Categories
Commentary

Daily Brief For August 15, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 800+ that read this report daily, below!

Graphic updated 7:30 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. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Fundamental

According to Goldman Sachs Group Inc (NYSE: GS) Prime Services, this is the third largest short-covering rally in three years.

Graphic: Retrieved from The Market Ear. Via Goldman Sachs Group Inc.

The rally, as discussed in past commentaries, is, in part, the result of “volatility-target funds” and “trend-following funds” getting back into the market as volatility falls, sentiment and data on jobs improve, as well as cooler-than-expected inflation figures.

Graphic: Retrieved from Stenos Signals. “Unless SMEs are lying, inflation has peaked for now … Will it change the market psychology?”

“The machines seem hell-bent on pushing the financial conditions easing trade,” said Dennis DeBusschere, the founder of 22V Research. 

“Machines are eating the words from the Fed speakers for breakfast.”

Graphic: Retrieved from Bloomberg. “The issue is the giant pool of systematic funds that moves in and out of the market based on how turbulent prices are. With peace at hand of late amid a four-week rally, so-called volatility-target funds and similar strategies such as risk parity are buying between $2 billion to $4 billion of stocks per day, according to an estimate by JPMorgan Chase & Co.’s Kate Gandolfo.”

Notwithstanding, JPMorgan Chase & Co (NYSE: JPM) estimates overall CTA exposures remain subdued. To incite ultra-impactful “buy signals” the S&P 500 would have to rise to $4,400.00.

This “would prompt CTAs to step up buying” and, potentially, turn “‘max long’ on stocks, buying probably $100 billion to $200 billion across various trend-following strategies.”

Graphic: Retrieved from Yardeni Research Inc.

Though the S&P 500 has yet to retake the $4,400.00 level, likely to remain as support until the end of the week, at least, are options hedging flows, which we talked about last week. 

“That can last perhaps another 100 days if volatility stays low,” JPM’s Kate Gandolfo suggested.

For context, at least at the index level, customers are short call, long put against their equity. In a rising market, the call side solicits increased hedging on the part of counterparties. 

If counterparties are long the call, and the market is rising (falling), they must sell (buy) underlying to re-hedge. This can further contain realized volatility and support the market.

To act on this information, you are best off shrinking your timeframe and using if/then statements to put on trades. For instance, if the market rises past the downtrend line in the S&P 500, then the 2022 equity bear market is over. We should bias ourselves long, at that point.

Graphic: Retrieved from Bloomberg. Drawn on by Physik Invest.

Accordingly, over a larger horizon, its growth impulses, as well as the availability of credit and liquidity determine whether a market’s movements have legs.

Accordingly, “in the 1970s, the peak in inflation proved THE timing to load up on risk assets, but the missing link is a bottoming growth cycle,” Andreas Steno Larsen explained.

“The swiftly weakening growth cycle may rather be the EXACT reason why inflation has started to fade.”

The likes of Campbell Harvey, PhD, Kai Volatility’s Cem Karsan, among others, share a similar belief. 

In fact, Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar sees inflation as a longer-lasting structural issue as “the pillars of the low inflation world – [de-globalization and populism] – are changing.”

As Crossmark Global Investments’ Victoria Fernandez puts it well, “We have probably reached peak inflation, but the stickiness of the inflation that remains (i.e., rents) keeps pressure on the Fed and therefore the markets.”

Graphic: Retrieved from The Macro Compass.

“We expected a summer rally due to better-than-expected earnings, but we aren’t satisfied that this is sustainable. A soft landing is still achievable, but we still anticipate volatility with so many unknowns out there.”

Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm. The “seasonal/cycle outlook is for a lower low or retest of the lows over the next three months as we are in the worst two months of the year and are smack dab in the *Weak Spot* of the 4-Year Cycle”

Positioning

Please refer to our detailed Daily Brief for August 12, 2022. We shall add to this narrative in the coming sessions.

Technical

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

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

Any activity above the $4,253.25 HVNode puts into play the $4,275.75 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,303.00 Weak High and $4,337.00 VPOC, or higher.

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

Any activity below the $4,253.25 HVNode puts into play the $4,231.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,202.75 RTH Low and $4,189.25 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

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, ex-Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

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

Categories
Commentary

Daily Brief For July 13, 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!

Graphic updated 6:20 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Fundamental

Key for Wednesday, July 13, are inflation figures – the CPI report – as this will drive perceptions regarding future Fed activity.

Expected is an 8.8% rise year-over-year (YoY) and 1.1% month-over-month (MoM). In May, these numbers were 8.6% and 1.0%, respectively. 

Graphic: Via Bloomberg. “The national average price for a gallon of gasoline retreated to $4.66 as of July 11, a decline of 7% from an all-time high of $5.02 a gallon on June 13. But that is not as large as the fall in oil prices, because fuel manufacturing is in such short supply. Refining now accounts for 26% of the cost of a gallon of gasoline, up from 14%.”

Core CPI (which excludes food and energy) is expected to rise by a rate lower than in April, 5.7% YoY and 0.5% MoM, respectively.

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

“If I’m right about June being the start of a string of lower core CPI prints, which is what the Fed wants to see, then I think comments from officials will quickly switch to a 50 basis-point hike for September and there were more calls for slowing to 25 basis points late in the year,” said Omair Sharif, founder of Inflation Insights LLC. 

On the other hand, if “higher than expected, we’ll feel this is definitely the peak,” said Tom Simons, money market economist at Jefferies Financial Group (NYSE: JEF).

Positioning

Carrying forward our July 12 narratives, here.

We can speculate as to where the market may move next, after the release of inflation figures, this week. What’s likely is that, even if the print is hot, the first move is to be structural, per Kai Volatility’s Cem Karsan.

“A function of inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Graphic: Retrieved from CrossBorder Capital. The “evidence of the huge Global liquidity squeeze. This is a major policy blunder building.”

Rising inflation probably bolsters the Fed’s backing of a 75 basis point rate hike on July 27. So, don’t fight the Fed. Rising rates and the withdrawal of liquidity prompts a continued de-rate.

Graphic: Via Bloomberg. “Money markets are betting on a three quarter-percentage-point hike by Federal Reserve officials later this month, wagering the US will need to keep the screws on policy to tame inflation.”

Knowing this, the “flattening in the downside fixed strike skew, while the upside wings [are] more smiley,” as described by JPMorgan Chase & Co (NYSE: JPM), has made for attractive low-cost spread opportunities, as talked about yesterday and in the July 8, 2022 letter.

Graphic: Shared by Benn Eifert of QVR Advisors.

The moral is as follows: own volatility where the market is likely to not expire. Sell it where the market is likely to expire. Just because implied (IVOL) volatility is at a high starting point does not mean it should be sold, blindly.

Read: Explanations and Applications – Moontower on Gamma.

Technical

As of 6:20 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

Any activity above the $3,830.75 MCPOC puts into play the $3,867.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $3,909.25 MCPOC and $3,943.25 HVNode, or higher.

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

Any activity below the $3,830.75 MCPOC puts into play the $3,800.25 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,774.75 HVNode and $3,755.00 VPOC, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: Updated 7/12/2022. 65-minute profile chart of the Micro E-mini S&P 500 Futures.

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

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

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, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

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

Categories
Commentary

Daily Brief For June 21, 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, the equity index and commodity futures were bid, all the while bonds and the dollar edged lower. This is after a week-long or so de-rate on tougher monetary policies.

Big headlines include the White House’s mulling of a U.S. gas tax suspension, Russia’s status as a top exporter of crude to China, Goldman Sachs Group Inc’s (NYSE: GS) recession warning, Elon Musk’s intent to cut Tesla Inc’s (NASDAQ: TSLA) workforce, and falling Iron ore prices on China’s building downturn.

Interesting reads from over the weekend include Dr. Pippa Malmgren’s letter on the market’s “nosedive” which is likely to be “followed by a newfound understanding of what is possible,” and how that plays into economic strength and military superiority. 

Adding, timely was a Sohn 2022 conversation with Stanley Druckenmiller on his experiences and the current market environment. 

Ahead is data on the Chicago Fed National Activity Index (8:30 AM ET), existing-home sales (10:00 AM ET), as well as Fed-speak by Loretta Mester (12:00 PM ET) and Tom Barkin (3:30 PM 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: Keeping this letter brief, today.

The sale of both bonds and equities worsened in part due to the implications of inflation and the Federal Reserve’s (Fed) response to that inflation.

Graphic: Via Nordea Bank’s (OTC: NRDBY) research. “We suspect that the real economy will be less sensitive to a rise in interest rates this time, which means that the Fed could have to move rates more-than-expected before policy gets restrictive. The strongest argument is that the household balance sheets are in a much better shape to sustain their level of spending as the massive injections of money and credit through both monetary and fiscal stimulus have changed household balance sheets dramatically.”

We talked about this in the weeks prior. 

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

“Investors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.” 

Graphic: Via Bloomberg.

Ultimately, an increase in the RRP (reverse repo) and QT (which is a direct flow of capital to capital markets) “would drain the pool of bank deposits by ~$1t by year-end,” and this may prompt investors to “continue to lower their selling prices to compete for the cash they want.” 

Graphic: Via CrossBorder Capital.

Positioning: Detailed was Friday, June 17’s commentary that honed in on some of the implications of pre- and post-Federal Reserve meeting positioning. 

Essentially, with the June monthly options expiration (OPEX), there was a roll-off of a large amount of customer negative delta exposure (via put options they owned). 

Graphic: Via SpotGamma’s S&P 500 Index (INDEX: SPX) Gamma Model. Updated June 17, 2022.

With expiration, liquidity providers (who were short these put options, as well as underlying to hedge) re-hedged (bought back some of their static short-delta), and this removes pressure.

“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, who we quoted last week.

“Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”

Accordingly, markets are off their lows. However, in the above text, we made little mention of participants’ rolling forward of their options bets to lower strikes, further out in time, as well as the impact of customers still maintaining a “sizable short put position,” a dynamic we’ve talked about before.

Graphic: Via SpotGamma. “Options flow, last week, was unsurprisingly dominated by index puts (red lines). Most interesting was index puts bought to cover (third chart) indicating there was a fairly sizable short put position heading into last week.”

Taken together, coupled with what SpotGamma observes is “anemic” call buying (viewed as the blue line in the top chart above), participants are hedged and volatility remains well-supplied. 

Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from The Market Ear. “The ‘muted’ VIX narrative goes on. The VIX vs SPX gap remains rather wide here. The second chart shows just how ‘depressed’ VIX remains vs the underlying px action. Most people have been stopped out/de-grossed risk, so there isn’t much demand to hedge exposure.”

Despite being stretched from a technical perspective, positioning-wise, lower prices are sticky and the context for a far-reaching bounce, all else equal, is not there.

We shall provide updates to this, later in the week. Read the Daily Brief for June 17, 2022, for more on how to position in light of the above information.

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 $3,735.75 HVNode puts in play the $3,749.00 ONH. Initiative trade beyond the ONH could reach as high as the $3,773.25 HVNode and $3,821.50 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,735.75 HVNode puts in play the $3,722.50 LVNode. Initiative trade beyond the $3,722.50 LVNode could reach as low as the $3,690.25 HVNode and $3,639.00 RTH Low, or lower.

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

Definitions

Volume Areas: 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.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 16, 2022

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

What Happened

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

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

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

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

Graphic updated 6:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

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

Graphic: Via Bloomberg

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

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

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

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

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

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

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

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For February 16, 2022

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

What Happened

After auctioning up into a key supply area, overnight, equity indices were responsively sold.

Ahead is data on retail sales and import prices (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), business inventories, and the NAHB home builders’ index (10:00 AM ET), as well as the release of Federal Open Market Committee (FOMC) minutes (2:00 PM ET).

Graphic updated 6:40 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: The market has de-rated substantially at the single-stock level.

“Stocks have been de-rating for almost a year now as investors began to anticipate the inevitable tightening from the Fed, given the robustness of the recovery and building imbalances,” Morgan Stanley’s (NYSE: MS) Michael Wilson says.

Graphic: Via Bank of America Corporation (NYSE: BAC). Taken from Bloomberg. “Perhaps most strikingly, fund managers are now more thoroughly underweight in technology stocks than at any time since 2006.”

“We think this de-rating is about 80% done at the stock level with the S&P 500 P/E still about 10% too high (19.5x versus our 18x target). In other words, the de-rating is more complete at the stock level than at the index level, at least for the high-quality S&P 500.”

At the same time, the bond market’s pricing of risk – reflected by the Merrill Lynch Option Volatility Estimate (INDEX: MOVE) – is not in line with the pricing of equity market risk, via the CBOE Volatility Index (INDEX: VIX).  

Graphic: MOVE Index. Taken from Lisa Abramowicz.

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

Graphic: Via True Insight. Taken from The Market Ear.

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

The “provision of liquidity and the creation of wealth through higher asset prices are intimately connected over time,” John Authers of Bloomberg explains.

Falling liquidity, while obviously necessary now that the emergency has passed and inflation is rising, could well signal problems ahead.”

Graphic: Via CrossBorder Capital. Taken from Bloomberg. 

To establish the point, these shifts in liquidity have large effects on bond markets, too, and that’s what participants are likely pricing in via MOVE.

A “flatter yield curve tends to be followed quite swiftly by rising credit spreads. While there is no great issue with solvency at present, this suggests that credit may already be causing problems by the end of this year.”

Graphic: Via Bank of America Corporation (NYSE: BAC). Taken from Samantha LaDuc

“The U.S. high yield OAS (option-adjusted spread) is breaking out above resistance to suggest a year-long risk-off bottom for this credit spread,” Bank of America explains. 

Deteriorating credit conditions are a bearish leading indicator, increasing the risk that the S&P 500 (INDEX: SPX) completes the head and shoulders top highlighted in the chart below.”

Taken together, it is the above-mentioned dynamics that will ultimately make it hard for the Fed to continue with rate hikes, Authers adds.

Graphic: Via Bloomberg, “there is a 50-year history that the Fed never hikes rates once the fed funds rate has risen above the five-year yield. That point could come before the end of 2022, and suggests that it will be very difficult to continue with tightening to the extent that the Fed currently believes necessary to bring down inflation to its target.”

To conclude this section, I quote Alfonso Peccatiello, the former head of a $20 billion investment portfolio and author of The Macro Compass: “If the Fed pushes the hawkish narrative further, we might see deeper cracks in the walls.”

Graphic: Via The Macro Compass, “Once real yields approach equilibrium levels, subsequent S&P500 returns tend to be poor.”

Positioning: In the past weeks this commentary expressed a more bullish tilt. 

This tilt is not entirely incorrect. Indeed, there are (as pointed to in past commentaries) few metrics that suggest that there have been strong(er) levels of accumulation.

Graphic: Via EPFR. Taken from The Market Ear. A “nice steady tune of >$50bn per month into global equities.”

However, other positioning metrics point to an increased potential for instability, and implied volatility, though heightened, may not provide much of a boost if further compressed. 

As options modeling and analysis provider SqueezeMetrics explains, “I don’t see the upside catalyst in the data right now. VIX back at 25 isn’t compelling from a vanna-rally perspective (back to 20 seems possible, but how much more?).”

“Have enough puts been bought to propel prices from vanna rally and subsequent vol rolldown? Mehhh.”

To put it in simpler terms, “it is a lot easier to knock [the market] down than it is to lift up.”

What’s known for sure is that this week’s put-heavy options expiration (OPEX) “may make gamma exposures less negative,” according to options analysis provider SpotGamma.

For context, delta is an options exposure to direction. Gamma is the rate of change in delta. ​​

“In an environment characterized by negative gamma (wherein an options delta falls with stock price rises and rises when stock prices fall), options expiries ought to make gamma less negative.”

Therefore, with a reduction in negative gamma, “there will be a removal of [counterparties’] linear short (-delta) hedges which may further bolster attempts higher.”

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 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 $4,438.00 key response area (balance boundary, high-volume area, and prior overnight low) puts in play the $4,483.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,499.00 untested point of control (VPOC) and $4,526.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,438.00 key response area puts in play the $4,393.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,365.00 POC and $4,332.25 HVNode, or lower.

Considerations: Tuesday’s trade built out areas of high volume via the cave-fill process in locations where prior discovery left weak structure – gaps and p-shaped emotional, multiple distribution profile structures (i.e., Friday’s knee-jerk liquidation of poorly positioned longs).

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.

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.

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

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

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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