Categories
Commentary

Daily Brief For January 19, 2022

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

What Happened

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

Ahead is data on Building Permits and Housing Starts (8:30 AM ET).

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

What To Expect

Fundamental: Narratives discussed, before, remain valid. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: VIX term structure via Vix Central. 

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

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

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

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

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

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

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

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

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

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

Definitions

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

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

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

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

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

Charm: The rate at which the delta of an option changes with respect to time.

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

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

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

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

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 13, 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 diverged from commodity and bond products. Measures of implied volatility showed signs of bottoming. The dollar continued a plunge. 

Overall, the stance is neutral as the “hottest U.S. inflation in 39 years sets up March rate liftoff.”

Ahead is data on jobless claims and producer prices (8:30 AM ET). The Federal Reserve’s Lael Brainard will have a confirmation hearing (10:00 AM ET), Tom Barkin will speak later (12:00 PM ET), with Charles Evans speaking last (1:00 PM ET).

Graphic updated 5:55 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 consumer price index printed 7%, rising 0.5% from November. 

Much of the increases were attributed to shelter, used vehicles, and food.

With unemployment falling and inflation proving stubborn, monetary policymakers have been emboldened to tighten, raising rates in March and (later) shrinking the balance sheet. 

“In terms of where the Fed is on their dual mandate — inflation and the labor market — they’re basically there,” Michael Gapen, chief U.S. economist at Barclays Plc (NYSE: BCS), said on Bloomberg Television. “I don’t really think anything stops them going in March except one of these kind of outlier events. I think they’re ready.”

Market reaction was muted, mostly, with commodities bearing the brunt of the bullishness.

The calm reaction in equities, ahead of the earnings season, and bonds “showed that there was nothing particularly surprising in the [CPI] report, and that traders were confident that prices already covered the risks,” Bloomberg’s John Authers explained

“Fed funds futures barely budged, leaving a first rate hike in March almost fully priced. As they did before these numbers came out, dealers feel certain that the Fed will hike at least three times this year, while a fourth in December is seen as a 50-50 call.”

Graphic: Via Callum Thomas of Topdown Charts, “With the composite measure of inflation expectations at 40-year highs it’s fair to suggest that the Fed may have some catching up to do as it kicks off the transition away from easing.”

As an aside, there was a big drop in the dollar. In raising rates, currencies ought to attract money. Right? 

“[T]he combination of another really bad inflation number and an insouciant bond market response has been enough to knock the dollar off course. Many factors drive currencies, but this is consistent with a view that the rate hikes already priced in, and supporting the dollar until now, won’t be enough to head off inflation.”

Graphic: Via Bloomberg, “a weaker dollar makes imports more expensive and increases inflation.”

Positioning: On January 7, this commentary suggested metrics of options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side) were positively skewed, even more so than before.

What followed was upside resolve, exacerbated in part by the compression in volatility and unwind of hedges to destabilizing customer options activity (i.e., put buying and call selling).

What now?

Scott Rubner of Goldman Sachs Group Inc (NYSE: GS) had the following to say.

“I am in the process of writing flow-of-funds note for February. My gut tells me to be bearish in February for when the ‘January Inflows’ run out. However, I just re-ran the CURRENT SET-UP for January and the conditions are not in place for a larger correction (>5%). Said another way, I want to be bearish, but this is the consensus. Investors are short, hedges are too big, everyone has on the puts, sentiment is negative (lowest in 86 weeks), I think everyone is already looking for the correction, and this may shift into buying dip alpha.”

So, what does all that mean? 

Demand for downside protection, as already touched on, coincided with customers indirectly taking liquidity and destabilizing the market as the participant short the put sold underlying to neutralize risk.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. For instance, in selling a put, customers add liquidity and stabilize the market. How? The market maker long the put will buy (sell) the underlying to neutralize directional risk as price falls (rises).

Expansion in implied volatility increases the directional exposure of that protection. 

This is good for put buyers and bad for put sellers, simply put. As a result, in weakness, hedging of these contracts pressures markets further, making for violent up and down trade.

Graphic: The “Biggest tail risk to SPX isn’t any macro data/virus/war but its own options market.”

As volatility contracts, however, and underlying prices rise, the directional exposure of protection declines. This is bad for put buyers and good for put sellers. In offsetting this decline in directional risk, counterparties will unwind earlier hedges to bearish customer options activity. 

The unwind of these hedges, as SpotGamma explains, “likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’).”

Couple this flow with strong passive buying support, as evidenced by metrics quoted elsewhere in this newsletter (e.g., DIX), the odds that markets continue to rally (or trade sideways, at least, short-term), in the face of “above-trend growth” and a record year of buybacks, as well as other things, seem good.

Graphic: Taken from The Market Ear. Goldman Sachs’ Scott Rubner: “The GS corporate buyback desk expects a record year for executions of $975B or >$4B per day.”

Technical: As of 5:55 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 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 $4,717.25 low volume area (LVNode) puts in play the $4,732.50 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,756.00 LVNode and $4,779.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,717.25 LVNode puts in play the $4,691.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,674.25 HVNode and $4,643.00 VPOC, or lower.

Considerations: As evidenced by the volume-weighted average price anchored from the release of FOMC minutes (blue color, below), the average buyer, since that, is winning.

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

What People Are Saying

Definitions

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

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

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.

Charm: The rate at which the delta of an option changes with respect to time.

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

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

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

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

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

Rates: Low rates have to potential to increase the present value of future earnings making stocks, especially those that are high growth, more attractive. To note, inflation and rates move inversely to each other. Low rates stimulate demand for loans (i.e., borrowing money is more attractive).

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 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, equity index, commodity, and bond futures were sideways to higher. This is ahead of important Fed-speak; Federal Reserve Chair Jerome Powell speaks at 10:00 AM ET.

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

What To Expect

Fundamental: JPMorgan Chase & Co (NYSE: JPM) strategists led by Marko Kolanovic noted, yesterday, that the selloff is overdone, arguing higher rates would not derail the bull market. 

Graphic: Interest rates relative to Russell 1000 Value/Growth. Via The Market Ear, “Higher bond yields and growth-to-value rotation within equities.”

“The pullback in risk assets in reaction to the Fed minutes is arguably overdone,” Kolanovic said. “Policy tightening is likely to be gradual and at a pace, that risk assets should be able to handle, and is occurring in an environment of strong cyclical recovery.”

An analysis of equity market performance in the face of past rate spikes, suggests Kolanovic’s comments aren’t out of line. 

“We found that while SPX tends to see returns slow in the short term, the NDX and RTY actually tend to outperform on a 1M basis,” Jefferies Group says on S&P 500 (SPX), Nasdaq 100 (NDX), and Russell 2000 (RTY) performance post major rate spikes.

“Looking further out, the NDX (naturally) is the only of the three that flags. The SPX trends back toward its historical return profile and the RTY actually tends to beat the SPX in the intermediate to longer-term”.

Graphic: Taken The Market Ear. Original source Jefferies Group.

Beyond asset price support from a recovering economy, strong growth in business profits, rents, and other income, Moody’s Corporation (NYSE: MCO) believes another reason “financial markets are brushing off QT is that there will still be a lot of excess liquidity—a little less than $1 trillion— when the central bank’s balance sheet does begin to decline.”

This excess liquidity is to shrink, naturally, as the economy grows quicker than the M2 money supply; the Marshallian K – the difference between year-over-year growth in M2 money supply and GDP – which had turned negative late last year (and prompted concerns around liquidity and its impact on the equity market) is now positive.

Graphic: Marshallian K had turned negative late last year. According to Bloomberg, “While stocks kept rising during frequent negative Marshallian K readings in the 1990s, the pattern since the 2008 global financial crisis — a period when the central bank was in what Ramsey calls a “perpetual crisis mode” — begs for caution.”

Notwithstanding, according to Callum Thomas, “[t]he election cycle + decennial cycle (i.e. that ‘years ending in 2’ line) suggest some challenging months ahead… (as opposed to the usual unconditional seasonal pattern).”

Graphic: Taken from Callum Thomas. Source: @mrblonde_macro.

Positioning: Heading into Monday’s session, the broader market was set to experience increased two-way volatility.

That happened. The S&P 500 and Nasdaq 100 explored lower but ended higher yesterday.

What’s next? There’s been a noticeable shift in relative strength. The Nasdaq 100 has firmed, relative to its counterparts, and overnight activity built on yesterday’s end-of-day advance.

At the same time, the VIX term structure, a good gauge of fear, remained upward sloping and volatility (via the Cboe Volatility Index) compressed suggesting a reduction in the demand for protection. 

Graphic: Visualizing the compression in volatility.

All that means is that the opposite of what was expected heading into yesterday happened.

Recall, in demanding downside protection (buying a put), customers indirectly take liquidity as the counterparties hedge their short put exposure by selling underlying. 

Higher implied volatility marks up options delta (exposure to direction) and this leads to more selling, as hedging pressures exacerbate weakness.

Alongside yesterday’s end-of-day rally, lower implied volatility marked down options delta (exposure to direction). This lead to buying by the counterparty.

We can maintain the notion that despite markets tending toward instability so long as volatility is heightened and products (especially some constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).

“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma.

Technical: As of 6:40 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,674.25 high volume area (HVNode) puts in play the $4,691.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as high as the $4,717.25 low volume area (LVNode) and $4,732.50 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,674.25 HVNode puts in play the $4,647.25 HVNode. Initiative trade beyond the latter could reach as low as the $4,629.25 HVNode and $4,593.00 untested point of control (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.

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.

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 10, 2022

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

What Happened

Overnight, equity index futures auctioned lower alongside bonds and most commodities.

Ahead is data on wholesale inventories (10:00 AM ET) and Fed-speak (12:00 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

Fundamental: Improvements in the U.S. labor market and increased hawkishness from the Federal Reserve are some of the factors playing into a recent rotation.

With yields climbing and the 10-year benchmark breaking out toward 2.00%, there’s been a clear move out of growth- and innovation-names to value- and cyclical-type stocks.

Graphic: Via Bloomberg, “Markets face increasing volatility as investors grapple with how to reprice assets as the pandemic liquidity that helped drive equities to record highs is withdrawn.”

This is just as Goldman Sachs Group Inc (NYSE: GS) announced that it expects four interest rate hikes this year (in MAR, JUN, SEP, and DEC) and a balance sheet runoff to begin in July.

“Valuations are at historical highs, companies are raising billions based on fairy dust, and the Fed is signaling a tightening cycle,” said Jason Goepfert of Sundial Capital Research. “All of these are scaring investors that we’re on the cusp of a repeat of 1999-2000.”

Why are higher rates scary? 

Though higher rates are to fend off inflation, they have the potential to decrease the present value of future earnings making stocks (especially high growth) less attractive.

For context, at no other point since the dot-com bubble has so many constituents have fallen while the index was so close to its peak.

Graphic: From Sundial Capital Research. Posted by Bloomberg.

Despite participation continuing to narrow, equities should be able to withstand rate hikes and balance sheet runoff amidst above-trend growth and a looming rebound in some international markets, JPMorgan Chase & Co (NYSE: JPM) adds.

“As long as yields are rising for the right reasons, including better growth, we believe that equities should be able to tolerate the move,” a JPMorgan note said. 

“The rise in real rates should not be hurting equity markets, or economic activity, at least until they move into positive territory, or even as long as real rates are below the real potential growth.”

Positioning: As discussed in Friday’s detailed write-up, bonds and equities are down.

That’s due in part to the bond-stock relationship being upended as a result of monetary tightening to combat inflation.

“At stake are trillions of dollars that are managed at risk parity funds, balanced mutual funds, and pension funds that follow the framework of 60/40 asset allocation.”

As explained Friday, we mention this (broken) relationship as it forces us (participants, in general) to look elsewhere for protection. 

The growing asset class of volatility, so to speak, is that protection. Investors are aware of both the protective and speculative efficiency afforded to them by options and that is the primary reason option volumes are so comparable to stock volumes, now.

If interested, read this primer on “Trading Volatility, Correlation, Term Structure, and Skew.”

With option volumes higher, related hedging flows can represent an increased share of volume in underlying stocks; the correlation of stock moves, versus options activity, is pronounced.

All that means is that we can look to the options market for context on where to next.

According to options modeling and data service SpotGamma (learn more here), the S&P 500, in particular, based on an earlier demand for protection is set up for higher volatility.

“End-of-week compression in volatility, in spite of a high-volatility, negative-gamma regime characterized by dealer hedging that exacerbates movement, sets markets up for instability in case of even lower prices and demand for protection.”

Why? 

Knowing that demand for downside protection coincides with customers indirectly taking liquidity and destabilizing the market as the participant short the put will sell underlying to neutralize risk, participants ought to keep their eye out on whether implied volatility expands or contracts.

All else equal, higher implied volatility marks up options delta (exposure to direction) and this leads to more selling as hedging pressures exacerbate weakness.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book.
Graphic: Per Interactive Brokers Group Inc (NASDAQ: IBKR), VIX futures show little concern; “An inverted curve, or even a flattish one, indicates a shortage of available volatility protection.  We saw that as recently as a month ago, but not now.”

Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

In ending this section, Friday’s put-heavy expiration removed some negative gamma that was adding to instability, at least at the index level. 

Though markets will tend toward instability so long as volatility is heightened and products (especially some constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).

“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma adds.

At present, there’s a push-and-pull; “no-touch” garbage stocks in the S&P and Nasdaq 100 are gaining strength. If this dynamic persists, in light of what was discussed above, what happens?

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

Spike Scenario Still In Play: Spike’s 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).

Spike base is at $4,761.25. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,647.25 high volume area (HVNode) puts in play the $4,674.25 HVNode. Initiative trade beyond the latter could reach as high as the $4,691.25 micro composite point of control (MCPOC) and $4,717.25 low volume area (LVNode).

In the worst case, the S&P 500 trades lower; activity below the $4,647.25 HVNode puts in play the $4,629.25 HVNode. Initiative trade beyond the latter could reach as low as the $4,585.00 and $4,549.00 untested point of control (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.

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.

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.

Charm: The rate at which the delta of an option changes with respect to time.

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

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

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

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 7, 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

Equity index futures auctioned sideways, mostly, ahead of important economic releases such as data on Nonfarm payrolls, the unemployment rate, and average hourly earnings (8:30 AM ET), as well as Fed-speak (10:00 AM and 12:15 PM ET), and consumer credit data (3:00 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

Fundamental: Participants will receive further clarity around payrolls data.

According to Bloomberg, the expectation is that Friday’s jobs report ought to show the addition of about 450,000 workers, last month. 

“[T]he so-called whisper number has already jumped to 500,000,” in light of this “Wednesday’s consensus-busting ADP Research Institute data that showed U.S. companies added the most jobs in seven months.”

This is all the while major equity indices are down on the week, “fueled by one of the most intense bouts of selling by professional speculators since the financial crisis.”

Per Goldman Sachs Group Inc (NYSE: GS) prime broker data, the sale of highly valued growth stocks reached levels not seen in more than 10 years. Selling worsened after minutes to the Federal Reserve’s last policy meeting pointed to faster hikes and balance sheet normalization.

As higher rates are to fend off inflation, they, too, have the potential to decrease the present value of future earnings making stocks (especially high growth) less attractive. 

“A strong [payrolls] print will see the market factor in hikes/quantitative tightening even earlier,” strategists at Mizuho International Plc said. “We’d therefore prefer to be positioned for more equity downside, and for higher yields.”

Positioning: Bonds down, equities down. Interesting, right?

Fresh in my mind is a conversation I had with Karan Sood, CEO and Managing Director, Head of Product Development at Cboe Vest Financial LLC, regarding his firm’s packaged options and volatility targeting strategies that help investors manage their portfolio volatility.

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

“Bonds have been giving you really good returns because interest rates have been going down since the 1970s when they peaked at about 11%,” Sood explained to me. 

“That’s changing now; we’re at the zero bound, and it’s unlikely that will be as a strong of a tailwind. Worse, it could be a headwind if interest rates start to rise.”

As a result of this dynamic, coupled with participants’ increased exposure to rate and equity market risk which can play into cross-market hedging and de-leveraging cascades, 60/40 can be somewhat of a poor hedge.

“Now, with the Fed poised to hike interest rates to combat raging inflation, the bond-stock relationship could be upended,” Bloomberg explains

“At stake are trillions of dollars that are managed at risk parity funds, balanced mutual funds, and pension funds that follow the framework of 60/40 asset allocation.”

Graphic: Via Bloomberg.

Why mention any of this? Well, it forces us to look elsewhere for protection. 

In this case, the growing asset class of volatility, so to speak, is that protection. Investors are aware of both the protective and speculative efficiency afforded to them by options and that is the primary reason option volumes are so comparable to stock volumes, now.

Notwithstanding, with option volumes higher, related hedging flows can represent an increased share of volume in underlying stocks. Therefore, the correlation of stock moves, versus options activity, is more pronounced.

To put it simply, we can look to the options market for clues on where to next, for lack of better phrasing. So, let’s do that!

Wednesday’s session unwound some of the single-stock bullishness (in stocks like Tesla) that fed into the S&P 500, itself; an expansion in volatility coincided with the demand for downside (put) protection and supply of upside (call) protection.

Conditions settled, Thursday. Though positioning metrics had little to offer in terms of predicting movement, implied volatility remained heightened and many products did not expand range.

All else equal, higher implied volatility marks up options delta (exposure to direction). 

Knowing that demand for downside protection coincides with customers indirectly taking liquidity and destabilizing the market as the participant short the put will sell underlying to neutralize risk, participants ought to keep their eye out on whether implied volatility expands or contracts.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book.

Higher implied volatility, higher delta, more selling. Hedging pressures will exacerbate weakness, as a result of real selling (as talked about above), at the index and single-stock level.

Graphic: The “Biggest tail risk to SPX isn’t any macro data/virus/war but its own options market.”

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

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

As stated yesterday, though the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher), markets will tend toward instability so long as volatility is heightened and the market remains in short-gamma territory.

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

Spike Scenario In Play: Spike’s 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).

Spike base is at $4,761.25. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,691.25 micro composite point of control (MCPOC) puts in play the $4,717.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,732.50 high volume area (HVNode) and $4,756.00 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,691.25 MCPOC puts in play the $4,674.25 HVNode. Initiative trade beyond the latter could reach as low as the $4,647.25 and $4,629.25 HVNode, or lower.

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

What People Are Saying

Definitions

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

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

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.

Charm: The rate at which the delta of an option changes with respect to time.

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

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

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

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For December 21, 2021

What Happened

After Monday’s post-options expiration (OPEX) positioning reset, equity index futures traded higher alongside no impactful news developments.

The rate-sensitive and growth-heavy Russell 2000 and Nasdaq 100 led the advance, a change in tone. The S&P 500 was up nearly 1.00% in early trade while volatility came in, markedly, with the CBOE Volatility Index printing 21 versus 27, yesterday.

Ahead is data on the current account deficit (8:30 AM ET).

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

What To Expect

On weak intraday breadth and divergent market liquidity metrics, the best case outcome occurred; responsive buyers surfaced at key areas of resting liquidity.

The response just so happened to coincide with the $4,523.00 /ES untested point of control (VPOC). This technically-sensitive trade seems to suggest that weaker-handed participants, which act on visual cues, are very much in control.

Moreover, the overnight follow-through on that buying resulted in a large gap that places the S&P 500 back in prior range, a clear rejection of Monday’s bearish price exploration.

Graphic: Divergent delta (i.e., non-committed selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: Have to keep it short, today, sorry!

In recapping yesterday’s on-point write-up, the thesis is as follows: divergent breadth, and what remained of “put-heavy” positioning, coupled with recent fundamental developments, fed into lower index prices.

According to the options modeling and analysis service SpotGamma, the December 17 options expiration (OPEX) cleared quite a bit of negative delta (e.g., the ARK Innovation ETF [NYSE: ARKK] had $1.5 billion in notional put delta expire) which, in theory, should open a window of strength and realized volatility, wherein positive fundamental forces and dealers’ covering of hedges would bolster any recovery.

With breadth still to recover, early expansion of range, this week, placed major products at key visual support; to note, responsive buying by short-term, visual traders seldom are defended.

At the same time, presented were dynamics such as the eventual management of big S&P positions, and relentless, seasonally-aligned “passive buying support,” in the face of expectations there will be “the strongest quarterly nominal [economic] growth in more than three decades.”

Graphic: Positively skewed return distribution amidst “natural, passive buying,” and supportive positioning metrics. Data SqueezeMetrics. Graph via Physik Invest.

Data Trek made comments with respect to the path of earnings surprises, a factor behind the persistence of this year’s S&P 500 rally; “This week’s upward revisions should have the same ability to backstop equities as we wrap up the year. The operative word is ‘should’, of course, and we do expect further volatility this week.”

With participants flush with cash, so to speak, will FOMO (fear of missing out) sentiment appear?

Net flows into global equity funds, out of cash equivalents, is one indicator to watch.

Graphic: Via The Market Ear. “Net flows into global equity funds rebounded in the week ending December 15 (+$32bn vs +$11bn the prior week) due to a surge in demand for US-dedicated products. Money market fund assets declined by $40bn.”

Expectations: As of 6:40 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

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

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,590.00 regular trade low (RTH Low) puts in play the $4,623.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,647.25 and $4,674.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,590.00 RTH Low puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,549.00 VPOC and $4,520.00 RTH Low, or lower.

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. Learn about the profile.

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.

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.

Rates: Low rates have to potential to increase the present value of future earnings making stocks, especially those that are high growth, more attractive. To note, inflation and rates move inversely to each other. Low rates stimulate demand for loans (i.e., borrowing money is more attractive).

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 20, 2021

What Happened

Overnight, equity index futures auctioned sideways to lower with growth-heavy and rate-sensitive names bearing the brunt of the move.

This is as Goldman Sachs Group (NYSE: GS) economists reduced their U.S. economic growth expectations, Senator Joe Manchin rejected a $2 trillion tax-and-spending package, hawkish central bank pivots, and rising COVID-19 lockdown risks. 

Ahead is data on leading economic indicators (10:00 AM ET).

Graphic updated 6:40 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

Divergent breadth in less heavily-weighted constituents, and what remains of “put-heavy” positioning, coupled with recent fundamental developments, is feeding into lower index prices.

Graphic: Sentimentrader writes: “Fewer than 65% of NDX stocks are currently trading above their 200-day moving averages. That is a stark change from a year ago when internal trends improved as the NDX marched steadily higher.”

Though the December 17 options expiration (OPEX) cleared positive delta and quite a bit of negative delta (e.g., the ARK Innovation ETF [NYSE: ARKK] had $1.5 billion in notional put delta expire) which, in theory, should open a window of strength and realized volatility, wherein positive fundamental forces and dealers’ covering of hedges would bolster any recovery, the January 21 expiry still carries $1.7 billion in notional put delta.

Continued weakness and higher volatility, among other things, likely solicits dealer hedging of exposure to increasing positive delta; weakness has dealers selling against short-dated, increasingly sensitive negative gamma positioning.

With breadth still to recover, a clear expansion of range places the S&P 500 below its 20- and 50-day simple moving averages, the levels which solicited responsive buying by short-term, visual traders who often lack the wherewithal (both emotional and financial) to defend retests.

Graphic: Monthly charts of the S&P 500 (top left), Nasdaq 100 (top right), Russell 2000 (bottom left), Dow Jones Industrial Average (bottom right). All indices come into major support areas.

Context: “The Fed is seen responding to the inflation fears stalking businesses by leaning toward an older playbook of prioritizing the fight against price pressures — even if that risks weaker growth over the longer term,” per Bloomberg.

Notwithstanding, per Nasdaq, “growth in earnings is so far stronger than the multiple compression caused by rising rates,” and that is what has helped support this year’s rally.

Couple that with the management of massive S&P positions, and relentless, seasonally-aligned “passive buying support,” in the face of expectations there will be “the strongest quarterly nominal [economic] growth in more than three decades,” weakness (especially in growth-heavy and rate-sensitive names) remains.

Graphic: Positively skewed return distribution amidst “natural, passive buying,” and supportive positioning metrics. Data SqueezeMetrics. Graph via Physik Invest.

That’s due in part to some of the dynamics discussed in an earlier section, coupled with some negative fundamental developments like the rejection of an economic stimulus package, cuts to Goldman Sachs Group’s GDP forecasts, among other things.

I end with a note from JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic who expects a year-end rally to be driven by stocks targeted by short-sellers. 

“For short-selling campaigns to succeed, there have to be positioning, liquidity and often systematic amplifiers of the selloff,” Kolanovic wrote. 

“We believe these conditions are not met, and hence this market episode may end up in a short squeeze and cyclical rally into year-end and January.” 

That aligns with light positioning, improving seasonality metrics, and data that suggests equity markets tend to rally into the first hike.

Graphic: S&P 500 performance before and after rate hikes.

Expectations: As of 6:40 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

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

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,548.75 low volume area (LVNode) puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,590.00 regular trade low (RTH Low) and $4,623.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,548.75 LVNode puts in play the $4,523.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,492.25 RTH Low and $4,471.00 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. Learn about the profile.

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, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 7, 2021

What Happened

Overnight, screens went green as equity index and commodity futures auctioned sideways to higher as fears regarding the Chinese economy and omicron were assuaged.

Specifically, China moved to ease monetary policy and studies revealed GSK’s antibody treatment working on the COVID-19 omicron variant.

Ahead is data on the trade deficit, productivity, and unit labor costs (8:30 AM ET), as well as consumer credit (3:00 PM ET).

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

What To Expect

On supportive intraday breadth and divergent market liquidity metrics, the best case outcome occurred, evidenced by an upside gap, expansion of range, and separation of value.

This activity, which marks participants’ willingness to change the trend, is on top of poor structure, a dynamic that adds to technical instability.

Specifically, Monday’s session left a gap and p-shaped emotional, multiple-distribution profile structure (i.e., old-money shorts covering).

Going forward, participants will look to revisit, repair, and strengthen – build out areas of high volume (HVNodes) via the cave-fill process – these areas of low volume (LVNodes).

Graphic: Divergent delta (i.e., non-committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggested current prices offered favorable entry and exit).

Context: COVID-19, China, and U.S. growth, as well as improvements in positioning metrics.

Overnight, there was news that GlaxoSmithKline Plc’s research showed its antibody treatment effective against mutations in the omicron variant.

This came after China’s decision to reduce the cash banks must hold in reserves; the development releases “funds in long-term liquidity to bolster slowing economic growth.”

As noted yesterday, though there is a potential that the U.S. realizes the swiftest tightening in financial conditions since 2005, now, more than during the tech-and-telecom bubble, do rates and earnings growth support current valuations.

At the same time, DIX, which is derived from short sales (i.e., liquidity provision on the market-making side), pointed to “natural, passive buying support,” while negative gamma exposures (i.e., an environment characterized by options dealers hedging their exposure by selling into lows and buying into highs), as a result of increased demand for very short-dated downside protection, left the market prone to destabilizing volatility. 

Graphic: Sensitivity in the VIX term structure, at the front end, suggests heightened activity in shorter-dated protection. As we’re starting to see, once that short-dated protection rolls off the table (and/or is monetized), counterparties/dealers will reverse and support the market, buying to close their existing stock/futures hedges.

Taken together, the distribution of forward S&P 500 returns was skewed positive, heading into Monday’s session.

Subsequent price action, after participants’ powerful responsive buying at the S&P 500’s 50-day simple moving average, which coincided with a large base of resting liquidity at $4,500.00, is follow-through on indices being positioned for a vicious rebound.

Graphic: “[N]atural, passive buying support,” coupled with strong put flows results in positive return distribution. Data via SqueezeMetrics. Graph via Physik Invest.

To tame our expectations, I end with a statement from Morgan Stanley (NYSE: MS) research: 

“We reiterate our view that tapering is tightening for the markets and it will lead to lower valuations like it always does at this stage of any recovery. How much lower? We forecast S&P 500 forward P/Es to fall to 18x, or approximately 12% below current levels. Obviously, for the more expensive parts of the market, that decline will be larger.”

Expectations: 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 upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

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

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,647.25 HVNode puts in play the $4,674.25 micro composite point of control (MCPOC)

Initiative trade beyond the MCPOC could reach as high as the $4,691.25 HVNode and $4,707.00 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,647.25 HVNode puts in play the $4,618.75 HVNode

Initiative trade beyond the latter could reach as low as the $4,581.00 untested point of control (VPOC) and $4,551.75 LVNode, or lower.

Click here to load today’s updated 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. Learn about the profile.

What People Are Saying

Definitions

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

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

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

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.

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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 December 3, 2021

What Happened

Overnight, equity index futures auctioned in-sync, within the confines of yesterday’s recovery. 

This is as participants position themselves for Friday’s data dump that may shed light on how fast the Federal Reserve (Fed) intends to tighten monetary policy.

Ahead is data on nonfarm payrolls, the unemployment rate, and average hourly earnings (8:30 AM ET). Later is Fed-speak by James Bullard (9:15 AM ET), Markit services PMI (9:45 AM ET), as well as ISM services, factory orders, and core capital goods orders (10:00 AM 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

In the face of strong intraday breadth, the best case outcome occurred, evidenced by the recovery of Wednesday’s value (i.e., the prices at which 70% of that day’s volume occurred).

This action negated the knee-jerk selling that coincided with COVID-19 variant news.

As a result, the S&P 500 is back inside of a short-term consolidation; participants had no interest in transacting the S&P 500 on prices advertised below the balance area.

Context: The Fed’s intent to moderate stimulus and uncertainty with regards to how a new COVID-19 variant will impact the global recovery.

In the face of it all, according to Bloomberg, “The market is again pricing June 2022 as the most likely timing for the first Fed rate hike, same as on Nov. 24. At various stages over the intervening days traders looked at July, or even as late as September.”

This is as an emerging trend from the Fed, confirmed by Chair Jerome Powell’s Congressional testimony – for weeks into this most recent equity – resulted in a re-pricing of bond market risk. 

That fear – demand for protection in the bond market – failed to appear in the equity market. 

Instead, there was an insatiable appetite for stocks, according to Bloomberg, with investors pouring more cash in 2021 than in the past 19 years, combined. 

That appetite for risk fed into the activity of some high-flyers like Tesla Inc (NASDAQ: TSLA), and, more recently Apple Inc (NASDAQ: AAPL). At the same time, the broader market was weakening, evidenced by a decline in breadth. 

With indices pinned, heading into the November monthly options expiration (OPEX), as a result of sticky and supportive hedging flows, correlations declined. 

Think about it. If heavily weighted index constituents are higher and the indices are pinned, then something has to give! 

After OPEX, the removal of certain hedging flows had the market succumb to fundamental forces. The addition of participants’ underexposure to downside put protection, according to SpotGamma, resulted in more rampant two-way volatility.

The reason being? The market quickly entered into an environment known as short-gamma. 

“What the heck is that? Please explain to me like I’m ten.” Okay, hold my beer.

Basically, funds holding long equity, in the interest of lower volatility returns, hedge. The S&P 500 is a benchmark and one of the best places to hedge, given liquidity, and so on.

These participants will sell calls against their long equity exposure. The proceeds from that sale will be put toward downside protection. Long equity, short call, long put. Get it?

The counterparty to this dominant positioning is a buyer (seller) of upside (downside) protection, a carry trade (i.e., long delta). 

This exposure is hedged, yes! However, this exposure will also decay, in time, all else equal. 

Volatility will slide down its term structure (vanna) and time will pass (charm); “as volatility ebbs and time passes, the unwind of these hedges brings in positive flows that can lead to lengthy sprints.” – Cem Karsan of Kai Volatility.

Now, within a certain range, said counterparties are, long-gamma also. Gamma is basically “the rate of change of delta per 1-point move in the underlying,” according to SqueezeMetrics.

As volatility and time to expiration decline, the gamma of at-the-money options rises; “option market-makers will hedge their positions in a fashion that stifles volatility (buying into lows, selling into highs).”

There are times, also, when the market is in a short-gamma; a “negative [gamma] implies the opposite (selling into lows, buying into highs), thus magnifying market volatility.”

With participants underexposed to downside protection, post-OPEX demand kicked the market into short-gamma; the conditions worsened when much of the activity was concentrated in shorter-dated tenors where the sensitivity of options to direction is higher, as stated.

Graphic: VIX term structure 11/25. Backwardation signaled an entry into an unstable environment with activity concentrated at the front-end of the curve.

Once that short-dated protection rolls off the table (and/or is monetized), counterparties will quickly reverse and support the market, buying to close their existing stock/futures hedges.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator on 12/2 shows positive options delta trades firing off, which likely had dealers buying stock/futures into the close.

This flow is stabilizing and may play into a seasonally-aligned rally into Christmas as participants see defenses rolled out against the new COVID-19 variant, and the positive effects of pro-cyclical inflation and economic growth, improvements in global trade, and continuity at the Fed, among other dynamics, play out.

We see participants opportunistically buying the dip, already, via metrics like DIX that’s derived from liquidity provision on the market-making side.

Graphic: Earnings are rising and helping support historic PE multiples, via Nasdaq

Notwithstanding, the market is still in short-gamma and unless participants began betting on the upside (i.e., committing increased capital to calls at strikes higher in price and out in time), and we cross over to long-gamma, volatility ought to remain.

To assuage fears, though, here is a quote from Goldman Sachs Group Inc (NYSE: GS): 

“We find that the market has already priced in a significant downgrade in the growth outlook off the back of Omicron concerns. While we don’t believe that the most extreme downside scenarios are fully reflected in current market pricing, there are clearly still scenarios that could prove better than anticipated by the sharp shift in pricing in recent weeks, in our view”.

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,574.25 high volume area (HVNode) puts in play the $4,590.00 balance area high (BAH). Initiative trade beyond the BAH could reach as high as the $4,629.00 untested point of control (VPOC) and $4,647.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,574.25 HVNode puts in play the $4,551.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,526.25 HVNode and $4,497.75 regular trade low (RTH Low), or lower.

Click here to load today’s updated 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. Learn about the profile.

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.

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.

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.

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

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

Rates: Low rates have to potential to increase the present value of future earnings making stocks, especially those that are high growth, more attractive. To note, inflation and rates move inversely to each other. Low rates stimulate demand for loans (i.e., borrowing money is more attractive).

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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

All You Need To Know For November 8, 2021

What Happened

Overnight, equity index futures auctioned sideways to higher alongside an absence in impactful fundamental developments and news catalysts.

Ahead, today, there are no major data releases scheduled.

In the following section, I unpack, in-depth, the fundamental and technical context shadowing recent trade. If you like what is said, consider sharing!
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

On supportive intraday breadth and lackluster market liquidity metrics, the best case outcome occurred, evidenced by a gap and hold of newly discovered S&P 500 prices.

This activity, which marks a potential willingness to continue the trend, coincides with poor structure, a dynamic that adds to technical instability.

Graphic: Divergent delta (i.e., buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY). The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: The aforementioned trade is happening in the context of interesting developments with respect to fiscal and monetary policy, as well as supply and demand imbalances.

To start, in regards to fiscal policy, ARK Invest’s Cathie Wood thinks that there will be no capital gains tax rate increases and an installment of a minimum corporate tax (about 15%). 

“I think that is one reason the market’s been rallying,” she said in an episode of In The Know

In sticking with Wood’s theses, why would the market be rallying if all that we (i.e., the market participants) see, in the news, is heavily focused around fears of inflation, so to speak? It wouldn’t; Wood feels that inflation is on its way out.

Major reasons? 

(1) Productivity increases will offset dented margins and therefore not lead to impactful price increases; (2) turmoil, with respect to China’s housing and financial sector, ought to depress commodity pricing further as “when China has caught a cold, commodity prices get pneumonia”; (3) at-home inventory build-ups may takeaway from consumption during the holidays (for which businesses are scrambling to increase inventories), and this ultimately should be reflected in commodity prices, given excess inventory; (4) disruptive innovation and declining cost curves.

“The markets are conflicting,” she explains. “You’ve got energy and financials at the top for the year, 54% and 35%, respectively. Those two sectors are associated with very strong boom time economies with a yield curve steepening, meaning long rates are rising faster than short rates.”

“That would be consistent with inflation, but the other two top-performing sectors are real estate and consumer discretionary, and those do not benefit from inflation. They benefit from inflation coming down and lower interest rates.”

The bond market, on the other hand, is in the lower inflation camp. At the same time, the dollar is going up alongside assets like bitcoin, often construed as an inflation hedge.

“Could this mean that the velocity of money is going down,” she asks. “Velocity of money has been coming down because people have been saving and putting money into assets.”

This dynamic is supported by disappointing GDP figures with growth coming mostly from inventories; “Real final sales were slightly negative. Could it be … that [millennials] would prefer not to spend on goods and services, but to invest?”

It seems that participants are increasingly extending moneyness to nonmonetary assets – given monetary policies and an environment of debt and leverage that ultimately cuts into asset price volatility – adding to the prevailing risks of carry when volatility does rise and the demand for money pushes deflation.

A great explainer on the growth of global carry is the book titled The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis.

“Ivy Zelman of Zelman Research came out this week. She made a fantastic call on the housing bubble and bust starting in 05-06, and she was right, just a little early. She is very concerned that the housing prices we’re seeing right now are not sustainable,” because of speculation, as well as iBuying and private equity participation. 

For instance, just last week, Zillow Group Inc (NASDAQ: Z), a major iBuyer, sought to raise liquidity, dumping properties en masse.

“This is unsustainable … and I’m wondering if even the housing market inflation is going to give way, here,” Wood added. 

That leads to the question: what effects will a taper and the eventual reduction in the Federal Reserve’s balance sheet – a removal of liquidity – have?

Thus far, given monetary frameworks and max liquidity, markets rallies have been enforced by some of the processes embedded within the volatility market

To quote Cem Karsan of Kai Volatility: “There’s this constant structural positioning that naturally drives markets higher as long as volatility is compressed, or there’s a supply of volatility.”

“As volatility is compressed, … the hedging vanna and charm flows, and whatnot will push the markets higher,” Karsan added in reference to options sliding down their term structure (vanna) and skew decaying (charm). Both dynamics have counterparties covering their hedges to the most dominant customer positioning in the market (i.e., short call, long put). 

With option volumes now comparable to stock volumes, related hedging flows can represent an increased share of volume in underlying stocks; “It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration. These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”

Learn more about the implications of convexity, edge, and risk management, as well as Liquidity Cascades: The Coordinated Risk of Uncoordinated Market Participants.

Aside from a lot of these big picture dynamics – growing derivatives markets and tail risk, the heightened moneyness of nonmonetary assets, trends in seasonality, earnings surprises, and more – we have some more impactful near-term happenings to be aware of.

Graphic: “Whenever the market has been up 20%+ YTD through to October (like e.g. THIS YEAR), it has *always* had an up month in November (albeit with a n=8). Basically I would say it speaks to the momentum in the market, which despite the September stumble seems pretty much alive and well.” – Callum Thomas

The first is fragile positioning. The second is the monthly options expiration (OPEX). 

According to SqueezeMetrics analyses, “middling dark pool sentiment and middling gamma exposure [portends] … 1-month negative returns.”

Alongside that, according to data compiled and analyzed by Pat Hennessy, “2 weeks prior to OPEX (e.g., 7/30/21 to 8/6/21 in this late-cycle) [have] been extremely bullish,” while “OPEX week returns peaked in 2016 and have trended lower since.”

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

This comes as investors marked the S&P 500 up to the $4,700.00 strike, at which positive gamma – delta sensitivity to underlying price – is highest. 

In referencing a note I wrote for SpotGamma, “as volatility continues to decline, the gamma of those options, which are now at the money, ought to increase, forcing counterparties to supply more liquidity.”

Ultimately, $4,700.00 ought to be a magnet (or resistance) into that aforementioned pre-OPEX weakness.

This is unless (1) volatility declines markedly, “a tailwind for the S&P complex as options slid[ing] down their term structure would cause dealers to continue covering their hedges in an asymmetric manner,” or (2) more capital is committed to options at higher strikes. 

Graphic: SpotGamma shows large positive gamma at the $4,700.00 strike. “Large options strikes are considered to be support or resistance zones. The change in gamma at various levels over time can shed light on how traders are viewing the market (i.e., adding calls is bullish, puts bearish).”

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

Market Is In Balance: Current prices offer favorable entry and exit. Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

In the best case, the S&P 500 trades sideways or higher; activity above the $4,674.75 visual low (likely paid attention to by short-term, technically driven market participants who seldom defend retests) puts in play the $4,711.75 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,722.00 and $4,735.00 Fibonacci, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,674.75 visual low puts in play the $4,663.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as low as the $4,619.00 VPOC and $4,590.00 balance area boundary (BAH), or lower.

As an aside, the $4,674.75 visual low corresponds with the volume-weighted average price (VWAP) anchored at last week’s Federal Open Market Committee (FOMC) meeting. 

This is 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.

Click here to load today’s updated 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. Learn about the profile.

Definitions

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure. In recent history, this reset in dealer positioning has been front-run; prior, there was an increase in volatility after the removal of large options positions and associated hedging.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.