Categories
Commentary

Daily Brief For June 27, 2022

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

What Happened

Overnight, equity index and commodity futures were higher while bonds were lower. Volatility measures were bid, too.

In the news is Russia’s default on foreign debts. Quarterly repositioning may bolster attempts higher, per JPMorgan Chase & Co (NYSE: JPM), while Morgan Stanley (NYSE: MS) strategists see the potential for lower with base cases calling for a soft economic landing.

Ahead is data on goods orders (8:30 AM ET) and pending home sales (10:00 AM ET).

Graphic updated 6:30 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: Very short, today.

Later this week, I’m excited to share some insights I gleaned from a veteran trader and macro strategist. As a preview, this person thinks that we are in a recession. However, a recovery in equity markets is not off the table with 2022 likely being a 1% total GPD year with 4% inflation.

Stay tuned for that.

Positioning: We’ve been speaking on the demand for protection and the still-strong supply of it lending to tameness in Wall Street’s preferred “fear gauge,” relative to those gauges tracking markets like rates and commodities.

Graphic: Via Bloomberg.

“The current behavior is playing out similar to the 2000-2002 dot-com bear market, with no big sudden shocks but sustained high realized volatility,” explained Talal Dehbi of PrismFP.

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

Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

Anyways, noteworthy is the sale of short-dated volatility, and this has played into generally poor performance in skew. In light of that, it makes sense to lean toward owning volatility, rather than selling it.

Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), was very depressed, too, in comparison to the VIX, itself.

The note to point out, here, is – and this is in accordance with some very recent notes – that a “higher starting point” in IVOL, and a still-present right-tail, makes it so we may position, for less cost, in shorter-dated spread structures with attractive and asymmetric payouts.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). Multi-expiry skew in the Invesco QQQ Trust Series 1 (NASDAQ: QQQ). Notice the v-shape in the shorter maturity and smirk in the longer maturity. Here’s what that means.

Heading into the end of the quarter is the expected rollover of large options positions. These are hedges to customer long-equity exposure, which the liquidity providers are short. A front-running of this repositioning flow is (and is expected), in part, to add to the equity market upside.

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.”

Per SpotGamma, after expiration, “it is more likely the [bearish] tone [all else equal] remains unchanged at least from a positioning perspective,” albeit many metrics appear a tad stretched.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from Callum Thomas’ Weekly S&P 500 ChartStorm.

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 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 $3,943.25 HVNode puts in play the $3,982.75 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,016.25 HVNode and $4,055.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,909.25 MCPOC. Initiative trade beyond the $3,909.25 MCPOC could reach as low as the  $3,889.00 VPOC and $3,821.50 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.

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

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

Definitions

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

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

Also, MCPOCs 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 June 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!

What Happened

Update: Technicals section now reflects the proper overnight inventory stat.

After a week-long or so de-rate to reflect the impact of higher inflation and harsher monetary policies, equity index futures are trading in a responsive fashion. 

The S&P 500, in particular, lies pinned against the $3,700.00 high options open interest strike. The large June monthly options expiration has implications on the expansion of the range, as noted in prior letters.

The newsflow remains depressing. Taken alone, you’d think the Federal Reserve (Fed) would be “soft[ly] landing” us into a depression, just in time for WWIII to help us get out of it. 

Kidding. The utmost sympathy for those negatively affected by war and economic hardship.

The distinction between the economy and the market is blurred and the drop is the recession. The equity markets are a mechanism pricing the implications of all the points we talk about, in real-time, months (6-12) in advance.

Given that, there are better measures to assess whether a de-rate has played out, fully. In the last session, information, generated by the market – internals, volatility measures, and the like – suggested to us that more selling was in store, all the while there was a definite change in tone in the non-linear strength of volatility and skew with respect to linear changes in price of assets.

Should you care for the narratives in news, then here it is:

The Bank of England (BOE) pointed to the potential for a more aggressive rate hike schedule if data were to reflect a wage spiral. The Swiss National Bank (SNB) upped rates an unexpected 50 basis points. The White House weighed fuel-export limits. Both residential permitting and housing starts plummeted with the 30-year fixed-rate breaching 6.00%. 

Adding, U.S. junk bond spreads topped 500 basis points for the first time since 2020, and China, also, launched its third most modern aircraft carrier. 

Ahead, Fed Chair Jerome Powell speaks at 8:45 AM ET. Then updates on industrial production and capacity utilization (9:15 AM ET), as well as leading economic indicators (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

Team. We’re going to have to keep it a bit shorter, today, and leave out the fundamentals section. Sorry!

Read: Daily Brief for June 16, 2022, on monetary updates and the implications of positioning.

In a nutshell, and this is borrowing from a past post-Federal Open Market Committee (FOMC) event letter, as well put forth by 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.”

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator alluded to counterparty buyback of static short delta hedges to positive delta options exposures.

“The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Essentially, the baseline bear trend held because, essentially, the Fed is, indeed, expected to continue raising rates and withdrawing liquidity. This will prompt a continued de-rate with QT being “a direct flow of capital to capital markets.”

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around March 2023.

Great, moving on. What’s next?

Essentially, with the June monthly options expiration (OPEX), expected is a roll-off of a large amount of customer negative delta exposure (via put options they own). Taken in a vacuum, with expiration, liquidity providers (who are short put options and short underlying to hedge) will re-hedge (buyback static short-delta, among other things), and this is taken as bullish.

Graphic: Via SpotGamma. “While many of these put positions could be paired off with other offsetting positions (i.e. netting out some of this delta), we remain of the opinion that a lot of these put positions are investor short hedges which will be rolled out and down on OPEX. This means that large ITM puts will be exchanged for OTM puts, which creates a short delta hedge imbalance for dealers (i.e. they need to cover short futures). This is what may drive the OPEX-related rally.

However, this is definitely discounting the impact on delta from participants rolling forward their bets on direction.

Graphic: Via Shift Search. Participants, mainly sell to close their short-dated bets on the downside while buying to open those that are further out in time and lower in price.

As talked about yesterday, we were to gauge the delta impact by how far below the high open interest strikes the equity indexes were to travel. As stated, these options, have little time to expiry and, thus, their gamma (the sensitivity of the option to change indirection) grows rather large, at near-the-money strikes.

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

As the time to expiry narrows, above the strike in question delta decays, and counterparts buy back their static delta hedges. 

As the time to expiry narrows, below the strike in question delta expands and counterparts sell more static delta to hedge.

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

This means that if far below these high-interest strikes, associated hedging, less any new reach for protection would keep markets pressured. If above, hedging, less new sales of protection, would bolster markets higher.

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.”

Ultimately, if lower, all else equal, the June 17 OPEX will coincide with the removal of the in-the-money options exposures in question. Negating the rollover of exposures and leaving the door open to some delta imbalance (need to buy to re-hedge exposure) suggests that after this expiration, markets may have less pressure to rally against. 

“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, wrote in a note. “Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”

What do you do with this information?

Well, recall that we’ve talked ad nauseam about the supply and demand of volatility, as well as how that impacted the volatility realized (RVOL) and implied (IVOL) by the market.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). The divergence in volatility implied (IVOL) by participants’ options activity, versus that which the market realizes (RVOL) resurfaced on June 15, 2022, in the Nasdaq 100 (INDEX: NDX).

Essentially there was an “absolute slamming” (i.e., sale of options), particularly in shorter-dated tenors and this played into the generally poor performance in skew, hence our comments on the benefit to buying into implied skew convexity should volatility reprice.

Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), was very depressed, too, in comparison to the VIX, itself.

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

To hedge or capitalize on a potential reach for protection, amid forced selling or demand for protection by a greater share of the market in ways not recently seen, then the repricing in those structures would be a boon to those that own them.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR).

To quote Benn Eifert of QVR Advisors: “Skew goes up if vol outperforms the skew curve a lot on  a selloff.”

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

And, as touched on in this morning’s introduction, there was a definite change in tone in the non-linear strength of volatility and skew with respect to linear changes in the price of assets.

Personally, I, along with a partner who I trade closely with, saw increases in the prices of ratio structures (long or short one option near-the-money, short or long two or more further out-of-the-money) by hundreds of percent for only a few basis points of change in the indexes.

As Karsan explained online, there was “a spike in short-dated -sticky skew, [the] first we’ve seen since [the] secular decline began and it hints [at] a potentially critical change in dealer positioning [and] the distribution of underlying outcomes.”

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

Graphic: Via English Stack Exchange. Visualizing the transition to a fat left tail and right-based distribution that is skewed negative (i.e., the green distribution).

So why does any of this matter?

This is a validation of our perspectives on how one should position, given what the supply and demand of volatility looked like prior.

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

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

In other words, by owning that protection, you are positioned to monetize on a continued non-linear repricing of volatility. However, doing this in a manner that cuts decay (when nothing happens) is the difficult part.

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

Graphic: Sourced via Towards AI. Skewness and kurtosis cheat sheet.

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 lower part of a positively skewed overnight inventory, inside 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 $3,688.75 HVNode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as high as the $3,773.25 HVNode and $3,808.50 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,688.75 HVNode puts in play the $3,664.25 HVNode. Initiative trade beyond the $3,664.25 HVNode could reach as low as the $3,610.75 HVNode and $3,587.25 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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 10, 2022

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

What Happened

Overnight, equity index futures continued lower after breaking a multi-day consolidation late yesterday afternoon.

This is amid growth concerns and the European Central Bank (ECB) decision to end asset purchases this month and commit to a 25-basis-point interest rate hike at its next meeting, setting the stage for further rate hikes, potentially 50-basis-points or higher.

Ahead are updates to consumer prices (8:30 AM ET), which may shed further clarity on the path of the Federal Reserve’s policies. Later are updates to consumer sentiment and inflation expectations (10:00 AM ET), as well as the budget balance (2:00 PM ET).

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

What To Expect

Fundamental: The CPI report is a driver of perceptions regarding future Fed activity.

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear. SocGen’s Kit Juckes explains that “the Fed put its foot down on the accelerator in 2020, harder than ever before, to keep the global economy going. Now it’s put its foot on the brake, equally hard but perhaps, a little bit late. How this plays out will become clearer in the coming weeks.”

Expected is an 8.2% rise year-over-year (YoY) and 0.7% month-over-month (MoM). In April, these numbers were 8.3% and 0.3%, respectively.

Core CPI (which excludes food and energy) is expected to rise by a rate lower than in April, 5.9% YoY and 0.5% MoM, respectively.

Graphic: Via Bloomberg. “For two straight months, fuel, power and grocery-store food have all been rising at double-digit annual rates—and tomorrow’s data is likely to show a further surge. Meantime, stocks fell with growth concerns in focus after the ECB moved to combat inflation.”

What matters most is the latter – core inflation – which the Fed has more control over. If lower than expected, that may warrant more appetite for risk.

“While inflation in some parts of the world [is] yet to peak, there are at least some signs emerging that we may not be too far off in terms of a turning point,” adds Khoon Goh of Australia & New Zealand Banking Group ADR (OTC: ANZBY).

Bloomberg reports semiconductor prices are now down 14% from the middle of last year. Also, the spot rate for shipping containers fell 26% while fertilizer prices are 24% below their record.

Still, the commitment to aggressive contractionary monetary policies is likely to remain. This reduction of liquidity and credit has consequences on the real economy and asset prices which rose and kept the deflationary pressures of monetary intervention at bay.

Positioning: It remains profitable to own options structures as implied (IVOL) underprices the volatility which is realized (RVOL).

This is the result of what options analytics service SqueezeMetrics suggests is an “absolute slamming” (i.e., sale of options) that’s compressing IVOL in shorter-dated tenors. 

It is “[o]nly rational to consider a bulk of them as put underwrites, because completely irrational otherwise.”

Important to note that this is in the context of next week’s large options expirations.

Into those events, typically, the frontrunning of delta hedging flows with respect to changes in time (charm), mainly, and volatility (vanna) provide an added boost. 

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.”

As stated Monday, however, the marginal impact of further volatility compression, since IVOL was falling from already low levels, was likely to do less to bolster equity upside. 

A lot of the supportive action happened in the days and weeks prior, hence the comments on owning options.

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

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 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 $4,016.25 HVNode puts in play the $4,055.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,071.50 BAL and $4,095.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,016.25 HVNode puts in play the $3,982.75 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,951.00 VPOC and $3,909.25 MCPOC, 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.

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

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

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

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

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.

Point Of Control: 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.

Micro Composite Point Of Control: 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 20, 2022

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

What Happened

Ahead of a $1.9 trillion options expiration, which we unpack later in the letter, the equity index and commodity futures, as well as yields, were bid.

This activity was on the heels of good news coming from overseas. China lowered prime rates on the five-year by a record to boost mortgages and loans amid an ongoing pandemic slump.

In other news, China warned the U.S. over a ‘dangerous situation’ forming over Taiwan, and the U.S. is set to block Russian debt payments, raising concerns of default. 

This is as Russian forces, per Michael Horowitz of Le Beck Int’l, broke “Ukrainian defenses west of Popasna in the Donbass, … a tactical success for Russia, the first in a very long time.”

Ahead, there is no data scheduled for release. Enjoy your Friday!

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: Fundamentally, the narrative remains the same, albeit there has been a rise in concern over global growth given persistent supply chokepoints and a commitment to reducing liquidity and credit.

Moody’s Corporation’s (NYSE: MCO) Mark Zandi explains “the odds that the economy will suffer a downturn beginning in the next 12 months at one in three with uncomfortable near-even odds of a recession in the next 24 months.”

Graphic: Via The Macro Compass. “Analyst consensus for the 2022 US real GDP growth has been consistently revised down this year.”

Per Bloomberg’s John Authers, U.S. housing is slowing down in the context of still-heightened sales. Data on home building suggests builders “aren’t running scared” while chokepoints still are feeding into support for house prices.

“Now, with inflation rising, the Fed is more concerned about wealth effects,” Authers explained. 

“The rise in asset prices has made a lot of people wealthier and encouraged them to spend accordingly. It’s also stoked inequality. A fall in home values would be helpful at this point,” and it’s something the Fed is keen on “pursuing,” as talked about in letters earlier this week.

Graphic: Via Bloomberg.

Positioning: Friday marks the roll off of $460 billion of derivatives across single stocks and $855 billion of S&P 500-linked contracts, according to a Bloomberg report quoting Goldman Sachs Group Inc (NYSE: GS) research.

Graphic: Via Goldman Sachs Group Inc. Taken from Bloomberg.

Into this event, participants are hedged and volatility remains well-supplied, due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

Consequently, the market’s descent has been orderly and not exacerbated by the demand for hedges and associated repricings of volatility.

This was expected, per Kai Volatility Cem Karsan’s commentary published in December 2021.

“If a meaningful volatility event has recently transpired [e.g., COVID-19], implied volatility demand tends to be high,” as sellers of it were liquidated in previous declines and “buyers have been rewarded with profits and demand for their services.”

Graphic: Via Bloomberg. “2022 is shaping up to be the busiest year for option trading. Almost 40 million contracts have changed hands daily on average, 6% above last year’s record, data compiled by Bloomberg show.”

“Market participants are thus overly hedged going into the second move, resulting in the suppression of implied volatility and skew along with a dampening of realized volatility.”

Graphic: Commentary published by Kai Volatility.

Given the aforementioned supply and demand dynamic, as well as illiquidity, we continue to observe a “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 @ftx_chris. “The relationship between illiquidity & volatility is a critical market driver for traditional markets now. In simple terms: lower liquidity creates increased volatility.”

“For some of these reasons – tempered measures of implied volatility – the market’s missing a lot of the ‘stored energy’ or ‘vanna fuel’ that’s helped support it in past periods of turmoil.”

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.”

So, barring changes in fundamentals, the catalysts to a potential rally are few and far between, and we elaborated on this in an earlier commentary.

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.”

Heading into Friday, Bloomberg quotes the $4,000.00 S&P 500 (INDEX: SPX) strike having “93,000 open positions set to run out, … includ[ing] 41,024 calls and 52,269 puts.”

Graphic: Via SpotGamma.

An open well below $4,000.00 means that this expiration will coincide with the removal of a lot of in-the-money put-delta. That means, post-expiration, per SpotGamma, “market makers will be free to buy back stocks to cover the short exposures that are no longer needed.” 

“Any ultimate rally off of Opex, we’d consider to be short covering, and subject to swift reversals into the end of next week.”

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, 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 $3,943.25 high volume area (HVNode) puts in play the $4,061.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,095.00 overnight high (ONH) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,908.75 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $3,862.75 and $3,836.25 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.

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

Such traders often lack the wherewithal to defend retests.

Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.

Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.

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 18, 2022

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

What Happened

Overnight, equity indices auctioned lower alongside commodities and bonds. The Cboe Volatility Index (INDEX: VIX) caught a bid ahead of its large expiration this morning.

Fundamentally, the context is the same. To note, Federal Reserve Chair Jerome Powell was at a conference, yesterday, and said the central bank would continue raising rates until there is evidence that inflation is in retreat. 

Until that evidence appears, the Fed could move “more aggressively.” That was hawkish.

Today we receive updates on building permits and housing starts (8:30 AM ET). Later, Philadelphia Fed President Patrick Harker speaks (4:00 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

Fundamental: If you have not already, check out Tuesday’s letter which discussed, in-depth, some of the implications of changing monetary policies, and their impact on markets.

Today’s letter will add to our narrative.

Over the course of a month or so, markets traded marginally lower while research houses have upped their calls for a slowing in the economy or, even, the prospect of a global recession.

So, in the span of a month, the tone changed to “[w]e’re on the brink of global recession.”

Graphic: Via Robin Brooks. Taken from The Market Ear. “Global GDP is flatlining.”

Let’s try to work through some narrative and theory, here.

On March 31, 2022, we unpacked what carry trades are (i.e., the act of borrowing at low rates and investing where there are higher rates to make money so long as nothing [bad] happens), and the implications of their unwind.

Such strategies are characterized by a sawtooth wave returns pattern (i.e., steady positive returns followed by sharp drops).

Graphic: Via Risky Finance. “Cumulative log returns from shorting the VIX future, a common carry strategy. Notice the poor returns in 2008 and other market crises.”

A great book on this – “The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decay Growth and Recurring Crisis – discusses many of the different forms of carry, their attractiveness, and the implications of their failure.

Further discussed is global monetary policy feeding into the growth and the reinforcement of carry, which has become embedded (or a core force of financial conditions).

Let’s elaborate.

Carry trades often involve leverage and, to avoid losses, these strategies force traders to close positions when positions move against them, buying strength and selling weakness. 

By that token, expansion of carry plays into increased liquidity, which is related to the ease with which credit is obtained and available in the economy, a driver of economic growth and what we talked about yesterday – Planet Palo Alto – over recent business cycles.

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

In other words, prevailing monetary policies made it easier to borrow and make longer duration bets on ideas with a lot of promise in the future. Central banks underwrote losses of this regime (e.g., post-1998 easing after widening of credit spreads), encouraging continued growth (and innovation). 

Now, there’s a strong commitment to reducing liquidity and credit. 

This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay.

What we’re getting to basically is the distinction between the economy and financial markets. 

This distinction has blurred. 

As the book explains, U.S. market liquidity, as well as the U.S. dollar’s role as a global reserve currency, makes the U.S. markets and S&P 500 at the center of the global carry regime.

A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s sentiment reflects this.

Graphic: Via Bloomberg. “[M]ore fund managers are worried about systemic financial risks than at any previous time in the survey’s history — which stretches back to before the GFC.”

So, what? 

Yesterday, we quoted Elon Musk saying the U.S. was facing a tough recession. This is on the heels of a large “misallocation of capital,” he says, by the government printing “a zillion amount of more money than it had,” which ultimately played into price instabilities we’re seeing today.

“The Fed has a mandate, which is completely unreasonable — to control price stability,” Kai Volatility’s Cem Karsan explains.

“With supply-side economics, the only way that they can control this ultimately is to pull back. And slow capital markets decrease via the wealth effect. Ultimately, there’s a significant lag, so they are not in a position to ultimately control inflation without bringing down markets.”

Graphic: Via Bloomberg. Taken from the Weekly S&P 500 ChartStorm. “Financial conditions are rapidly and drastically tightening (= bad [for] stocks).” 

“Unfortunately for the Fed, the U.S. economic growth rate is already decelerating,” Lyn Alden of Lyn Alden Investment Strategy adds. To cut inflation, the Fed must reduce demand for goods, and this is recessionary (just as “Walmart Inc [NYSE: WMT] and Target Corporation [NYSE: TGT] are feeling the effect of the stretched consumer,” per Bloomberg).

Graphic: Via Andreas Steno Larsen. “Demand destruction in one chart. Retail sales before and after inflation adjustments.”

Positioning: Participants legged into protective put options.

Graphic: Via Sentimentrader. Taken from The Market Ear.

As talked about before, with this stretched positioning, liquidity providers had a lot of synthetic exposure to the upside (positive delta) and asymmetric losses to the downside (negative gamma). To hedge, underlyings were sold. 

Graphic: Via SpotGamma. Total call delta to put delta for all expirations. Participants are concentrated in puts.

As markets rise, and that particular options exposure decays, the pressure these liquidity providers must add, softens. That’s what we’ve been seeing over the past few sessions.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for the SPDR S&P 500 ETF Trust (NYSE: SPY) reveals strong put selling and light call selling. This plays into a reduction in the liquidity providers’ negative gamma exposure and is a positive.

If participants were to continue trading in this manner, that may offer markets additional support. Notwithstanding, this activity likely does little to disrupt the balance of trade heading into and around the May 2022 options expiration (OPEX). 

Into that event, we expect delta hedging flows with respect to changes in time (charm), mainly, and volatility (vanna) to provide an added boost. However, with volatility coming in from lower levels, SpotGamma says, there’s not as much “stored energy to catalyze a rally.”

Instead, SpotGamma adds, “[o]ur fear, here, is that, fundamentally, markets are weak and the May OPEX opens the door for lower lows as some of the ‘max put’ positioning is cleared and markets succumb to the remaining negative gamma positioning.”

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

In the best case, the S&P 500 trades higher; activity above the $4,061.00 untested point of control (VPOC) puts in play the $4,095.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,119.00 VPOC and $4,148.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the  $4,061.00 VPOC puts in play the $4,013.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $3,978.50 low volume area (LVNode) and $3,943.25 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.

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 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!

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 10, 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, inside of the prior day’s range. Most other commodity and bond futures were bid while implied volatility metrics came in a bit.

Notable was the depth and breadth of Monday’s decline. Though the indexes were tame, some of which is attributable to suppressive hedging, single stocks expanded their ranges, greatly, to the downside, and this points to potential capitulation.

On the news front, a U.S. central bank report found that “the risk of a sudden significant deterioration [in liquidity] appears higher than normal” and stablecoin use to meet margin requirements in crypto trades makes them “vulnerable to runs.”

This is just as some algorithmic stablecoins have lost their peg (e.g., UST/USD ~$0.60).

Additionally, the report found elevated inflation, as well as the reaction to that “could negatively affect domestic economic activity, asset prices, credit quality, and financial conditions.”

Ahead is data on real household debt (11:00 AM ET).

Graphic updated 6:25 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

Context: We continue to build out the narrative.

A market-wide drop, Monday, pointed to signs of capitulation as “small-time investors offloaded a net of about $1 billion in equities, the most aggressive selling in 14 months,” per JPMorgan Chase & Co (NYSE: JPM).

Graphic: Via @TaviCosta. “Nasdaq has already declined almost as much as it did during the March 2020 crash. Back then, the Fed was all about saving the stock market and the economy. Today, it’s all about how much more they are going to hike rates.

Notwithstanding, the volatility divergences this letter has pointed to, in the face of pronounced realized volatility, continue.

Graphic: Via Topdown Charts. Wednesday (FOMC) price rise (right) versus Thursday (post-FOMC) liquidation.

As Pat Hennessy of IPS Strategic Capital explains, at-the-money implied volatility is high and term structure is in backwardation, which are reflections of uncertainty and demand for hedges.

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

“It’s just rare to see wingy short-dated puts like this so cheap relative to ATM.”

As explained in Monday’s letter (and in greater detail, Friday), a measure like the Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

To quote Benn Eifert of QVR Advisors: “Skew goes up if vol outperforms the skew curve a lot on  a selloff.”

Graphic: Updated May 9, 2022. The VVIX via Physik Invest.

What’s going on? 

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.

There are “plenty of put-buyers, but nearly as many sellers,” SqueezeMetrics explains

You “don’t have to protect what you don’t own. Some investors de-grossed. Short momo (e.g., CTA) wants to bet on a bleed (a la 2000), but not on a crash. Put underwriting! No carry trades elsewhere. Sell SPX vol!”

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, the SPDR S&P 500 ETF Trust (NYSE: SPY) was a recipient of heavy put selling and call buying on 5/9/22.

Why does this matter?

When you think there is to be an outsized move in the underlying, 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.

When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (positive exposure to volga) so that you may have gains that are potentially amplified in case of implied volatility repricing.

So, in all, it is a question of whether the reward is worth the risk (see below “How To Play”).

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options, particularly puts.

As The Ambrus Group’s Kris Sidial sums well: 

With an S&P 500 below $4,000.00, “I would expect more of an aggressive reach for hedges … that spot- vol correlation break (weakness) would not be as present.”

“Spot- vol correlation has sucked recently, but vol relative strength should kick in.”

How I’m Playing: Borrowing from May 3’s letter, here.

Presently, the market is stretched to the downside and, as SpotGamma says, “traders are underpricing right-tail risk,” which opens the window for unique ways to play a returns distribution that continues to be skewed positive (albeit with large negative outliers).

This letter’s author is concentrated on zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals.

This letter’s author is structured positive delta and gamma in the Nasdaq 100 (INDEX: NDX) via ratios spread (1×2) and butterfly (1x2x1) structures.

Graphic: Via Banco Santander SA (NYSE: SAN) research, the return profile, at expiry, of a classic 1×2 (long 1, short 2 further away) ratio spread.

The concern with these strategies is the width and time to expiry. Should either of those be wrong, then spreads initially positive gamma turn negative, meaning losses are amplified.

For instance, in the Nasdaq 100, to put in short, 500-1000 points wide ratio spreads (buy the closer leg, sell two of the farther legs) expiring in ten to fifteen days work well.

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk, and, as explained, the risk has yet to meet the reward.

Read more about these strategies, here. The above is NOT a trade recommendation or advice.

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

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode/gap boundary puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 could reach as low as the $3,907.75 HVNode and $3,862.75 LVNode, or lower.

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

Definitions

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

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.

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.

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): Reduction of 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 May 9, 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, commodity, and bond futures were all lower while yields, and implied volatility metrics we monitor were bid.

This is as new fundamental data did little to disrupt the Federal Reserve’s (Fed’s) course to hike rates and reduce the size of its balance sheet, as well as the odds of further slowing as a result of actions to curb the spread of COVID-19 abroad, and geopolitical conflict.

Goldman Sachs Group Inc (NYSE: GS), among others, cut their equity market forecasts. Presently, they see an economic contraction playing into the S&P 500’s test of $3,600.00.

Notable is the market’s retest of a very key technical area ($4,055.75 in the E-mini S&P 500). This area, last week, likely solicited responsive buying by technically-driven market participants who often lack the wherewithal to defend retests, just days before the Fed’s decision on policy.

Now, the market is set to open below those key technical areas and that is the worst outcome.

Ahead is data on wholesale inventories (10:00 AM ET), as well as inflation (11:00 AM ET).

Graphic updated 6:35 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

Positioning: Last week’s letters went in-depth on the implications of volatility divergences, the post-Fed rally, responses to key technical levels, and beyond.

On Friday, May 6, 2022, this letter essentially remarked the following:

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options.

Graphic: Via MarketWatch. “[B]ack-to-back swings in the internals on the scale seen this week are rare, with the last one occurring close to the COVID lows in stocks of March 2020. Indeed, investors had never seen a swing in internals as severe as Thursday’s before the financial crisis of 2008-09.”

How do you know whether the risk is worth the reward? 

A naive measure like the Cboe VVIX Index (INDEX: VVIX), which measures the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

Graphic: Updated May 6, 2022. The VVIX via Physik Invest.

We’re not there yet and the market remains well-hedged, as SpotGamma explains well:

“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).”

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.”

Noting, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma.

Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

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

This is amid what is a front-running of the bullish flow associated with the delta decay of options with respect to changes in volatility (vanna) and time (charm), among other factors.

In other words, it is participants’ increased awareness of the implications of options and OPEX that 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.’”

So what?

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. 

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.”

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: Via Bloomberg. 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 can happen in the days and weeks prior.

Technical: As of 6:35 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 $4,055.75 low volume area (LVNode/gap boundary) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,153.25 regular trade high (RTH High) and $4,212.25 micro composite point of control (MCPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,055.75 LVNode/gap boundary puts in play the $3,978.50 LVNode/gap boundary. Initiative trade beyond the LVNode/gap boundary could reach as low as the $3,943.25 and $3,907.75 high volume areas (HVNodes), 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: Last Tuesday, we discussed the response to a key technical level ($4,055.75).

Specifically, the E-mini S&P 500 probed $4,056.00 before staging a sharp reversal and closing higher. This was noteworthy as it told us a lot about who was gaining the upper hand.

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

Such traders often lack the wherewithal to defend retests.

Moreover, heading into last week’s Federal Open Market Committee (FOMC) event, large participants (who often move by committee) de-grossed and hedged resulting in poor reliability of our technical levels.

In the days leading up to the event, these larger had little to do with respect to repositioning. 

The market’s tests of key technical areas solicited responsive buying by these short-term traders, and this played into a rally that continued through FOMC. Post-FOMC, the market quickly succumbed to the initiative selling by longer time frame participants.

All else equal, Monday’s regular trade is expected to start somewhere below a key technical area that solicited strong responsive buying by shorter timeframes. 

Given capital constraints and tolerances, shorter timeframes may fuel an acceleration of the prevailing downtrend.

What People Are Saying

Definitions

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

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

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

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

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 2, 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 off of Friday’s regular trade lows. Yields, the dollar, and implied volatility metrics were bid.

There were no changes in the newsflow’s tone this weekend; investors remain concerned over the implications of monetary policy shifts and inflation, as well as war, COVID, and the supply pressures associated.

Ahead is data on S&P Global Inc’s (NYSE: SPGI) U.S. manufacturing PMI (9:45 AM ET), as well as the ISM manufacturing index and construction spending (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 indexes continue to hold well in the context of severe weaknesses under the hood, so to speak, especially in the high-flying technology and growth of 2020-2021.

Stocks like Zoom Video Communications (NASDAQ: ZM) and Netflix Inc (NASDAQ: NFLX), the beneficiaries of the work-from-home trends, have de-rated substantially since the start of 2022.

Graphic: Via Bloomberg.

In spite of earnings growth (~10% for S&P 500 companies that have reported, per Bloomberg), “the reaction to earnings surprises in April was asymmetric,” and a display of “the outsized role played by outliers.” 

For context, “Mega-cap growth (MCG) & Tech earnings are missing by -6.0% at the aggregate level [while] the median company [is] beating by 5.7%.”

This is as inflation, among other factors, continues to bite into the “over-optimistic multiples driven by the assumption that pandemic-era performance could continue in perpetuity.”

Per Bank of America Corporation (NYSE: BAC), the S&P’s current P/E is way too high, given the current CPI.

Graphic: Via Bank of America Corporation. Taken from Bloomberg. “It’s straightforward common sense that higher inflation would lead to paying a lower multiple of earnings because you expect future earnings to be eaten into by inflation. And common sense is borne out empirically; all else equal, higher inflation does indeed tend to mean lower earnings multiples.”

Notwithstanding, trimming outliers, inflation may have peaked and that is a positive for those equity investors who think “inflation is high, but they’re confident that it’s transitory,” therefore current valuations are just.

Graphic: Via Bloomberg.

Per @ConvexityMaven, recession chatter is unwarranted. The economy is expanding and the only worry investors should have is “if the Fed cannot chill nominal GDP.”

That means “rates are going north” and, according to Bank of America Corporation’s Michael Hartnett, “asset prices must reset lower.”

Some investors, like the Japanese, have heeded this message and are offloading billions in Treasuries in anticipation of more attractive levels and “stabilization in long-dated yields.”

Perspectives: Some, including Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, believe market participants are in for a world of [much more] hurt as “central banks can only deal with nominal, not real chokepoints.”

“Banks’ stock buybacks are lowering SLRs as we speak, and the Fed is about to embark on QT, and these nominal balance sheet and liquidity trends, will at some point clash with the realities of a garden variety of supply chain issues,” as a result of geopolitical chokepoints.

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

Given Pozsar’s findings, “The Fed will do QE again by summer 2023.”

Positioning: Recall that the indexes are trading relatively strong, in comparison to constituents, especially those that are smaller technology and growth companies.

Essentially, “we’re two-thirds of the way through a dot-com type collapse,” explains Simplify Asset Management’s Mike Green.

“It’s just happened underneath the surface of the indices which is [that] … dynamic of passive flows supporting the largest stocks within the index, whereas the smaller stocks can be influenced to a greater extent by the behavior of discretionary managers.”

This liquidity supply, apart from passive flows, stems from index-level hedging pressures, also.

Here’s why, as borrowed from our April 27, 2022 commentary.

Participants are well-hedged and use weakness as an opportunity to buy into a less highly valued broader market.

Well-hedged means that customers (i.e., you and I) own protection against long equity exposure. So, that could mean customers own puts and/or are short calls. One of the most dominant flows is the long put, short call.

Such trade offers customers positive, yet asymmetric (gamma), exposure to direction (delta). In other words, negative delta and positive gamma. 

The counterparty has exposure to positive delta and negative gamma. If the underlyings trade lower and volatility rises, all else equal, the position will lose. To hedge against these losses, the counterparties will sell underlying into weakness.

If prices reverse and move higher, these counterparties will re-hedge and buy underlying.

Normally, as seen over the bull run of 2020 and 2021, markets are in an uptrend and there’s a strong supply of volatility. Often, customers sell more calls than puts and, in an uptrend, those calls solicit more active hedging than the put options.

Recall that the customer is short the call. That means the counterparty is long the call (a positive delta and gamma trade) and will make money if prices rise, all else equal. 

The hedging of this particular exposure (i.e., sell strength, buy weakness), in an uptrend, occurs slower (i.e., counterparts will allow their profits to run), and that’s what can help the market sustain lower volatility trends for longer periods.

When prices reverse and underlyings trade lower, put options solicit increased hedging activity. Given the nature of counterparty exposure to those puts, that hedging happens quickly and can take from market liquidity as to volatility (i.e., buy strength, sell weakness).

Graphic: Via SqueezeMetrics. Equity move lower solicits increased hedging activity of put options. Counterparties have negative gamma exposure to these puts. Therefore, to hedge, they buy strength and sell weakness, adding to realized volatility. This trend is ongoing.

So, what now?

Participants are most concerned (and hedging against) unforeseen monetary policy action and economic chokepoints like a potential Russian default. 

Investors will get clarity on some of these issues in the coming sessions.

Graphic: Via SpotGamma, the estimated gamma for calls by strike as a positive number and puts as a negative number on the S&P 500 ETF, the SPY. Notice the weight on the put side.

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.”

Whether those price rises kick off a sustained reversal depends on what the fundamental situation is, then.

Presently, the largest index constituents are starting to succumb to worsening fundamentals and that will, ultimately, feed into the indexes which are pinned due to passive and hedging flows.

In other words, fundamentals will trump this talk of positioning (i.e., it is only in the short-term does this positioning we’ve talked about have greater implications).

Consideration: The returns distribution, based on implied volatility metrics alone, is skewed positive (though there are some large negative outliers pursuant to The Ambrus Group’s Kris Sidial recent explanation that despite negative sentiment, “nobody is truly scared” and “Fixed strike vols continue to underperform, along with the lack of concern in the VX term structure”).

Caution.

Graphic: Via SpotGamma, “Put vs Call gamma suggests stretched positioning.”

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 balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,118.75 regular trade low (RTH Low) puts in play the $4,158.25 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 untested point of control (VPOC) and $4,279.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,118.75 RTH Low puts in play the $4,101.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,055.75 low volume area (LVNode) and $3,978.50 low volume area (LVNode), or lower.

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

Considerations: Terribly weak price action, last week, with the S&P 500, Nasdaq 100, and Russell 2000 all flirting with early 2022 lows.

The weaker of the bunch – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – just broke 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, it is the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called demand zone, the level ought to be looked at as overhead supply on tests, higher. Caution.

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 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!

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.