Categories
Commentary

Daily Brief For November 23, 2022

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Graphic updated 6:45 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Team, it’s been insane on my end. Physik Invest’s Daily Brief will be paused through the end of this week (November 24 and 25). Wishing you happy holidays!

Hopefully, clearer notes and consistent releases to resume, after the break.


Crypto Turmoil Persists:

The FTX (CRYPTO: FTT) debacle has induced even more illiquidity.

Bloomberg’s Matt Levine wrote that the fall in liquidity “has been dubbed the ‘Alameda Gap,’” noting that “[p]lunges in liquidity usually come during periods of volatility as trading shops pull bids and asks from their order books.”

Turmoil and Opportunity:

You may take advantage of the aforementioned uncertainties through arbitrage (i.e., buy at a lower price at one venue and sell at a higher price at another venue). Notice the ~$500 spread on BTC/USDT, for instance.

Graphic: Retrieved from Shift Search at 6:53 AM ET on November 23, 2022.

Elsewhere, the Grayscale Bitcoin Trust (OTC: GBTC) is trading at a ~43.00% discount to the value of the Bitcoin (CRYPTO: BTC) it holds.

Per Bloomberg, “US regulators have repeatedly denied applications to convert GBTC into a physically-backed exchange-traded fund,” and that means the fund is not “able to redeem shares to keep pace with shifting demand.”

To note, the discount pales in comparison to the 101.00% premium to the net-asset value achieved in December 2017. The average net-asset value is a 12.00% premium.

Graphic: Retrieved from Bloomberg.

Anyways, in greater detail, we discussed the crypto turmoil on November 9 and 10. Those notes may be of interest if the context is desired. Though this is not a crypto-focused letter, crypto is “tied up in the liquidity bubble that exists across all assets.”

Graphic: Retrieved from Physik Invest’s Daily Brief posted on November 10, 2022.

As an example, during the week of November 8, when the narrative surrounding FTX’s demise was at its peak, the S&P 500 (INDEX: SPX), Bitcoin (CRYPTO: BTC), and FTX Trading token (CRYPTO: FTT) slid lower, bottomed, and rallied in sync.

Uncertainty, Correlation, and Positioning:

This is a part of the letter that may appear somewhat similar. We continue carrying forward and building on past analyses.

At its core, breakages in correlations some may have observed are accentuated by positioning forces we have talked about recently, as well as the above. These forces are important as you may have noticed the S&P 500’s tendency in responding to areas quoted by this letter.

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

In a nutshell, in light of a “de-grossing of ‘shorts’” per Nomura Holdings Inc (NYSE: NMR), the sale of the volatility investors owned, after events such as elections and CPI, boosted markets indirectly (i.e., counterparty exposure to risk declines as the market rises and investors sell volatility → counterparty reduces the size of their negative Delta hedges → this reduces market pressure and bolsters a rally).

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

Investors’ continued supply of protection, all the while markets were rising, resulted in further indirect support and, later, prompted responsiveness to key areas at which the options activity was concentrated. This was better detailed on November 16 and 18.

Graphic: Retrieved from Bloomberg.

While this activity is happening – the S&P pinning – underlying constituents are swinging far more amid traders’ own “uneasiness” in stocks and the crypto turmoil; if there are forces pinning and supporting the S&P, all the while there are constraints connecting it to wild(er) components, then something (e.g., correlation) has to give.

Expecting More Of The Same For Now:

Nonetheless, it’s likely for this wild activity under the surface to continue, and for the S&P 500, itself, to be the recipient of even more supportive flows.

For example, the buyback related to the pulled-forward decay of options’ Delta with respect to time (Charm) and continued sale of volatility (Vanna), in a lower liquidity environment, likely results in hedging flows enforcing seasonality and masking the wild(ness) mentioned above.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via The Market Ear.

Risks Building Under The Surface:

However, what is happening right now may set the stage for persistently high realized volatility (RVOL) when something bad does happen and those flows we talked about do less to resist that underlying volatility and weakness.

To explain, implied volatility (IVOL) has performed poorly in the context of 2022’s far-reaching decline. That’s in part the result of proactive hedging and monetization of protection (i.e., supply) into the decline.

Graphic: Retrieved from Bloomberg. Measures of equity IVOL tame relative to bonds and FX.

Investors, with IVOL performing poorly, are pushed into better-performing strategies. That includes selling IVOL which does less and less to boost the markets more and more (i.e., per SpotGamma, “the marginal impact of added volatility compression is far lower” at this juncture).

Accordingly, the market is left in a more precarious, less well-hedged position, and that’s concerning given some of the cracks that have appeared including the Credit Suisse Group AG (NYSE: CS) debacle covered in October, the UK liability-driven investment funds covered in September, interest rate swap risks, and beyond.

SCT Capital’s Hari Krishnan talked about some of these risks on a recent podcast.

In Essence, It’s Cheap To Hedge:

According to SpotGamma, “if you wanted to hedge, … it is historically cheap.”

Graphic: Cboe VVIX (INDEX: VVIX) measuring the expected volatility of the 30-day forward price of the VIX. Retrieved from TradingView. Via SpotGamma: “The VVIX is a naive check of participants’ exposure to the volatility of volatility itself (i.e., the non-linear sensitivity of an options price to changes in volatility or Vega convexity). This goes back to the point about the marginal impact of much more volatility compression; the marginal impact of volatility (expansion) compression would have a (bigger) smaller impact, comparatively.”

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma or positive exposure to directional movement).

When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga or positive exposure to IVOL changes).

If there’s a large change in direction (RVOL) or IVOL repricing, you may make money.

As an example, in mid-June, a trading partner and I noticed a change in tone in the non-linearity of volatility and skew with respect to linear changes in the price of the market (or S&P 500). The prices of ratio spread structures (i.e., long or short one option near-the-money, short or long two or more further out-of-the-money) changed by hundreds of percent for only a few basis points of change in the indexes.

At the time, Kai Volatility’s Cem Karsan noted this was “a spike in short-dated -sticky skew, [the] first we’ve seen since [the] secular decline began and it hints [at] a potentially critical change in dealer positioning [and] the distribution of underlying outcomes.” 

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

So why does any of this matter?

In essence, it’s cheap to hedge and the context is there for you to do so, at least from a volatility (not directional) perspective. 

Here is an excerpt from Mohamed Bouzoubaa et al’s book Exotic Options and Hybrids to support some of the earlier statements.

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” Bouzoubaa et al explain. “ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.” 

In other words, by owning protection that’s far from current prices, you are positioned to monetize on a non-linear repricing of volatility, something we saw earlier this year and may continue to see.

Doing this in a manner that cuts decay (when nothing happens) is the difficult part.

Calendar and diagonal spreads come to mind (i.e., sell a short-dated option and buy a far-dated option). You are betting against movement (negative Gamma) over a span of time you don’t think the market will move (e.g., Thanksgiving). And, you are betting on movement (positive Gamma) over a larger span of time (e.g., after Thanksgiving) where decay may not be as accelerated.

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

Ultimately, counterparties’ response to new demands for protection, if something bad happens later, would exacerbate movement and aid in the repricing of IVOL.

At that new IVOL level, there would be more stored energy to catalyze a rally and this letter would express that.

To sell downside volatility (or puts) at this juncture (with time) is a poor trade. To sell downside volatility as part of a larger, more complex structure could be a good trade (e.g., sell a call spread to finance an ultra-wide SPX put ratio spread).

It all depends on structure and management.

Technical

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

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

Key levels to the upside include $4,027.00, $4,051.00, and $4,069.25. 

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

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

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

Definitions

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

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

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

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


About

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

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

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

Contact

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

Disclaimer

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

Categories
Commentary

Daily Brief For November 8, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1,200+ that read this report daily, below!

Graphic updated 9:15 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

This letter’s author is ramping up coverage and returning to speed after a short hiatus. Today’s focus will be on adding to the “Positioning” section of Monday’s letter.

Positioning

After some late-October weakness that is coinciding with the Federal Reserve’s (Fed) decision to raise rates, stocks are tame. This is heading into midterm elections, today, and inflation updates, Thursday.

Graphic: Retrieved from Bloomberg. Created by JPMorgan Chase & Co (NYSE: JPM).

Republicans are likely to add to their control of the House and Senate.

Having fewer Democrats in Congress would lower “the odds of fiscal measures [that would] embolden a hawkish Federal Reserve.” 

This is a boon for stocks.

Graphic: Retrieved from Bloomberg. “With things looking that bad, current polls show the Democrats appear to be headed for a drubbing, almost certain to lose control of the House and increasingly likely to see the Senate slip away.”

Indeed, Wells Fargo & Co (NYSE: WFC) strategists found a “GOP-controlled Senate historically is associated with superior equity returns.”

Graphic: Retrieved from Wells Fargo & Co (NYSE: WFC).

In spite of recessions, even, the S&P 500, a year after midterms, often netted positive 20% or so returns Citigroup Inc (NYSE: C) strategists add.

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

A post-election bump is on top of the general positiveness of equity performance during the earnings season and periods of strong pessimism as we have today.

Graphic: Retrieved from Mr. Blonde’s Stuck in the Middle letter.

Why all the potential positivity over this short period?

The aforementioned events are happening during a period wherein market liquidity eases (i.e., the holiday season).

It’s during this period, from a positioning perspective, the effects of decay (which we discuss more below) accelerate, and a lack of liquidity, according to Kai Volatility’s Cem Karsan, makes markets sensitive to positive-leaning flows.

Pessimism and hedging may indirectly give rise to bullishness. Why is that?

Demand for options exposures, especially across shorter time horizons, evidenced by heightened implied volatility (IVOL) at the front end (see below), has indirectly added to the pressures of de-grossing, as observed.

Graphic: Retrieved from Bloomberg.

Though positioning is generally thin, as we also talked about in yesterday’s newsletter, thus reducing the impact of the hedging of this positioning, demand remains “strong,” per Karsan, and “dealers are short that volatility.”

Derivatives strategists at the likes of the Royal Bank of Canada (NYSE: RY) agree with Karsan’s remarks; Amy Wu Silverman said that the Cboe Volatility Index’s (INDEX: VIX) elevation was the result of demand for hedges after October options expiry.

“Part of today’s move at least is a function of new positions. There is likely demand for future months since we just went through October options expiry,” she said. “Part of it is a function of the ‘floor’ of a new volatility regime.”

So, what’s the point to make?

For IVOL measures to remain wound, something bad needs to happen, in short.

Otherwise, per SpotGamma, a “decline in IVOL … can aid in a push-and-pull that actually serves to … resist far-reaching weakness” and keep selling orderly.

That’s because, from here, the removal of the protection that’s been demanded in the past days and weeks compounds the sped-up effects of Charm.

Graphic: Retrieved from SpotGamma. SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility (Vanna) and time change (Charm), hedging ratios change. The graphic is for illustrational purposes, only.

Charm, which is the change in options Delta (i.e., exposure to direction) with respect to changes in time, “drives a positive window or seasonality”; “the reduction in time” and “lack of liquidity” make markets more sensitive to those positive flows.

Graphic: Retrieved from SqueezeMetrics.

In the long term, however, weakness is here to stay. Poor IVOL performance and little skew also likely set the stage for a post-holiday tail. More on this, later.

Graphic: Retrieved from Corey Hoffstein on Twitter.

Technical

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

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

If above the $3,806.25 LVNode, the $3,845.00 VPOC is in play. Initiative trade beyond the latter could reach as high as the $3,874.25 HVNode and $3,909.25 MCPOC, or higher.

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

If above the $3,806.25 LVNode, the $3,787.00 VPOC is in play. Initiative trade beyond the latter could reach as low as the $3,727.00 and $3,685.00 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.

Considerations: Futures tied to the S&P 500 are trading within close proximity to a blue line in the above graphic. This blue line depicts a volume-weighted average price (VWAP) anchored to price action following the release of consumer price data on September 13, 2022.

The VWAP metric is highly regarded by chief investment officers, among other participants, for the quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

Should the S&P 500 auction away from this level, and come back to it, a prudent response is to fade. If the price is above the VWAP, and it auctions lower, into the VWAP, traders would buy. On the other hand, if the price is below the VWAP, and it auctions higher, into the VWAP, sell.

At this time, the S&P 500 is near VWAP offering traders lower (directional) opportunities.


Definitions

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

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

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

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.


About

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

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

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

Disclaimer

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


Categories
Commentary

Market Commentary For The Week Ahead: ‘Hello, Goodbye’

Key Takeaways:

What Happened: Coming into the extended holiday weekend, on tapering volumes, U.S. index futures balanced for four regular trading sessions (9:30 AM – 4:00 PM ET), before breaking out.

Pictured: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures

What To Expect: Thursday’s session found initiative buying surface above the $3,731.00 high-volume node (HVNode), the market’s most recent perception of value.

Given four-sessions worth of unchanged value, and the failure to fill the gap beneath a weak low (i.e., a visual level that attracts the business of short-term, technically-driven market participants) at $3,714.50, participants will come into Monday’s session knowing the following:

  1. Amid Thursday’s late-day buying, price diverged from value.
  2. The overnight rally high at $3,747.75 was recovered (i.e., based on historical trade, there were low odds that the overnight all-time high would end the upside discovery process).
  3. The multi-month upside breakout targeting S&P 500 prices as high as $4,000.00 remains intact.

In light of the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 remains above its $3,731.00 HVNode. Expectations thereafter include continued balance, or a response followed by initiative buying to take out the price extension at $3,756.75.

In the worst case, the S&P 500 initiates below its $3,731.00 HVNode. Expectations thereafter include a test of the weak, minimal excess low at $3,714.50, and subsequent follow-through as low as the $3,691.00 break-point. 

Noting: Excess forms after an auction has traveled too far in a particular direction and portends a sustained reversal. Absence of excess, in the case of a low, suggests minimal conviction; participants will cover (i.e., back off the low) and weaken the market, before following through.

Two go, no-go levels exist; trade that finds increased involvement above $3,752.75 and below $3,714.50 would suggest a change in conviction. Anything in-between favors responsive trade.

Conclusion: From an uneven recovery, stimulus, elections, trade, and the like, it helps to boil it down to what actually matters: price and value. 

Though risks remain, markets are pricing in the odds of a continued rebound. All broad-market indices are in an uptrend. A break below $3,600.00 in the S&P 500 would denote a substantial change in tone.

Pictured: Retest of the upside breakpoint on a weekly candlestick chart of the cash S&P 500 Index

Levels Of Interest: $3,752.75 rally-high, $3,714.50 weak low, $3,731.00 HVNode, $3,756.75 price extension, $3,691.00 break-point.

Bonus: Here is a look at some of the opportunities unfolding.

Photo by Max Walter from Pexels.