrease), the position could have been a large loss.

So, if the flatter part of the skew curve (where the position was structured) became more convex, which is not something that was anticipated would happen, then the only recourse would have been to (1) close the position or (2) sell (i.e., add static negative Delta in) futures and correlated ETFs.

In the second case, then, the trade would have been allowed time to work and turn into a potential winner, particularly amidst the passage of time.

Additionally, in accordance with Physik Invest’s risk protocol, more units of the Short Put Ratio Spread could have been initiated on the transition into Sequence 2. These units could have been held through Labor Day, then, and monetized for up to an additional ~$4.00 credit per unit.

Though additional units of the Vertical Spreads could not have been added, due to the strict limits to debit risks, there were still months left to that particular component of the trade. With lower prices expected, there was little reason the Verticals should have been removed fast.

Going forward, should the context from a fundamental and volatility perspective remain the same, only on a rally could Physik Invest potentially re-enter a similar position.

Categories
Commentary

Daily Brief For April 1, 2022

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

What Happened

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

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

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

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

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

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

Later is Markit manufacturing PMI (9:45 AM ET), as well as ISM manufacturing index and consumer spending data (10:00 AM ET).

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

What To Expect

Fundamental: The S&P 500 bagged its first quarterly loss in two years as recession probabilities, implied by some yield curves, have risen.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via Bloomberg.

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,546.00 spike base puts in play the $4,573.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,583.00 untested point of control (VPOC) and $4,611.75 low volume area (LVNode), or higher.

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

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

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

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

What People Are Saying

Definitions

Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test. 

If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For February 23, 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!

What Happened

Overnight, equity index futures traded sideways to higher after Monday’s post-options expiration (OPEX) probe lower. Ahead, there are no data releases scheduled.

Graphic updated 6:15 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: At what point are monetary tightening and geopolitical tensions priced in? 

According to some strategists, such as JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic, the sell-off is overdone and, if anything, Ukraine tensions “would likely prompt a dovish reassessment.” 

“Short-term rates markets have likely moved too far vs. what CBs will ultimately deliver in hikes this year,” he adds. “We expect risky asset markets to rebound as they digest these risks and sentiment improves, aided by inflows from systematic investors and corporate buybacks.” 

In the worst case, though, pursuant to notes by peers in the industry, Kolanovic nods to the fact that if selling were to continue, there would likely be a point the would Fed reassess tightening.

Basically, in the worst case, there is the potential that further selling invokes the so-called “Fed put,” which is about 15% below current prices. 

“[R]isk is being repriced to fit the world where real rates are a lot higher, and the Fed put (is) much lower thanks to the Fed’s need to fight inflation,” says rates strategist Rishi Mishra. 

Graphic: Via Bank of America Corporation (NYSE: BAC). Retrieved from Callum Thomas.

Positioning: Markets stabilize after last week’s large monthly options expiration (OPEX). 

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from Bloomberg.

Per Bloomberg, that event saw the roll-off of nearly $2.2 trillion in options. In the past, this event had bullish implications (i.e., markets rose into OPEX). That is not the case, really, any longer.

It is participants’ increased awareness of the implications of options and OPEX has resulted in a front running; according to SqueezeMetrics, “People didn’t know about the OpEx week effect (in this case, largely charm). Now everyone and their mother knows about it.”

For context, charm is a measure of an options delta’s change with respect to the passage of time. As time passes, delta “bleeds” as options decay. 

As most participants, at least at the index level, own protection, the counterparties to this trade are short protection. These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

Moreover, given the growth of options volumes, participants’ heavy demand for protection matters more, to put simply. Counterparties, in light of this recent drop, pressured markets with their hedging. The decay (and eventual expiry) of this protection marks options deltas down.

Graphic: Rising put volumes coincide with early 2022 market sell-off.

To re-hedge, counterparties buy back short stock and futures hedges. This supportive action is what has been front-run; the bullishness of the event happens days and weeks prior. 

The unwind of these hedges now, as seen Friday-Tuesday, often culminates in a post-OPEX low. That “means chase-y accelerant flows from dealer hedging into moves and creating overshoots in both directions,” Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott wrote.

Taken together, according to SpotGamma, though “post-OPEX, the removal of linear short (-delta) hedges [to put-heavy exposures] may further bolster attempts higher, … [t]he removal of downside (put) protection may also open the door for weakness in a case where some outside (fundamental) event solicits real-money selling and a new demand for protection.”

Graphic: Via EPFR, Barclays, and Bloomberg. Taken from The Market Ear.

“The market looks fairly well hedged and it’s why up until today we’ve had little follow-through on the downside despite negative headlines,” Danny Kirsch, head of options at Piper Sandler Companies (NYSE: PIPR), said in an interview.

“We’ll see if things open up after the February expiry.”

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 its 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 $4,332.75 high volume area (HVNode) puts in play the $4,415.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,438.00 key response area and $4,464.00 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,332.75 HVNode puts in play the $4,249.00 LVNode. Initiative trade beyond the LVNode could reach as low as the $4,212.50 regular trade low (RTH Low) and $4,177.25 HVNode, or lower.

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

What People Are Saying

Definitions

Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test. 

If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

Liquidation Breaks: The profile shape suggests participants were “too” long and had poor 

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.

Options: If an option buyer was short (long) stock, he or she would buy a call (put) to hedge upside (downside) exposure. Option buyers can also use options as an efficient way to gain directional exposure.

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

Market Commentary For 2/8/2021

Notice: To view this week’s big picture outlook, click here.

What Happened: U.S. stock index futures established record all-time highs overnight, alongside hopes of a speedy economic recovery, as a result of pandemic relief efforts.

What Does It Mean: After a quick de-risking event and v-pattern recovery, U.S. stock indexes are positioned for further upside, as high as the 100% price projection, which happens to be above $4,000.00, a primary target in the S&P 500. According to The Market Ear, similar risk rallies have happened after hedge fund de-grossing events; now, “Equities are rising along higher yields, dollar and [volatility], and the magic word here is discounting inflation.”

Important to note also is the persistent presence of bearish undercurrents, as evidenced by non-participatory speculative flows and delta, as well as a divergence in the DIX.

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

More On Volume Delta: Buying and selling power as calculated by the difference in volume traded at the bid and offer.

More On 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.

More On Speculative Flows: Participants looking to capitalize on either upside or downside through the purchase and sale of options, the right to buy or sell an asset at a later date and agreed upon price.

What To Expect: Monday’s regular session (9:30 AM – 4:00 PM ET) will likely open on a gap, outside of prior-balance and -range, which — in normal circumstances — suggests the potential for immediate directional opportunity. However, market participants must not discount how far the discovery process has come.

Over 11 sessions (overnight and regular-trade), participants traversed nearly 7%, a non-typical weekly trading range. Adding, the S&P 500 took out its $3,900.00 price extension (i.e., a typical recovery price target) overnight, before leaving minimal excess at the high (i.e., a proper end to price discovery).

Now, in light of the low historical probability associated with overnight rally-highs ending the upside discovery process, the odds favor (1) backfilling or (2) balance before a participants restart the upside discovery process.

So, in the best case, the S&P 500 does some backfilling to repair poor structures left in the wake of strong initiative buying. In such a case, participants would look for responsive buying to surface at or above the $3,840.00 high-volume area (HVNode). In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below the $3,840.00 HVNode, would favor continuation as low as the $3,794.75 and $3,727.75 HVNodes.

More On Volume Areas: A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). 

If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of high-volume for favorable entry or exit.

Today’s go/no-go level is the $3,880.00 HVNode. Below, would portend downside discovery and structural repair. At or above denotes balance, a sign that the market is awaiting new information to make its next move.

Levels Of Interest: $3,880.00 HVNode.

Bonus: It’s very tough to read the market at this juncture.

Buying has run out (as evidenced by the aforementioned bearish undercurrents) and it’s as if market risks are not being priced in correctly, an opinion shared by Nomura’s Charlie McElligott.

According to McElligott, crash and tail risk is holding back dealers from supplying volatility amid “a near-endless need for skew/forward vol/convexity from hedgers.” In an environment in which true fundamental buying is absent, flows as a result of activity in the derivatives market become increasingly impactful.

Adding, as the Heisenberg Report states, “markets are increasingly susceptible to the self-referential, flows-volatility-liquidity feedback loop (colloquially: the ‘doom loop’) and other manifestations of VaR shocks. Long periods of apparent calm hide an underlying fragility in true ‘stability breeds instability’ fashion.”

As a result of this new regime, as stated in the “What To Expect” section above, dealers have a difficult time taking the other side. Due to this, market participants see a persistent bid in volatility, a factor preventing many systematic and hedge fund strategies from going “all-in” on the long-side.