Categories
Commentary

Daily Brief For May 11, 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, index and commodity futures were bid while yields and the Cboe Volatility Index (INDEX: VIX) came in, little.

In the news was continued crypto market turmoil. The TerraUSD stablecoin maintained its break with the U.S. dollar, trading as low as ~0.25. Shanghai reported a drop in new COVID-19 cases.

Key, today, is data on consumer prices (8:30 AM ET). If Wednesday’s print shows price pressures continuing to mount, traders will put more weight on the potential for larger hikes.

Later, is some Fed speak (12:00 PM ET) and federal budget updates (2:00 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: Shortened commentary, today.

Participants expect inflation to have peaked. This would be confirmed by the annual CPI printing 8.1%, down from 8.5% in March.

Graphic: Via Bloomberg.

“Perhaps the tightest questions will concern core inflation (excluding food and fuel, which continue to be roiled by the situation in Ukraine),” says Bloomberg’s John Authers. 

“Now, if the economists polled by Bloomberg are correct, core month-on-month inflation is going to rise a bit. That does not help the narrative that the peak is in. If this particular number comes in below expectations, we can expect that to be taken very, very positively on the markets.”

Graphic: Via Bank of America Corporation (NYSE: BAC). 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.”

Positioning: Participants are most concerned and hedging against aggressive monetary policy action and economic chokepoints.

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 continue to decay (i.e., removal of event premiums).

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.

Accordingly, hedging flows with respect to time and volatility may, then, 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.”

The alternative is that participants’ fears for whatever matter are not assuaged. In case of an imbalance, demand for protection may kick off a repricing of volatility, particularly that which is further away from current prices (i.e., skew), depressed by strong supply.

Graphic: Updated May 10, 2022. The VVIX via Physik Invest. 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 has been, the VVIX typically trades closer to 150.

Whether any price rise kicks off a sustained reversal depends on what the fundamental situation is, then.

Presently, some of the largest index constituents (e.g., Apple Inc [NASDAQ: AAPL]) are starting to succumb to the fundamental situation, if we will, and that may 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).

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics. A higher DIX/GEX ratio has historically been associated with S&P 500 outperformance in the subsequent month. A very low DIX/GEX ratio has historically been associated with positive S&P 500 performance in the subsequent month, though there are many more negative outliers.

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

In the best case, the S&P 500 trades higher; activity above the $4,055.75 low volume node (LVNode) puts into 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 (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,055.75 LVNode puts into play the $3,978.50 LVNode. Initiative trade beyond the $3,978.50 LVNode could reach as low as the $3,943.25 and $3,907.75 high volume areas (HVNode), or lower.

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

Definitions

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

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

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

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

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 6, 2022

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

What Happened

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

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

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

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

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

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

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

What To Expect

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

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

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

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

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

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

Graphic: Via Toggle.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: The VVIX via Physik Invest.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 3, 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 were sideways, inside of the prior range, after exploring much lower, Monday. Measures of implied volatility, bonds, and most commodities were bid.

This is alongside news that Russia is dodging default, the necessity for the Fed to drop inflation down to 4% by year-end per Citadel’s Ken Griffin, the U.S. Treasury’s intent to scale back sales of longer-term debt, falling earnings estimates, Taiwan preparing to fend-off a potential invasion as Beijing ordered officials to find ways to fight against western sanctions, similar to those used against Russia, among other things including Fitch trimming China’s 2022 growth forecast.

Also, near risk-free, inflation-protected I bonds will pay 9.62% through October, the Treasury said, and here’s more on the Citigroup Inc (NYSE: C) trader that’s behind a European crash.

Ahead is data on job openings and quits, as well as factory and core capital goods orders (10:00 AM ET).

Read on for coverage on the fundamental and technical position of the market, as well as ways to position for future trade.

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: The Federal Reserve (Fed) is expected to raise its target overnight rate by about 50 basis points and provide updates on quantitative tightening (QT).

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Market participants expect a near-100% chance the fed moves its target rate to 75 or 100 basis points.

The expectations of the aforementioned have played into a tightening of financial conditions which, as Columbia Threadneedle’s Gene Tannuzzo explains, “reduces demand and ultimately slows inflation.”

Graphic: Via Bloomberg. “Tighter financial conditions are the mechanism that reduces demand and ultimately slows inflation,” said Tannuzzo, the firm’s global head of fixed income. “If financial conditions don’t tighten and inflation remains high, in their eyes, they need to hike more.”

The key is the update on QT. As Bloomberg’s John Authers puts it well, “what the Fed does with its balance sheet at the margin [] matters for asset prices, and there is little or no lag.”

Graphic: Via Crossborder Capital Ltd. Taken from Bloomberg.

The Fed’s liquidity reductions, thus far, have played into the market’s troubles since the start of the year. This is as QT has an impact on the “ability to roll over or refinance investments.”

Graphic: Taken from The Market Ear. “46% of non-earnings driven market cap changes were explained by Fed balance sheet expansion since GFC.”

Perspective: JPMorgan Chase & Co (NYSE: JPM) strategists note that investors’ fears are unwarranted. The U.S.’s economic expansion has not been derailed. 

“Worries about China’s growth outlook, a negative take on the Q1 earnings reporting season, concerns about higher bond yields and further tightening of financial conditions from a strong dollar, all appear to have soured equity and credit investors’ sentiment,” the strategists said. 

“We find these fears overblown.”

Positioning: Comments from yesterday’s morning letter remain valid, today.

Participants’ bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and extremely sensitive to changes in implied volatility and direction.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “Retail Investors buyers of 0-1 DTE (days-to-expiry) puts are largest on record.”

Those options carry a lot of gamma and are exposed to the potential for asymmetric or convex payouts. This is not good for those who are on the other side.

In hedging a short put, for instance, a positive delta and negative gamma trade, counterparties sell underlying if there is weakness or jumps in implied volatility. If the underlying trades higher, or dips in volatility, the counterparty will buy the underlying, all else equal.

Taken together, in such an environment, the counterparty leans toward taking liquidity and this exacerbates underlying movement if there’s a thinning liquidity environment, SpotGamma says.

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

In other words, hedging matters more in such an environment. This was clear during Monday’s trade when a bout of put selling and light call buying appeared in both the SPDR S&P 500 ETF Trust (NYSE: SPY) and Invesco QQQ Trust Series 1 (NASDAQ: QQQ).

This, ultimately, too, fed into the compression of volatility at the short-end of the term structure, yesterday. To re-hedge, counterparts likely bought into the market’s weakness and bolstered the near-vertical reversal, and close higher.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. A rising blue and orange denote put selling and call buying, respectively.

The odds of follow-through, to the upside, come back to the fundamental situation and Fed announcements this week. Should fears with respect to monetary policy be assuaged, then volatility can compress and that, alone, will spur a buy-back of those underlying short hedges.

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

Technical: As of 6:45 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 $4,123.00 untested point of control (VPOC) puts in play the $4,176.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 VPOC and $4,279.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,123.00 VPOC puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,978.50 LVNode and $3,943.25 high volume area (HVNode), or lower.

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

Considerations: Most interesting was Monday’s response at a key technical level ($4,055.75) outlined in the morning letter.

Specifically, the E-mini S&P 500 probed $4,056.00 before staging a sharp reversal and closing higher. This is noteworthy as it tells us a lot about who has (or is 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 and, additionally, this type of trade may suggest other time frame participants are waiting for more information to initiate trades.

Adding, the Federal Reserve’s meeting this week concludes with statements to be shared on Wednesday. For weeks heading into this event, (larger) participants (that move by committee) have de-grossed and hedged. For that reason, the reliability of our technical levels took a hit.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear. Per Bloomberg, “Hedge funds tracked by Morgan Stanley have also cut their net leverage — a measure of risk appetite that takes into account long versus short positions — to a two-year low.”

In the very near term, until more fundamental information is revealed, these technical-driven traders may play a larger role in the volatility. These traders, given capital constraints and tolerances, often trigger sharp moves in their entry and exit on news. Caution on whipsaw.

How I’m Playing: Presently, the market is stretched to the downside and participants are leaning, heavily, one way.

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

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

Consider zero- or low-cost bets that deliver asymmetric payouts in case of reversals.

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

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. Read more about these strategies, here.

Please note that the above is NOT a trade recommendation or advice.

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.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 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.

Categories
Commentary

Daily Brief For April 27, 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 probed higher, essentially negating Tuesday’s end-of-day, knee-jerk liquidation.

Tuesday’s selling came alongside Russia cutting gas to Poland and Bulgaria, Vice President Kamala Harris testing positive for COVID-19, and heavy selling in growth and tech stocks, amid doubts corporate profits can withstand the Federal Reserve’s bid to tame inflation.

As Jerome Schneider of Pacific Investment Management Co says, QT will “have a profound effect on the cost of liquidity and more importantly the cost of transacting business and reallocating assets from one avenue to another avenue.” 

“There might not necessarily be a rapid deceleration or decline in the stock market or other risk assets, but there’s going to be a changing cost of capital that this balance sheet is going to be part of.”

After the close, weakness continued. Alphabet Inc (NASDAQ: GOOGL) (NASDAQ: GOOG) missed on slowing sales growth and digital-ad spending. One of the biggest losers was Tesla Inc (NASDAQ: TSLA) which shed 12% or so on news that Elon Musk would use his fortune, much of which is tied up in Tesla, to buy Twitter Inc (NYSE: TWTR).

Germany’s passage of a bigger borrowing budget, coupled with China’s pledge to boost infrastructure bolstered an overnight advance that fed into price action at home. The S&P 500, in particular, for a brief moment, took back a key level, negating much of yesterday’s liquidation.

Ahead is data on international trade in goods (8:30 AM ET), as well as pending home sales and the rental vacancy rate (10:00 AM ET).

Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Positioning: Markets are positioned for continued volatility. 

Based on a reading of market gamma exposure (GEX) and buying support (DIX), the returns distribution is skewed positive. There’s buying in the context of an environment in which the hedging of options positioning implies selling into weakness and buying of strength.

Graphic: Via Barclays PLC (NYSE: BCS) research.

In the most simple way that I can explain: when positioning is stretched one way, that often tends to mark a turning point – the returns distribution is either skewed positive or negative.

Graphic: Via Physik Invest. Data via SqueezeMetrics. Updated March of 2022. A high DIX/GEX ratio often portends positive 1-month returns.

An updated read, after Tuesday’s weak close, tells us that we can (1) definitely expect larger ranges to continue and (2) potential for short-term bounces

Based on overnight activity, one of those is happening, now.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

This is as participants are both well-hedged and using weakness as an opportunity to buy into a less highly valued 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).

See, below, E-mini S&P 500 book depth, a proxy for market liquidity, and how much it has declined since the end of last year when markets became more volatile and noise around the Federal Reserve’s intent to taper bond-buying and raise rates grew louder.

Graphic: Via CME Group Inc (NASDAQ: CME) Liquidity Tool. Note how in late March, book depth rose as markets rose and customer call activity solicited increased hedging of counterparty long-gamma exposure (i.e., buy weakness, sell strength), adding to market liquidity.

In the above environment, counterparty hedging matters; the market is more sensitive to the flow, so to speak. That sensitivity is expected to continue.

SpotGamma, an options data and analysis service, sees the early May period as pivotal. Then is the Federal Open Market Committee (FOMC) meeting and the potential Russian default, per Moody’s Corporation (NYSE: MCO).

As quoted: “Russia ‘may be considered in default’ if it does not pay two bonds in US dollars by end of a grace period on May 4.”

Graphic: Via Bloomberg.

Until those events are resolved, participants will likely continue to (remain) hedge(d). Upon resolve, customers likely monetize their protection to offset losses on underlying equity exposure. 

That means selling volatility which reduces counterparty exposure to short puts (negative gamma and positive delta). To re-hedge, underlying is bought back and that may support a price rise.

Graphic: VIX term structure via VIX Central. Expansion (higher) solicits counterparty selling which pressures the market lower. Compression (lower) solicits counterparty buying which bolsters attempts higher.

Whether that price rise has legs depends on what the fundamental situation is, then. See the below section titled Considerations for a full technical picture and the most likely turning points.

Technical: As of 7:00 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the 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 $4,217.25 overnight high (ONH) puts in play the $4,267.75 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,303.75 ONH and $4,337.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,217.25 ONH puts in play the $4,193.25 spike base. Initiative trade beyond the spike base could reach as low as the $4,136.50 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), or lower.

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

Additionally, the indexes continue to trade below their 20-, 50-, and 200-day simple moving averages, confirming the trend change and bearish tone (further validated by poor breadth).

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

All indexes remain, as stated, yesterday, below their volume-weighted average prices (VWAPs) anchored from the start of this year (or their respective peaks). 

VWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Liquidity algorithms, too, are benchmarked and programmed to buy and sell around VWAPs.

The Invesco QQQ Trust Series 1 (NASDAQ: QQQ) just tested a major VWAP, yesterday, anchored from the lows of March 2020. That’s a fair price to pay for Nasdaq 100 exposure.

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

Notwithstanding, notice the flat-to-declining AVWAP that’s black in color. So long as prices remain below this level, the index is likely a sell. 

Should that level flatten (and begin to rise), and if the QQQ was able to trade above it for a sustained period, there is potential for sustained upside.

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

Definitions

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

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

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

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

About

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

Capelj 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 26, 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-lower ahead of an earnings season that’s set to accelerate.

Concerns that remain include the implications of China’s response to COVID-19, the resolution of the tension between Russia and Ukraine (and the rest of the world for that matter), as well as the intent, by policymakers, to accelerate a pivot to normalization (i.e., rate hikes and beyond).

Graphic: Via Sanford Bernstein. Taken from The Market Ear.

With a larger part of the market moving in sync (as talked about more in the “Technical” section), many strategists suggest the outlook for equities is continuing to worsen and positioning is likely to compound further volatility.

Ahead is data on durable goods and core capital equipment orders (8:30 AM ET), the S&P Case-Shiller U.S. home price index and FHFA U.S. home price index (9:00 AM ET), as well as consumer confidence index and new home sales (10:00 AM ET).

Graphic updated 7:00 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: “With defensive stocks now expensive and offering little absolute upside, the S&P 500 appears ready to join the ongoing bear market,” Morgan Stanley (NYSE: MS) says.

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. “[T]he accelerative price action on Thursday and Friday may also support the view we are now moving to this much broader sell-off phase.”

“The market has been so picked over at this point, it’s not clear where the next rotation lies. In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison.”

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

Adding, Bank of America’s global EPS model predicts negative growth by year-end.

Graphic: Via Bank of America Corporation. Taken from The Market Ear.

Positioning: Monday’s bottoming at $4,200.00, near intraday lows, came as participants sold puts, and the hedging of the consequent volatility compression, thereafter, bolstered a price rise.

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

At this juncture, though positioning appears (a tad) stretched and prices are nearing a lower bound, there may be room for volatility to expand, further.

Per SpotGamma’s Delta Tilt indicator, which “reflects the market approaching a maximum put threshold, [there’s] potential for further hedging that may result in sharp rallies and declines with volatility climaxing around early May (FOMC and potential for Russian Default).”

Graphic: SpotGamma’s Delta Tilt.

This is as options counterparts themselves have hedges (i.e., protective puts) that reduce hedging requirements, so to speak, when underlyings trade down to certain levels. 

SpotGamma explains

“Using this logic, when the downside puts gain value, they may reduce the need to delta hedge. In turn, dealers may be able to advantageously reduce delta hedging (sell less), and supply markets with more liquidity (buy more stock). This could serve to reduce volatility.”

So, in summary, participants are pretty well-hedged. Should they begin to monetize protection, that may lower counterparty exposure to positive delta, thus fueling a price rise.

Whether that price has legs is dependent on improvement in the fundamental situation.

Graphic: Via Bloomberg.

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

In the best case, the S&P 500 trades higher; activity above the $4,272.00 high volume area (HVNode) puts in play the $4,303.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,272.00 HVNode puts in play the $4,233.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,195.25 regular trade low (RTH Low) and $4,129.50 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: The market is weak and all major indexes covered by this newsletter are trading below their 20-, 50-, and 200-day simple moving averages.

Additionally, all indexes are below their volume-weighted average prices anchored from the start of this year (or their respective peaks). Further, AVWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

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

The modus operandi is to sell into a flat-to-declining AVWAP. So long as prices are below the below AVWAPs, sellers remain in control and rally attempts are to likely fail, all else equal.

Another important note to make is the market’s poor breadth (via VOLD and ADD). Previously, there were divergences; rate-sensitive areas of the market were sold while more value was bid. Last week, there was a change in tone. All areas of the market were sold, heavily. 

This suggests the potential for a broader sell-off (and this is supported by the U.S. Equity ETF flows graphic included, above).

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

What People Are Saying

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 30, 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 lower while most commodities and the ten-year yield were higher.

The bullishness of the past days, driven in part by breakthroughs in Russia and Ukraine peace talks is threatened by new updates. Now, the Kremlin said that its talks with Ukraine yielded no breakthroughs. Geopolitical matters and supply chain issues are major headwinds for markets.

Ahead is data on ADP employment (8:15 AM ET), GDP revision, gross domestic income, and corporate profits (8:30 AM ET), as well as Fed-speak. Tom Barkin speaks at 9:15 AM ET and Esther George speaks at 1:00 PM 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

Positioning: Buying the March 14 S&P 500 low would have yielded you nearly a 12% gain. Buying and holding the Nasdaq 100 low would have yielded you about 17%.

Graphic: Via Bloomberg.

The forward returns when the 10-day S&P 500 return crosses above 10% are mixed. 

From 2000 to 2009, forward returns are weak. From 2009 and beyond, returns are strong.

Graphic: Via @HalfersPower. “Every time the $SPY has a 10-day return crossing above 10%, and fwd returns from those dates.  2000-2009 weak forward returns, 2009 fwd, strong fwd returns.”

These powerful moves are due in part to the “reflexive dynamic coming from structural flows,” explains The Ambrus Group’s Kris Sidial who sees a lot of opportunity in the “front of the term structure.”

Sidial and I have spoken a couple of times regarding the implications of increased derivatives exposures and the transmission of those risks associated to underlyings. 

Mainly, counterparties, as a result of regulatory frameworks, among other things, lend to cascading reactions that exacerbate underlying price movements.

Graphic: Via VIX Central. Shorter-dated implied volatility is sold aggressively at the front end. The steepening of this curve bolstered a near-vertical price rise as options counterparts bought back stock and futures hedges to downside (put) protection they were short.

Further, this recovery is in the context of geopolitical tension and monetary uncertainties that have lent to volatility spikes across other asset classes. Though fear tends to spread across markets, it is not, today, as discussed in past commentaries.

Basically, the equity market’s pricing of risk, which we use the CBOE Volatility Index (INDEX: VIX) as a proxy for, is not moving in lockstep with that of measures in FX and rate markets. 

Notwithstanding, as SqueezeMetrics explains, there are no “hardcore vol[atility] sellers in the SPX right now,” and this may actually be a good thing.

As SqueezeMetrics explains in their Implied Order Book paper, “Selling options is a tough business, since you’re on the wrong end of a derivative with a convex payoff.”

“In terms of gamma [an option deltas sensitivity to direction] and vanna [delta hedging flow with respect to changing levels of implied volatility], crash risk is a function of how many investors have sold puts [which] … are, quite literally, a bunch of huge buy limit orders below the market, and then a bunch of liquidity-taking stop-losses further down.”

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

Heading into the early-to-mid March reversal period, this newsletter revealed the forecasted returns distribution of a comparison of proxies for buying (DIX) and gamma exposure (GEX). 

At the time, the returns distribution was skewed positive given a deeply negative GEX and strong DIX.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

The bullishness of those metrics was taken with a bit of a discount, given the aforementioned cross-asset divergences, as a result of geopolitical conflict, among other things.

In hindsight, the right call would have been to buy hand over fist.

A bout of speculative demand (expressed through short-dated options highly sensitive to direction), as well as the compression of ultra short-dated volatility heading into and through the Federal Open Market Committee (FOMC) meeting and large March monthly options expiration (OPEX) bolstered strong buying support and lent to the market’s resolve higher.

The price rise, now, has likely reached a climax. The S&P 500, in particular, is at an overbought level: the concentrations of call open interest at and around $4,600.00.

As SpotGamma explained well, recently, “customers are short calls up top (to finance put options, or bets on the downside, down below). As underlying SPX prices rise, the call (put) side solicits more (less) hedging.” 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for the S&P 500 SPY ETF on 3/29/2022.

“Since counterparties’ call positions provide positive exposure to direction (positive delta) and profits are amplified to the upside (positive gamma), counterparties must sell into higher prices and buy into lower prices, thereby adding liquidity and supporting the market.”

Participants’ selling of volatility at these higher levels suggests increased odds of sideways, rather than up or down; as time and volatility trend to zero for these options, their gamma increases, and the reaction to this will result in the promotion of pinning.

Thereafter, the clearing of this options exposure likely opens the door to underlying breadth which has improved markedly since early March. 

Though today’s market is unprecedented, so to speak, improvements in breadth support a historical case for sideways-to-higher through tightening cycles.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM).

In opposition to this narrative (i.e., higher prices through the tightening cycle) are some Bank of America Corporation (NYSE: BAC) strategists.

“The worsening macro backdrop and market-unfriendly Fed make sustained U.S. equity gains unlikely,” Bank of America strategists said in a statement that recommended investors sell upside (call) protection to hedge downside. 

If Bank of America is correct, it’s possible that, given the recent clearing of puts, participants’ demand for protection, and the hedging of this exposure, would add velocity to the move lower.

SqueezeMetrics’ remark on hardcore volatility selling, however, has us a little less concerned (about some sort of armageddon situation).

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 $4,597.00 untested point of control (VPOC) puts in play the $4,611.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,631.00 regular trade high (RTH High) and $4,641.75 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,597.00 VPOC puts in play the $4,574.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 Spike Base and $4,533.00 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.

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

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.

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 a reduction in dealer gamma exposure.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 23, 2022

Editor’s Note: Hey team! Thanks for all the support. I enjoy putting together these notes as it helps keep me aware of narratives that may impact my own trades.

I’ll be taking the rest of the week off (i.e., no notes till Monday most likely), focusing on other areas of the business like prep for the weeks and months to come.

Take care and trade safe,

Renato

What Happened

Overnight, equity index futures auctioned sideways to lower while commodities, bonds, and implied volatility metrics were bid.

This is in the context of a global bond market rout. Central banks intend to tighten policy in light of surging inflation; investors are selling bonds and rotating into areas that have “better upside.”

Ahead is data on new home sales (10:00 AM ET). The Federal Reserve’s (Fed) Loretta Mester speaks at 10:00 AM ET. Mary Daly follows at 11:45 AM ET.

Moreover, yesterday’s commentary carried a pessimistic tone. In hindsight, too pessimistic. The reality is that this is a market environment like no other. Certain metrics that were very reliable carry little-to-no value (predictive ability) right now. This is true for those who base much of their decision-making on “fundamental” and “technical” analyses, too.

To combat this, we zoom out and look for trades that offer asymmetric payouts. We’re careful to provide liquidity when others demand it en masse. Similarly, we are to give ourselves room for error; stops are widened and lot sizes are smaller.

Read on for today’s lighter-hearted take on what’s happening and frameworks to trade on.

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: Bloomberg’s John Authers published a discussion on the performance of stocks, relative to bonds. Essentially, there have only been four previous two-week periods when stocks beat bonds by this much.

Graphic: Via Bloomberg. The 10-trading-day return of the SPDR S&P 500 ETF (NYSE: SPY) relative to the iShares 20 Plus Year Treasury Bond ETF (NASDAQ: TLT).

“All of the big positive moves were driven by classic stock market rebounds that proved to be durable. There was no particular move in bond yields. This is the first time a turn this dramatic has been pushed almost as much by falling bond prices as by rising stock prices.”

Graphic: Via Bloomberg. “The upper bound of the fed funds rate is still only 0.5%, but the two-year bond yield implies confidence that there are seven more hikes to come in that time.”

Authers explains that “equities are enjoying a false dawn as they’re recipients of the money coming out of bonds, and that we are about to be reacquainted with the bear markets in both bonds and stocks which come when rates [i.e., cost of money] have to rise to control inflation,” which impacts longer duration stocks (i.e., a stock whose value lies further in the future) most.

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

Adding, the impact of rising Treasury rates is magnified further when credit spreads (i.e., the difference in yield between bonds of similar maturities but different credit quality) also rise.

Graphic: Via Bloomberg. “But the speed with which corporate yields are rising again gives the impression of a market process that is coming around from an anaesthetic injected to help it survive the trauma of the credit crisis back in 2008.”

“The performance of stocks relative to bonds suggests we’re at the beginning of a big upswing; the absolute performance of bond yields in their own right suggests we need to bail out now before another crisis engulfs us,” Authers says.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “GS has lowered GDP a number of times over the past few weeks. Remember that during the fantastic bull from Q220 and 1 year onwards it was the flipside with GS way above consensus…”

Positioning: Dip buying serves investors well.

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. “Buy the dip has worked well during periods of QE but has not historically worked during QT. Better to ‘buy the rally’ during QT (2018-2019), which was also the case during the 80s/90s.”

The near-vertical price rise in markets, over the last week, comes after a long period of weakness during which participants concentrated their activity in negative delta trades (which make money when markets trade lower, all else equal).

From a static delta perspective, now, there is both the covering of shorts and so-called macro buying (pointed to in the above section). 

From a dynamic delta perspective, there are the implications of volatility compression (e.g., Cboe Volatility Index [INDEX: VIX] and term structure dropping), the removal of put-heavy exposures via last week’s options expiration (OPEX), and the market’s trade higher.

Graphic: Via Deutsche Bank AG (NYSE: DB). Taken from The Market Ear. Volatility control is the concept of managing assets “through continual rebalancing between a risky asset holding – often, but not always, equity – and cash holdings,” via The Actuary.

Taken together (short covering, macro buying, volatility compression, OPEX, and so on), the aforementioned dynamics bolster markets. It is the dynamics of positioning (demand or supply of liquidity) that magnify (add to) the velocity of moves up (or down).

Graphic: Via Refinitiv. Taken from The Market Ear. “Poor liquidity (and short gamma) magnified moves on the way down. It seems poor liquidity works both ways seeing px action during the latest squeeze.”

Earlier this week, this newsletter pointed to the potential non-sustainability of the market’s rise. This was based on metrics that have provided tremendous predictive power, in the past. 

Participants’ commitment to positive delta exposure (i.e., buying calls and selling puts), is a feature of sustained reversals. Data through Tuesday did not show this at the index level. 

As discussed by SpotGamma, yesterday, in the S&P, participants bought puts and sold calls (i.e., a negative delta trade).

This was in the context of aggressive call buying and put selling in heavily weighted index constituents like Tesla Inc (NASDAQ: TSLA).

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for TSLA.

As stated in yesterday’s commentary, markets remain vulnerable to sharp drops. In the case of further volatility suppression (e.g., customer call and put selling), counterparties will tend toward supporting markets and laying the foundation for later-dated rallies.

However, if markets trade down and volatility rises, accordingly, as participants seek protection, the potential exists for magnified moves on the way down.

Straight up could well precede straight down. A bottom (as some strategists are calling for) may take time to hammer out.

Graphic: Via Vix Central.

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 $4,489.75 low volume area (LVNode) puts in play the $4,515.25 LVNode. Initiative trade beyond the $4,515.25 LVNode could reach as high as the $4,548.75 LVNode and $4,565.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,489.75 LVNode puts in play the $4,464.75 LVNode. Initiative trade beyond the $4,464.75 LVNode could reach as low as the $4,438.25 high volume area (HVNode) and $4,409.00 VPOC, or lower.

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

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

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

Definitions

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

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

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

About

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

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

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

Disclaimer

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