Categories
Commentary

Daily Brief For June 30, 2022

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

What Happened

Overnight, equity index and commodity futures auctioned lower while bonds, the dollar, and implied volatility metrics were bid at the tail-end of the quarterly rebalancing period.

Participants have bet on a half-point rate cut in 2023 amid heightened recession odds, all the while the projected target rate sits in the range of 2.25-2.50% for the July 27, 2022 meeting.

Pursuant to this letter’s remarks in the days prior, trades biased long volatility are performing well, particularly those structured a standard deviation and beyond prior prices. We’ll unpack why that is, today.

Ahead is data on PCE inflation, disposable income, and consumer spending, as well as jobless claims (8:30 AM ET) and Chicago PMI (9:45 AM ET).

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

What To Expect

Fundamental: Discussed in recent letters were the prospects of whether a recession would be necessary for stemming inflation.

Read: The Fed needs to remove the heat from the demand without prompting an accident among mortgage financiers.

Graphic: Via Bloomberg. “[W]hat’s happened to mortgage-backed bonds this year is a radical departure. Bloomberg’s index dates back to 1988 when the asset class was still in its infancy. This is the first time it has ever withstood a decline that stretches into double figures.”

“That’s the message the market took,” Bloomberg’s John Authers explained. “[T]he most painful surprise over the second half of this year would be for inflation to stay sticky.”

“That would quash the belief in a swift easing campaign in 2023.”

Graphic: CME Group Inc’s (NASDAQ: CME) FedWatch Tool.

Some, like the Federal Reserve’s (Fed) Loretta Mester, suggest that gone are the days to err on the side of being too accommodative.

“It also calls into question the conventional view that monetary policy should always look through supply shocks,” Mester said. “In some circumstances, such shocks could threaten the stability of inflation expectations and would require policy action.”

Graphic: Via Bloomberg. “The Richmond Fed’s survey of manufacturing isn’t generally one of the most closely monitored releases, but as this one was the worst since the Great Recession (barring only one month during the Covid shutdown), it garnered more attention than usual.”

Moreover, the Fed’s preferred inflation measure – the personal consumption expenditure deflator (PCE) – is set to update. The expectation is that core PCE drops, “thanks to base effects from last year,” bolstering the “narrative that inflation will soon be licked.”

Graphic: Via Bloomberg.

Positioning: Discussed, earlier this week, was whether it made sense to lean toward owning volatility, rather than selling it outright.

A “higher starting point” in implied volatility (IVOL), and a still-present right-tail (from the positioning for a bear market rally), made it so we could position, for less cost, in short-dated structures with asymmetric payouts, on both sides of the market.

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

For instance, S&P 500 (INDEX: SPX) spreads +1 (near-the-money) x -2 (out-of-the-money), in excess of 200 points or so in width and up to 15 days to expiration, are performing well, today, pricing in excess of a 600% gain, only after pricing for little to no cost to enter in the days prior.

Disclaimer: Have delta in the direction you want the market to move, as well as positive gamma. In our case, we wanted negative delta (short bias) and positive gamma (profits amplified).

Graphic: Via Glyn Holton. “Positive gamma corresponds to curvature that opens upward. Negative gamma corresponds to curvature that opens downward.”

Recent market weaknesses will allow us to monetize and rotate those proceeds into speculative directional bets on the call-side, potentially. After all, the money is made in not losing it. Stay nimble. These are not trade recommendations. Be open-minded.

Graphic: Via Pat Hennessy. “[T]he performance of short-dated 1×2 put ratios in SPX this year. Despite being short the tail, the grind lower has been well captured by this trade structure.”

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

In the best case, the S&P 500 trades higher; activity above the $3,770.75 HVNode puts in play the $3,793.25 Ledge. Initiative trade beyond the Ledge could reach as high as the $3,821.50 LVNode and $3,840.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,770.75 HVNode puts in play the $3,735.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,722.50 LVNode and $3,696.00 LVNode, or lower.

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

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

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

Definitions

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.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 16, 2022

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

What Happened

Overnight, equity index futures took back the post-Federal Open Market Committee (FOMC) bump. Bonds and most commodity products (less gold) followed suit. 

The Federal Reserve (Fed) admitted to run-away prices and committed to slaying inflation via tougher action. Accordingly, the central bank upped interest rates by 75 basis points. This was the largest increase since 1994 and, as the Fed commented, another 75 basis point hike may be in store at the next meeting in July.

In other news, the Celsius Network (CRYPTO: CEL), a crypto favorite that amassed in excess of $20 billion in assets, froze withdrawals to stop what some say was a potential bank run. Private equity is facing a so-called “crisis of value” given over inflated prices in that market. 

We shall unpack the latter, below, a bit.

Also, U.S. retail sales posted their first drop in five months, the Bank of England raised its rates along with the Swiss central bank which surprised with its first hike since 2007.

This is all the while Goldman Sachs Group Inc’s (NYSE: GS) buyback desk was flooded with volumes about 3 times last year’s daily average. This could be construed as companies viewing the latest selloff as an “opportunity to repurchase shares rather than retrenching.”

Ahead is data on jobless claims, building permits, housing starts, as well as the Philadelphia Fed’s manufacturing index (8:30 AM ET).

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

What To Expect

Fundamental: Fed funds rate upped 75 basis points. 

Now, it appears the rate will surpass 3% after the FOMC affirmed its commitment “to returning inflation to its 2% objective.” Participants reacted, pricing in the potential for a rate peak in the range of 4.00-4.75% early-to-mid 2023, after which the easing cycle is to likely take place.

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool.

The overnight rate is expected to peak near 4.23% by mid-2023. This is a given via a quick check of the Eurodollar (FUTURE: /GE) futures curve, a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around March 2023 (previously it was June).

For context, the price of /GE reflects the interest offered on U.S. dollar-denominated deposits at banks outside of the U.S. With that, they’re “expressed numerically using 100 minus the implied 3-month U.S. dollar LIBOR interest rate,” per Investopedia. This means that at current March 2023 prices (95.775), this reflects an implied interest rate settlement rate of 4.225%.

Read: The shift from the Eurodollar to SOFR is accelerating as “SOFR adoption cracked 50%.”

Moreover, the FOMC’s forecasts for inflation have moved all the while predictions for 2023 and 2024 have not. 

Graphic: Via FOMC. Taken from Bloomberg.

GDP growth estimates, too, have shifted but with the expectation there still will be growth.

Graphic: Via FOMC. Taken from Bloomberg.

As stated in this morning’s introduction (above), these policy adjustments are inflicting damage on some inflated areas of the market like crypto and private equity.

Recall that prevailing monetary policies made it easier to borrow and make longer-duration bets on ideas with a lot of promise in the future. Central banks, too, underwrote losses of this regime and encouraged continued growth. This had consequences on the real economy and asset prices which rose and kept deflationary pressures at bay.

As well put forth in our May 18, 2022 commentary, the recent market rout is a recession and the direct reflection of the unwind of carry. Capital was “misallocated” and the Fed’s move to control price stability is “completely unreasonable” as they’re not in a position to do it “without bringing down the markets,” per Kai Volatility’s Cem Karsan.

Read: Kris Abdelmessih’s Moontower #148 on prevailing macroeconomic perspectives.

As Lyn Alden of Lyn Alden Investment Strategy put forth, “unfortunately for the Fed, the U.S. economic growth rate is already decelerating” and, to cut inflation, it must reduce demand for goods. Indeed, this is recessionary and is already reflected by slowing retail sales.

Graphic: Via Bloomberg. “As price pressures become more entrenched in the economy, spending will likely ebb either due to higher prices, higher interest rates, or both.”

As Bloomberg explains, spending has shifted and is supported by consumers spending down their savings and leveraging credit cards. 

Read: Klarna’s debt costs rise as buy-now-pay-later sector suffers.

Graphic: Via Bloomberg. This “could be concerning if Americans fail to keep up on payments. That could ultimately mean a slowdown in the pace of inflation-adjusted consumption.”

“If this credit bubble ever pops, it’s going to be the most catastrophic market failure that anyone has ever read about — but let’s hope that doesn’t happen,” Mark Spitznagel, Miami-based Universa’s CIO, said in early June. “We’ve gotten ourselves into a tough spot.” 

Perspectives: “The move in markets prices in more than enough recession risk, and we believe a near-term recession will ultimately be avoided thanks to consumer strength, Covid reopening/recovery, and policy stimulus in China,” JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic and his team said

Positioning: Measures of implied volatility had come in, yesterday, and that was significant in that participants have a lot of exposure to put options.

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

Further, (naively) we see it as liquidity providers being short those puts. As volatility continues to come in, the exposure of those options to direction (delta) compresses. 

As a result, liquidity providers cut some of their negative (static) delta hedges to that positive delta put position.

Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”

This means that the potential options expiration (OPEX) related bullishness, so to speak, was pulled forward and, now, markets, being markedly lower than they were immediately after the FOMC event, are at risk of trading into (and below) the sizeable interest down below.

Read: Daily Brief for June 15, 2022.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). Updated 6/15/2022.

As stated, yesterday, these options, down below, have little time to expiry and, thus, their gamma (options sensitivity to direction) grows rather large, at near-the-money strikes.

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

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

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

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

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

Ultimately, if lower, all else equal, the June 17 OPEX will coincide with the removal of the in-the-money options exposures in question. This opens a window during which markets may have less pressure to rally against.

Bonus: As SpotGamma explains, “​​[g]iven the supply and demand of volatility, as well as divergences in the volatility that the market realizes and implies from options activity, there’s a case to be made for maintaining positive exposure to direction via long volatility.”

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

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

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

In the best case, the S&P 500 trades higher; activity above the $3,688.75 HVNode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as high as the $3,773.25 HVNode and $3,808.50 HVNode, or higher.

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

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

What People Are Saying

Definitions

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 14, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-higher, along with bonds, snapping the pricing in of tighter monetary policies and economic slowing.

Creeping up are expectations regarding the amount of tightening policymakers are to add. Treasury yields had their biggest jump in decades. U.S. 3-year Treasury yields, in particular, were up 25 basis points, to 3.49%, the highest since 2007, per Bloomberg.

Now, traders see nearly 200 basis points of tightening by the Federal Reserve’s (Fed) by September, as well as the possibility of a one-off 75 basis point hike. The overnight rate is expected to peak near 4% by mid-2023.

Accordingly, the U.S. and European real estate values have taken a hit amid rising rates and inflated prices, falling 5-10%. Rental demand has thinned, also. 

In other news, the U.S. sought to boost supplies of Russian fertilizer as “sanctions fears have led to a sharp drop in supplies, fueling spiraling global food costs.”

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: In what seems to be “a coordinated attempt to guide the market through trusted journalists,” recent updates on the path of inflation may push policymakers to surprise markets.

Graphic: Via Tier1Alpha. “A disappointing CPI suggested that calls for inflation peaks were premature and now markets are trying to interpret Powell’s (and Lagarde’s) true intentions.”

Markets reacted, accordingly, pricing in a near-certainty of a 75 basis point hike, later this week.

Graphic: Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. In one session, participants priced in a near-certainty of a 75 basis point hike.

Looking into the future, Fed Funds target rates, based on the Fed Fund futures contract prices, are projected to peak into the mid-next year (Spring/Summer 2023).

Graphic: Via CME Group Inc’s FedWatch Tool

Accordingly, Treasury market turmoil continued with liquidity “worse than it was leading up to Lehman,” says Christian Hoffman, a portfolio manager for Thornburg Investment Management.

“That creates even more risk because if the market doesn’t have liquidity, it can gap down very quickly.”

Graphic: Via Bloomberg. Taken from @DonutShorts. This could “be a sign of another shortage of collateral and that another systemic risk event might come up in the future,” as Fabian Wintersberger well explained in his newsletter.

As talked about in past newsletters, pressures in the financial system, all the while the economy is slowing, are rising. This is amidst a dash for cash as fixed income and equity markets are not perceived to be as safe.

Graphic: Via Bloomberg. “Two-year US Treasury yields surged 29 basis points as bond prices tanked, … the biggest two-day increase since 2008, a sign of just how rapidly traders are adjusting where they think the Federal Reserve will take interest rates.”

“People are trying to process what’s behind these large moves,” Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA (OTC: SCGLY), said. She attributes some of the volatility to poor liquidity, panic selling, and margin calls.

Ultimately, according to Bloomberg’s John Authers, this is a tantrum the Fed is likely to let “rip for a while” before, potentially, suffocating “with more easy money.”

“The relationship between central banks and bond markets is, as I’ve said before, a lot like that between a parent and an angry toddler. Indulging the bond market early last year might prove a critical mistake in losing parental authority for the Fed.”

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. MS’s Mike Wilson says: “From our vantage point, both rates and ERP appeared to be mis-priced [and] we think the S&P 500 is headed toward 3,400 before a more tradable low is in.”

Positioning: Last night, as I wrote a report for SpotGamma’s subscribers, noteworthy is how “subdued” volatility was with, recently, “realized outpacing that which is implied by participants’ options activity.”

That dynamic resolved, Monday, as implied (IVOL) finally retook that which is realized (RVOL).

Read, also, the Daily Brief for Monday, June 13, 2022.

Graphic: Via Robson Chow.

Moreover, for much of the session, the equity markets were range-bound as most of the movement in both equity and volatility markets happened overnight. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for ES (SPX + SPY). Via SpotGamma, “Into weakness, participants mainly sold puts (a bullish trade). Into strength, they bought puts (a bearish trade). Throughout the session, too, there was light call buying (a bullish trade). This helps with understanding why the VIX moved much less during the day session.”

Noteworthy, was the absence of demand for protection that performs non-linearly with respect to changes in direction (delta) and volatility (vega).

“Fixed strike vols actually caught a bid, VIX futures are in backwardation,” The Ambrus Group’s Kris Sidial explains.

“However, that spot-vol relationship in the S&P still underperformed and skew was also lackluster.”

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

As said before, it is supply and demand dynamics that played into divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL). Participants are hedged and volatility remains well-supplied.

Was there to be forced selling and demand for protection en masse, we’d likely see that repricing in volatility we have been looking for.

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

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

And so, to position for that, (although it is not as opportune as it was a week ago), it continues to make sense to own volatility structures (that, one, either sold very short-dated pre-FOMC and OPEX volatility to fund that which is farther-dated or, two, buy into implied skew convexity, non-linear with respect to delta [gamma] and vega [volga] changes).

Notwithstanding, per SpotGamma, a lower bound in the market is near $3,700.00. It is at this level options flows may shift from “inducing” to “reducing” volatility as, “beneath this level, all else equal, liquidity providers would have less and less pressure to add on further weakness.”

Ultimately, it is at higher levels of volatility that the marginal impact of further volatility compression is likely to do more to bolster equity market upside as liquidity providers buy back their negative delta hedges to positive delta (short put) exposures. 

SpotGamma’s founder, Brent Kochuba, adds: “Ultimately this expiration is clearing out a lot of equity put protection, which clears the way for lower lows in the weeks and months ahead.”

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

In the best case, the S&P 500 trades higher; activity above the $3,768.25 HVNode puts in play the $3,808.50 HVNode. Initiative trade beyond the $3,808.50 HVNode could reach as high as the $3,836.25 LVNode and $3,863.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,768.25 HVnode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as low as the $3,688.75 and $3,664.25 HVNode, or lower.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 13, 2022

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

What Happened

Overnight, futures for commodities, the equity indexes, and bonds were weak. There was no salvation in different assets. Instead, the realized correlation, across markets, tightened.

This is on the heels of inflation data updates that have traders pricing a 50-50 odds for a 75 basis point interest rate hike in July, after a 50 basis point hike this month.

That said, Ben Bernanke, who is a former Federal Reserve (Fed) Chair, said monetary policy leaders may be able to sidestep a big recession, expressing hopes that improvements in supply chains, among other things, would help rein inflation.

In other news, Chinese military officials warned their U.S. counterparts to avoid the Taiwan Strait and dismissed the need for the United Nations to review labor standards in the Xinjiang region.

This is as Britain’s economy unexpectedly shrank and Russia claims it has destroyed U.S. and European weapons stores in Ukraine. Additionally, despite OPEC+’s modest output gains, the average price of a gallon of gas rose to over $5 per gallon in the U.S. 

This output shock is likely to last into 2023 with gas potentially reaching as high as $6-$7.

Interestingly, as an aside, power grid operators in the Midwest are suggesting rolling blackouts in the coming years. This is just as power use in the South hit all-time records.

Ahead is data on inflation expectations (11:00 AM ET). This week’s focus is on the Federal Open Market Committee’s (FOMC) monetary policy decisions and large derivative expirations.

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

What To Expect

Fundamental: The CPI report was released Friday. 

Expected was an 8.2% rise year-over-year (YoY) and 0.7% month-over-month (MoM). Core CPI (which excludes food and energy) was to rise by 5.9% YoY and 0.5% MoM, respectively.

Officially, the headline number rose to 8.6%, and, the same day, consumer sentiment dropped to record lows while expectations for inflation (5-10 years from now) jumped 0.3%.

Graphic: Via All-Star Charts. Taken from the Weekly S&P 500 ChartStorm.

As Bloomberg’s John Authers put it well, the report’s details “were if anything even more alarming. There’s no way around it; this was a bad report.”

Graphic: Via Schroders plc (OTC: SHNWF). Taken from the Weekly S&P 500 ChartStorm. “Everyone’s (current) favorite economic data report was out this week and it showed annual CPI inflation running at an 8.6% clip. On this chart that would imply a P/E ~11x (Current P/E is ~20x).

Subsequently, a key part of the U.S. yield curve turned upside down while traders priced more tightening by September (i.e., two 50 basis point hikes and one that is potentially 75 basis points), selling nearly everything but the U.S. dollar.

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool.

Early last week, after commentaries resumed, we talked about the reach for cash amid poor safety in fixed income and stock price declines.

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

Graphic: Via McClellan Financial Publications. “These bonds move a lot more like the stock market than like T-Bonds. What makes them even more interesting is that they tend to be terribly sensitive to liquidity, both good and bad.”

“Inflation is eating margins, eating consumer demand, and causing the dramatic monetary tightening we are witnessing. None of this is good for stocks,” said James Athey of Abrdn. 

“There is still much downside to come.” 

Positioning: In short, prior-mentioned supply and demand dynamics resulted in divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL).

Graphic: Via Robson Chow, founder at Tradewell. The SPDR S&P 500 ETF Trust (NYSE: SPY) “is off ~5% in two trading sessions and implied volatility is still below realized volatility.”

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

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

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

Graphic: Commentary published by Kai Volatility.

Accordingly, for “divergences in RVOL and IVOL to resolve, it would likely take forced selling,” as I explained in a recent SpotGamma commentary.

This is similar to the happenings of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).”

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

In light of this, on June 8, we talked about long volatility structures (that, one, either sold very short-dated pre-FOMC and OPEX volatility to fund that which is farther-dated or, two, buy into implied skew convexity, non-linear with respect to delta [gamma] and vega [volga] changes).

Why would you do that?

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

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

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

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

More on these dynamics later this week.

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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,808.50 HVNode puts in play the $3,836.25 LVNode. Initiative trade beyond the $3,836.25 LVNode could reach as high as the $3,863.25 LVNode and $3,911.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,808.50 HVNode puts in play the $3,768.25 HVNode. Initiative trade beyond the $3,768.25 HVNode could reach as low as the $3,727.75 and $3,688.75 HVNode, or lower.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 3, 2022

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

What Happened

Overnight, equity index futures were sideways, inside of the prior range, after exploring much lower, Monday. Measures of implied volatility, bonds, and most commodities were bid.

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

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

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

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

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

What To Expect

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

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

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

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

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

Graphic: Via Crossborder Capital Ltd. Taken from Bloomberg.

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

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

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

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

“We find these fears overblown.”

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

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

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

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

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

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

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

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,123.00 untested point of control (VPOC) puts in play the $4,176.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 VPOC and $4,279.75 ONH, or higher.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk. Read more about these strategies, here.

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 29, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-lower after a mid-day price bump Thursday, on the heels of dismal earnings, among other things including a contraction in economic growth, last quarter.

Amazon Inc (NASDAQ: AMZN) shares fell after the company projected sluggish sales as well as higher costs.

Apple Inc (NASDAQ: AAPL) saw strong sales and profit help top estimates. The company announced a $90 billion share buyback and fears over supply constraints.

Tesla Inc’s (NASDAQ: TSLA) Elon Musk offloaded $4 billion worth of shares just after his deal to buy Twitter Inc (NYSE: TWTR) was reached days before.

Also in the news: Russia’s urgency to avoid a default. Food Inflation hits an all-time high. China’s currency plunge raises the risk of 2015-style panic. No-money-down crypto mortgages and why housing may be topping. Barclays PLC (NYSE: BCS) halts ETN sales.

Ahead is data on the employment cost index, PCE, personal income and consumer spending (8:30 AM ET), as well as Chicago PMI (9:45 AM ET), and University of Michigan consumer sentiment and inflation expectations (10:00 AM ET).

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

What To Expect

Fundamental: In hindsight, a very volatile week characterized by large, two-sided action and little constructive movement (i.e., a week that ended sideways rather than up or down).

Graphic: Via Bloomberg. Indexes sideways, mainly, as large constituents report their earnings.

This is ahead of what many think is likely to be front-loaded 50 basis point tightening next week and in June with rates, ultimately, trading in the range of 2.25-2.50% end-of-year.

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool.

In light of tightening expectations, Columbia Threadneedle’s Gene Tannuzzo says “Tighter financial conditions are the mechanism that reduces demand and ultimately slows inflation.”

Graphic: Via Bloomberg. Financial conditions have started to tighten.

“If financial conditions don’t tighten [i.e., stocks regain their swagger] and inflation remains high, in their eyes, they need to hike more.”

Graphic: Via S&P Global Inc (NYSE: SPGI). Food Inflation Hits All-Time High, Fuels Security Risks.

In regards to balance sheet reduction, “QT will consist of run-off caps of USD 60bn for US Treasuries (UST) and USD 35bn for mortgage-backed securities (MBS), which will make up for a cap of USD 95bn per month going forward,” Nordea Bank (OTC: NRDBY) research says.

“The balance sheet reduction will revolve around coupon securities, with the Fed’s c. USD 326bn Treasury bills only allowed roll-off in months when maturing caps do not reach the cap. We expect the Fed to use a 3-month roll-on period in its reduction, which will make up for a relatively smooth and predictable treasury run-off.”

Positioning: Our April 27 discussion on positioning went into great detail on the likelihood of continued volatility and lower prices. 

On April 28 we noted the implications of heightened implied volatility and no follow-through to the downside. 

The returns distribution, based on implied volatility metrics alone, was skewed positive, albeit with a potential for large negative outliers.

Graphic: Via @HalfersPower. “In backwardation via $VIX: $VIX3M next month [realized volatility] is highest amongst the deciles (d10 >1) ~43% subsequent realized volatility.”

During Thursday’s trade, markets endured a near-vertical price rise alongside repositioning and what SpotGamma says is a “put-heavy expiration [Friday] (20% of gamma roll-off expected).”

Graphic: SpotGamma’s Hedging Impact of Real-Time Options indicator for the QQQ.

The idea is as follows: customers are well-hedged (customers own puts and/or are short calls) and this offers them positive, yet asymmetric (gamma), exposure to direction (delta). In other words, negative delta and positive gamma

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

If this exposure is to roll off or underlying prices reverse and move higher, these counterparties will re-hedge and buy underlying. That’s what SpotGamma is hinting at.

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

SpotGamma also notes: “VIX call open interest (blue) is near March ’20 highs. With VIX near 1-yr highs put interest (red) is near lows. Equity rally/vol decline seems like it would catch most everyone offsides.”

Graphic: Via SpotGamma.

Technical: As of 6:15 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.

In the best case, the S&P 500 trades higher; activity above the $4,235.00 overnight low (ONL) puts in play the $4,279.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,303.50 regular trade high (RTH High) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,235.00 ONL puts in play the $4,191.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,182.50 ONL and $4,156.75 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.

Considerations: Into this week, markets were extremely weak alongside hawkish remarks from the Fed and dismal responses to earnings results, among other things.

Graphic: Via Bloomberg.

Then, as a major index – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – tested a major VWAP anchored from the lows of March 2020. After, a rounded bottom began to form while implied volatility metrics continued to trend higher.

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

Thursday’s price rise and volatility compression, particularly at the short-end of the term structure coincided with some of the strongest breadth in days. 

Notwithstanding, the entire advance was taken back overnight and now the S&P 500 is trading back inside a multi-day consolidation. 

If a short-term trader, playing responsively (i.e., fading edges) is likely the best course of action until the indexes, at least, are able to break above this week’s ranges and remain there (i.e., not trade back down).

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 25, 2022

Editor’s Note: Wow, what a month! Looks like there was a ton of volatility we weren’t able to navigate together.

I’m back now and will be making changes to both the quantity and quality of notes sent. In total transparency, I took on way too much work, and quality suffered a tad. I look forward to making things a bit more sustainable and am grateful for your interest in remaining a subscriber.

Interested in getting this free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 200+ that read this report daily, below, today!

What Happened

Overnight, the equity index and most commodity futures explored lower. Bonds and implied volatility metrics were bid.

This is alongside news that China’s reaction to a local COVID-19 outbreak may feed into global slowdowns just as supply pressures, among other things, are pushing the Federal Reserve (Fed) to adopt a more hawkish policy stance.

Notable is the pace at which China’s yuan is falling. 

Per TD Securities, it suggests “the PBOC is utilizing the yuan as another tool to provide stimulus to the economy at a time when they are showing restraint on the monetary policy front.” 

Ahead, there are no important economic events scheduled. See who is reporting earnings, here.

Graphic updated 7:30 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: A push-and-pull, continues.

At a high level, it was surmised that many of the responses to geopolitical tension and inflation were priced in. The economy, since early pandemic disruptions, has strengthened and the need for ultra-accommodative policies is no more.

Graphic: Via S&P Global Inc (NYSE: SPGI).

That means low rates and quantitative easing (QE) – easy money so to speak – are on the way out, at least for the time being.

Recall that QE is a policy to expand the Federal Reserve’s balance sheet “to provide monetary accommodation, typically when interest rates are at a zero-lower bound (when nominal interest rates are at, or near, zero),” as JH Investment Management explains.

With QT, central banks remove assets (e.g., government bonds they bought from the private sector) from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities.”

With that, we note that when bonds rise in value, their yields decline; “when the Fed embarks on bond-buying program[s] to support the U.S. economy, … [it nudges] the prices of these assets higher while pushing yields lower, which also has the effect of driving yield-hungry investors into relatively riskier asset categories that promise high returns.”

Graphic: Via ICI. Taken from The Market Ear.

As a result, participants’ demand for risk assets prompts their divergence from fundamentals. As liquidity is removed and funding costs increase, this may prompt risk assets to converge with fundamentals.

This is because, for investors to take on additional risk for return, they must receive in excess of the risk-free rate (as provided by the Treasury). This excess is the risk premium.

Previously, as the Damped Spring’s Andy Constan had previously commented, “[a]dditional risk premium expansion pressures from these levels is not likely.”

“However, if, in the unlikely event, details of QT do emerge suggesting a start of QT before June and at a greater size than expected, we would no longer be willing to hold [risk] assets as that would cause an end to any risk premium contraction possibilities.”

Well, that’s what happened in early April when Fed members said their debt holdings would be reduced “at a rapid pace” as soon as May, as well as hike rates, faster. 

“Given that the recovery has been considerably stronger and faster than in the previous cycle, I expect the balance sheet to shrink considerably more rapidly than in the previous recovery,” the Fed’s Lael Brainard said

The Fed may even raise “caps” on the pace of QT.

Graphic: Via The Market Ear. Goldman Sachs Group Inc (NYSE: GS) sees the balance sheet shrinking “to an equilibrium size of just over $6tn by early- or mid-2025, though there is substantial uncertainty about its terminal size.”

Per CME Group Inc’s (NASDAQ: CME) FedWatch Tool, market participants are pricing a near-100% probability that the Fed will move the target rate to 75-100 bps (+50 or +75 bps).

Graphic: Via CME Group Inc. FedWatch Tool suggests a near-100% chance of a Fed hike that moves the target rate between 75 and 100 bps.

At a high-level, rates hikes take time to flow through to the economy while “QT is a direct flow of capital to capital markets or flow out of,” according to statements by Kai Volatility’s Cem Karsan. 

“An increase in the pace of tightening of QT should mean lower stocks, wider credit spreads and a slight reduction in the need for front-end hikes,” explains Kevin Muir of the MacroTourist.

“Using the balance sheet as a tightening tool represents a large change in the Fed’s attitude, and IS NOT priced into the market.”

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

As an aside, adding to earlier comments on the yuan’s fall, Bob Parker, a senior adviser at Credit Suisse Group AG (NYSE: CS) explains that “When Chinese investors lose confidence in their own economy/markets, capital outflows from China accelerate, … [and] this, then, leads to a central bank which has to prop up the currency by selling some of the country’s huge reserve piles.” 

“Part of their reserves will have been/are in U.S. equities so as the reserves fall, they are natural sellers of the S&P.”

Graphic: Via Refinitiv. Taken from The Market Ear. CNH versus SPX.

Positioning: In a comparison of options positioning and passive buying support, the returns distribution is skewed positive and points to building support for a potential short-term bounce.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

The most recent liquidation resulted in participants reaching for protection and this exacerbated movement to the downside amidst the reflexive hedging.

As this short-dated exposure decays, the counterparts’ hedges are to be tapered and this may assist in the market hammering out a bottom or rallying. 

On the contrary, however, as SpotGamma explained in a recent note, “[t]op of mind as we head into new trade on Monday is the likelihood traders will not aggressively sell volatility (i.e., if they sell volatility -> that drives volatility lower -> resulting in hedging flows that support the market) until the FOMC (5/4) and/or some resolution on the geopolitical front.”

“Therefore, [] expect larger trading ranges this upcoming week.”

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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,247.75 regular trade low (RTH Low) puts in play the $4,274.50 spike base. Initiative trade beyond the spike base could reach as high as the $4,314.75 high volume area (HVNode) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,247.75 RTH Low puts in play the $4,227.75 HVNode. Initiative trade beyond the $4,227.75 HVNode could reach as low as the $4,177.25 HVNode and $4,129.50 overnight low (ONL), or lower.

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

In a spike up (down) situation, trade below (above) the spike base, negates the buying (selling).

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 11, 2022

Hey team, you’re going to have to forgive me. Still am traveling through the rest of this month. Therefore, coverage will remain sporadic and less in-depth. Apologies and take care!

What Happened

Overnight, equity index futures were mixed after last week’s liquidation alongside news that the Federal Reserve was interested in sharper interest-rate hikes and balance-sheet reductions to stem inflation. 

China equities were weak on the implications of COVID-19 outbreaks, among other things. 

Some Russian entities entered into effective default, as ruled by markets. The conflict between Russia and Ukraine, that spurred crippling economic sanctions, is ongoing. 

And, in other news, some Bitcoin (CRYPTO: BTC) pundits suggest weakness in risk assets, like technology, may bring down cryptocurrency. 

Crypto prices “do not trade on the fundamentals of being peer-to-peer, decentralized, censorship-resistant digital networks designed for the transfer of money,” explained BitMEX founder Arthur Hayes on correlations with the Nasdaq 100 trading at record highs. 

Crypto “will lead equities lower as we head into the downturn, and lead equities higher as we work our way out of it.”

Ahead is data on NY Fed median 1- and 3-year expected inflation (11:00 AM ET). Fed-speak by Charles Evans (12:40 PM ET). The quarterly earnings season begins this week. Bank stocks to start reporting Wednesday, April 13.

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

What To Expect

Fundamental: The ruling narrative, so to speak, is concerned with the management of inflation through monetary policies, credit impulse contractions, as well as the implications of Russia’s invasion of Ukraine, China’s COVID-19 actions, and beyond.

Graphic: Via The Macro Compass.

The Federal Reserve’s (Fed) roadmap for shrinking the balance sheet and raising rates was revealed in the recent release of Federal Open Market Committee (FOMC) minutes. 

“The FOMC stayed far too easy for far too long and has belatedly realized their mistake,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC. 

“They are now scrambling to get policy back to neutral as quickly as they can. Once they arrive at something close to neutral, they will have to ascertain over time how far into restrictive territory they have to move to get inflation back under control.”

Graphic: Via Bloomberg.

Moreover, as talked about in past commentaries, quantitative tightening (QT) amplifies the impact of rate hikes.

Per statements by JH Investment Management, through QT, central banks remove assets from their balance sheet. This is “either through the sale of assets they purchased or deciding against reinvesting the principal sum of maturing securities.” 

With that, we note that when bonds rise in value, their yields decline; “when the Fed embarks on bond-buying program[s] to support the U.S. economy, … [it nudges] the prices of these assets higher while pushing yields lower, which also has the effect of driving yield-hungry investors into relatively riskier asset categories that promise high returns.”

As liquidity is removed, this may prompt risk assets to converge with fundamentals.

Graphic: Via Bloomberg. Bonds continue their losing streak. This is amid end-of-quarter rebalancing inflows; “Bonds performed so poorly in the past month that exchange-traded fund investors were forced to buy in record amounts.”

At present, via CME Group Inc’s (NASDAQ: CME) FedWatch tool, participants are pricing in a heightened probability of a half-point hike next month.

Graphic: Via CME Group Inc. FedWatch tool.

Notwithstanding, per Credit Suisse Group AG (NYSE: CS) research, there has been no meaningful breadth disconnect; breadth remains supportive of higher S&P 500 prices.

Via: Credit Suisse research. Taken from The Market Ear.

At the same time, JPMorgan Chase & Co’s (NYSE: JPM) Mislav Matejka sees continued gains in earnings while equity versus credit and bond yields are still supportive of valuations.

Positioning: Keeping this section light, today.

After quarterly rebalances and options expiries, the reduction in counterparty exposure to positive gamma freed indexes (i.e., unpinned), as expected

Why? 

We see counterparties as those participants who take the other side of customer trades. The collapse in realized volatility and the move higher in equity markets solicited counterparties’ decreased (increased) hedging of put (call) options. 

The naive assumption is that counterparties are short (long) put (call) protection. When implied volatility declines and underlyings move higher, counterparties have less (more) exposure to amplified losses (gains). 

To hedge, they sell into strength and buy into weakness, basically.

As participants start to concentrate their bets in shorter-dated expiries, at higher prices, counterparties take from underlying movement in their provision of liquidity. It takes an options expiry, or some exogenous event, to disrupt this balance. 

That happened at the end of last month. Since then, increases in implied volatility and lower underlying equity prices have helped pressure indexes and increase realized volatility.

Technical: As of 6:45 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.

In the best case, the S&P 500 trades higher; activity above the $4,468.75 poor low puts in play the $4,489.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,501.00 VPOC and $4,519.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,468.75 poor low puts in play the $4,444.50 weak low. Initiative trade beyond the weak low could reach as low as the $4,409.00 VPOC and $4,395.25 high volume area (HVNode), or lower.

Considerations: 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.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 29, 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 higher alongside progress in cease-fire talks between Russia and Ukraine.

Geopolitical improvements could play into the Federal Reserve’s (Fed) pivot toward more aggressive, front-loaded interest-rate hikes.

Ahead is data on the Case-Shiller and FHFA national house price indexes (9:00 AM ET), consumer confidence, as well as job opens and quits (10:00 AM ET). 

Later, the Fed’s Patrick Harker speaks at 10:45 AM ET, followed by the Atlanta Fed’s Raphael Bostic (6:30 PM ET).

Graphic updated 6:50 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: In Monday’s commentary, we discussed the Fed’s intention to tighten policy and yield curve inversions, the implications of quantitative tightening (QT), and other things.

Graphic: Via Bespoke Investment Group. Taken from Bloomberg. The chart “suggests even more tightening than is currently priced by two-year bonds. Nothing as aggressive as this has been seen since Paul Volcker was Fed chair four decades ago.” 

In a nutshell, the gap between shorter and longer yields is smaller, and, in some cases, the shorter yield is above that of the longer yield––the consequence of suppressed yields lifting, now, after the Fed’s historic bond-buying spree and balance sheet growth over the past years.

Graphic: Via Macrodesiac. “The yield curve looks ‘normal’ at the start of the cycle, then flattens mid-cycle (as central banks hike and short-dated yields catch up to growth), then inverts as economic contraction begins. Usually, longer-dated yields are more stable. Economic growth will expand and contract in the short term. Over time it will average out to around 2% per year in developed economies. Shorter-dated yields are more volatile because they’re sensitive to the current market cycle.” 

As Bloomberg’s John Authers explains, “an inverted yield curve is regarded as an alarm for a central bank — it’s taken as the bond market saying that this can go no further, and makes it hard for the Fed or any other central bank to proceed with a tightening.”

There is the “argument that something will break before the central bank gets [inflation back down to 2%].”

Graphic: Via Andreas Steno Larsen. “Policy real rates are basically [at a] record low.”

Though curve inversions often preceded economic slowings, we pointed to the 5-30 curve, yesterday, specifically, which has provided false positives in the past. 

This time things truly are different as, without the Fed’s QE, the fair value of the 2s10s spread could be in the 150bp-200bp range, according to statements by Richard Bernstein Advisors’ Michael Contopoulos says on the potential for steepening via QT.

“Though the Fed is likely to maintain a sizeable balance sheet, thereby keeping yields relatively anchored versus what would be expected had they never bought bonds, there is clearly scope for yields to increase in the long end over coming quarters. Whether or not this happens with ever-higher 2y yields, time will tell, but for now, we would search for other indicators of recession.”

Graphic: Via @mark_ungewitter. Taken from Callum Thomas. “A tell in terms of the lateness-of-cycle.”

Correlation isn’t causation, Authers ends. Markets are reflections of investor psychology and expectations about the future. 

“Just as the Fed now admits that it has been behind the curve, so investors have also been slow on the uptake, and may now be over-compensating. That suggests that a curve inversion here should be treated with some caution.”

Positioning: Alongside participants’ heavy sale of puts and some call buying, implied volatility metrics compressed markedly, and this bolstered a near-vertical price rise in the equity market.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator shows put selling in the SPY coincides with a reversal attempt.

Heading into the end-of-week large quarterly options expiration, comparing buying and options positioning metrics, the returns distribution is skewed positive.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

However, the skew is nothing like what it was in the weeks prior, before the early March reversal period. Caution new buyers.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

As SpotGamma explains, “All else equal, it’s likely the SPX levels out in the $4,600.00 area over the coming sessions as the factors of time and volatility trend toward zero for highly short-dated options exposure concentrated in the end-of-month expiry,” at those higher prices.

“When the gamma of these options increases, as a result, counterparties add liquidity (i.e., sell [buy] more into strength [weakness] against increasing [decreasing] positive delta exposure).”

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

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 $4,592.75 overnight high (ONH) puts in play the $4,611.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,618.75 and $4,631.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,592.75 ONH puts in play the $4,574.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 spike base and $4,533.00 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.

Definitions

Spikes: 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).

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 14, 2022

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

What Happened

A lot to unpack, today. Part of the newsletter may be cut off, as a result, in your inbox. Just click to view in another window.

Overnight, equity index futures auctioned sideways-to-higher, masking turmoil in products listed abroad, as well as commodities and fixed income.

In regards to bonds, they slumped (globally) in light of participants’ pricing in monetary action given heightened inflation. The Federal Reserve, Bank of England, and Bank of Japan are to issue policy updates this week.

Commodity markets are still roiling after a price spike in some products “created a systemic risk” that prompted exchanges to cancel trades, while equity markets in Asia saw their worst-selling in years.

The Hang Seng China Enterprises Index (INDEX: HSCEI) closed down 7.2%, the biggest drop since 2008. This was after Russia asked for China’s assistance in Ukraine (which could result, later, in sanctions from the U.S.), thus compounding uncertainties with respect to an ongoing regulatory crackdown.

Ahead is data on 1- and 3-year inflation expectations (11:00 AM ET).

Graphic updated 6:11 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: We may attribute participants’ uncertainty to how far monetary policymakers want to tighten, slower economic growth, the implications of geopolitical tensions, imminent Russian defaults, a resurgence in COVID-19 abroad, and more.

Graphic: Via Bloomberg. As Treasury yields rise, participants price in Fed tightening.

As revealed by metrics like CME Group Inc’s (NASDAQ: CME) FedWatch Tool, for instance, participants are pricing a high certainty of an increase in rates.

Graphic: Via CME Group Inc (NASDAQ: CME). Participants price in an increased probability of a shift in the target rate. Click here to access the FedWatch Tool.

“Yields are reflecting a surprise higher shift upward in inflation expectations,” said Morgan Stanley’s (NYSE: MS) Jim Caron. “Many thought inflation would peak in the first quarter and fall. Now, with oil prices, inflation may stay high.”

At the same time, there are some indications of market stresses.

Graphic: Via McClellan Financial Publications. “The Daily A-D Line for corporate high yield bonds continues to look quite ugly. That is a concern for the overall stock market because high yield bonds drink from the same liquidity pool as stocks do, and these bonds are arguably more sensitive than stocks are to liquidity problems.”

As explained in DC’s Chartbook discussion, however, “stress in money markets is for now mostly contained and not an imminent risk to financial sustainability.”

Graphic: Via DC’s Chartbook. Funding spreads “have stabilized over the past week, not making new highs after the gap-up open on March 7. These are encouraging signs that the stress in money markets is for now mostly contained and not an imminent risk to financial stability.”

In regards to credit default swap spreads, though they are wider than in recent history, “they are still far below where they were during times of material solvency risk such as March of 2020, and the term structure of CDS spreads suggests this is more due to mechanical de-risking.”

Graphic: Via DC’s Chartbook. Cost of credit insurance for Citigroup Inc (NYSE: C). Hedging with CDS results in mechanical steepening which raises the curve. “This is in sharp contrast to the curve in March 2020 (yellow, orange, and red), when the short end of the CDS curve rose quickly and flattened the curve.”

Okay. So, the “financial system is functioning smoothly.” How do you trade slowing growth in the face of heightened inflation?

As Andreas Steno Larsen of Heimstaden explains, the “best way to assess this question is via a historical study of empirical returns during times of actual stagflation dating back to the early 1970s.”

Graphic: Via Andreas Steno Larsen. “Heatmap on quarterly inflation-adjusted returns across asset classes during stagflation periods (1973 – today).”

“Assets that tend to keep the value intact or even increase in real terms through stagflation are typically negatively correlated to low or negative real rates, which is why gold and real estate (REITs) are some of the best places to hide during stagflation,” Steno Larsen says. 

“Equities overall struggle to perform in real terms and so do bonds, which might be even worse this time around due to the outset of bond yields into this potential stagflationary environment.”

To note, pursuant to the idea that participants have “priced in” the aforementioned, S&P Global Inc (NYSE: SPGI) data suggests “the initial stages of a monetary tightening cycle have not been disastrous for the U.S. stock market historically.”

Graphic: Via S&P Global.

Positioning: Based on a comparison of present options positioning and buying metrics, the returns distribution is skewed positive.

This is in the face of an S&P 500 (INDEX: SPX) and Cboe Volatility Index (INDEX: VIX) down environment.

Graphic: Via Bloomberg. S&P 500 (INDEX: SPX) down, CBOE Volatility Index (INDEX: VIX) down.

In part, this has to do with the supply and demand of protection; mainly, the market is “well hedged and well-positioned,” Amy Wu Silverman of Royal Bank of Canada’s (NYSE: RY) says

Graphic: Via SpotGamma. “Netting call & put delta, you can see we’re near extremes in terms of put:call positions. Often large put positions are removed by expirations, which seems to coincide with market lows. Many of these are quarterly expirations which coincide w/FOMC meetings – such as next week.”

Given this, as JPMorgan Chase & Co (NYSE: JPM) analysts explain, “we could be closer to the end” of discretionary de-risking, and the compression of volatility (via passage of FOMC), as well as the removal of counterparty negative exposure (via OPEX) may serve to alleviate pressure. 

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “18-Mar has more expiring near-the-money SPX open interest than any expiration since 2019.”

As SpotGamma, explains, “As it stands, without further geopolitical events causing, even more, fear, the markets are due for a relief rally,” on improving seasonality, among other things. 

“Following the FOMC meeting, as well as the reduction in put-heavy exposures post-OPEX (options expiration), the need for put ownership (protection) and relative short positions is reduced (less positive delta = less selling to hedge = less pressure).”

Graphic: Via EquityClock. Taken from The Market Ear.

Technical: As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, 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 $4,227.75 high volume area (HVNode) puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,285.25 and $4,314.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,227.75 HVNode puts in play the $4,189.00 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,138.75 and $4,101.25 overnight low (ONL), or lower.

Considerations: Participants resolve a pinch of two anchored volume-weighted average price indicators (VWAPs). A VWAP 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.

We look to buy above a flat/rising VWAP pinch. We look to sell below a flat/declining VWAP pinch.

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

Definitions

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

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

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

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

About

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

Capelj 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.