Tag: FOMC – Federal Open Market Committee Event

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Commentary

Daily Brief For May 27, 2022

The Daily Brief will be on pause till June 7, 2022, due to the author’s travel commitments. Apologies for this inconvenience.

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What Happened

Overnight, U.S. equity index futures came off of their Thursday peaks before, late in the morning, trading to a new rally high, at which is a confluence of technical nuances.

Thursday’s cash session was characterized by a near-vertical advance into mid-day. Then, trade became two-sided, a feature of short-covering and not new buying. More on this, later.

In the news was Citigroup Inc’s (NYSE: C) downgrading of U.S. stocks on recession risks and the “elements of a deflating bubble,” while leaning optimistic on China assets due to marginal policy support, there. This is on the heels of similar conclusions put forward by BlackRock Inc (NYSE: BLK) and Morgan Stanley (NYSE: MS).

Mortgage rates staged their biggest drop since April of 2020 as “the housing market has clearly slowed, and the deceleration is spreading to other segments of the economy,” the Federal Home Loan Mortgage Corporation’s (OTC: FMCC) Sam Khater explained.

In other news, Secretary of State Antony Blinken took aim at China, commenting on the U.S.’s intention to “shape the strategic environment around Beijing to advance [its] vision for an open, inclusive international system.” This is as the U.S. also plans economic talks with Taiwan.

Pippa Malmgren, who is a former White House adviser and economist we wrote on earlier this week, discussed more of this decoupling and coordination among Eastern and Western powers.

In a two-part series, she explains the challenging of U.S. island bases by China and Russia, as well as their maritime strategies, “island hopping [and] shopping.” Check them out.

Today we received data on PCE inflation, real disposable and personal income, along with consumer spending and trade in goods (8:30 AM ET). University of Michigan Sentiment and five-year inflation expectations come later (10:00 AM ET).

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

What To Expect

Fundamental: At its core, there’s a commitment to cutting liquidity and credit after the spending of COVID-era “benefits and lockdown savings … created a lot of demand,” and inflation.

Graphic: Via the Federal Reserve. Taken from Nasdaq Inc (NASDAQ: NDAQ). “Rates have risen dramatically this year, impacting valuations of stocks and bonds.”

This has consequences on the real economy and asset prices, accordingly, which rose and kept the deflationary pressures of prevailing monetary policies at bay.

Graphic: Taken from Nasdaq Inc. “At a very simple level, rising rates increase interest expenses, reducing profits. But they also cause investors, who can earn more interest on safe cash deposits, to demand stronger returns from all other investments too.”

As unpacked, in detail, on May 18, 2022, there is an argument that stock market drops are both a recession and a reflection of the unwind of carry (or investment in long-duration bets with cheap debt) – a deflationary shock.

Graphic: Via Bloomberg. “Tighter financial conditions themselves are a clear success story for the Fed — it is the only way they can reduce inflationary pressures,” said Seema Shah, chief strategist at Principal Global Investors.

“The Fed has a mandate … to control price stability,” Kai Volatility’s Cem Karsan had explained.

“With supply-side economics, the only way that they can control this ultimately is to pull back. And slow capital markets decrease via the wealth effect. Ultimately, there’s a significant lag, so they are not in a position to ultimately control inflation without bringing down markets.”

Graphic: Via Bloomberg. “Of course, economic growth is a good thing. But too much of that good thing will just continue to stoke inflation. With that perspective in mind, the slowdown in surprises is positive.”

Accordingly, in our May 25, 2022 commentary, in which we discussed what to search for in the minutes of the last Federal Open Market Committee (FOMC) meeting. Knowing that there’s a lag in policy impact, we accurately floated the potential for the Federal Reserve (Fed) to “shift gears” late this summer if further cooling of inflation and “evidence of a growth slowdown.”

Graphic: Via Bloomberg. “After hitting a record above 3% last month, 10-year breakevens are on track for their biggest monthly drop since March 2020. The so-called five-year, five-year forward — the Fed’s favored measure — is set to post its biggest drop in May since August 2019.”

“Policy works with a lag,” as Diane Swonk of Grant Thorton explained. The Fed may pause as it seeks to “catch up but not outrun the market in its effort to tighten credit market conditions.” 

“There is still more progress to be made in bringing inflation expectations down to resonate with the Committee’s target, but current valuations are at least in the realm of acceptable,” Ian Lyngen, who is head of U.S. rates strategy at the Bank of Montreal (NYSE: BMO), said. 

“The market is showing some faith in Powell’s inflation-fighting creditability.”

Graphic: Taken from Nasdaq Inc. “Although inflation is high right now, it’s because of Covid and the Ukraine war. Both, hopefully, will pass, and 3%-4% inflation a year from now seems possible if the economy slows to a more normal level. In turn, that means the interest rate that keeps the U.S. economy growing slowly is likely much lower than we might currently be thinking. It might, in fact, be right around where bond rates are now.”

Concluding the fundamental section with remarks from a March 2022 Substack newsletter published by Andreas Steno Larsen of the Stenos Signals Substack.

“I simply don’t find >3.5% territory for the Fed Funds feasible as the hiking cycle peaked at 2.25-2.50% in 2018/2019 and fundamentals have worsened since. Debt loads are much higher, demographics have weakened, and the labour force is smaller, which suggests that the neutral rate is lower, not higher, than in 2018/2019.”

Graphic: Via Bloomberg. “​​The swaps market and consensus forecasts to Bloomberg Economics both imply considerably faster rate hikes, while Bloomberg’s own forecast is more hawkish still.”

Positioning: Per Bank of America Corporation (NYSE: BAC) notes, investors poured nearly $20 billion into global stocks (in the week to May 25, 2022).

As I wrote in a SpotGamma note, notable was the reversal in beaten-down areas of the market, as well as the implosion at the front-end of the volatility term structure, affecting protection most sensitive to changes in direction and volatility.

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), dropped off markedly, too, in comparison to the VIX, itself.

Graphic: Via Physik Invest. Taken from TradingView. VVIX, top. VIX, bottom.

Further, as stated in SpotGamma’s note, a “falling VVIX (and VIX term structure drop off) may be the product of a collapse in the value of customers’ long put exposures concentrated in very short-dated timeframes (potentially exposures hedging tail risks with respect to the release of FOMC minutes, among other things).”

“It is then as the skew, here, decays, and term structure compresses, that liquidity providers buy back their hedges to the puts they are short (i.e., the vanna dynamic pointed to, earlier).”

This market-generated information helps us give context to this most recent equity market rally that is characterized by a little change in demand for bets on upside further in price and time 

All else equal, this is not a feature of sustainable market rallies.

Why you ask?

Those names that have been most depressed, and are now reversing, were recipients of heavy demand for protection in the months prior.

For this reason – participants being well hedged – selling was orderly, rather than violent as in past episodes of market shock when the reach for protection solicited a cascading reaction that exacerbated underlying price movements due to liquidity providers’ hedging.

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

The large drop off in term structure, as well as the VVIX versus the VIX, is affecting protection most sensitive to changes in direction and volatility and the unwind of liquidity providers’ short futures and stock hedges to this protection is, in part, playing into this internally weak rally.

So, what? How do you play this? Good question.

It still may make sense to have exposure to underlying markets, synthetically (i.e., own options), as detailed, well, May 25, 2022. Read that letter for detail on how to think about trade structure.

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

In the best case, the S&P 500 trades higher; activity above the $4,069.25 HVNode puts in play the $4,095.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,119.00 VPOC and $4,148.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,069.25 HVNode puts in play the $3,997.75 RTH High. Initiative trade beyond the RTH High could reach as low as the $3,982.75 LVNode and $3,951.00 VPOC, or lower.

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

Definitions

Overnight Highs And Lows (ONH and ONL): 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.

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, 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 26, 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!

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Separately, the Daily Brief will be on pause from May 30, 2022, to June 7, 2022, due to the author’s overseas travel commitments. Apologies for the inconvenience and happy trading!

What Happened

Overnight, equity index futures were divergent, albeit nearly flat, after Wednesday’s release of minutes to the last Federal Open Market Committee (FOMC) meeting were less hawkish than expected, bolstering a small expansion of the range to the upside.

Though higher prices were held at the index level, some products like Apple Inc (NASDAQ: AAPL) were lower after issuing updates on its production. Yesterday, it was social media and advertising businesses like Snap Inc (NYSE: SNAP) that fell on forecasts for meager growth.

In other news, Sequoia Capital warned that the current environment for founders is a “crucible moment,” and there is no indication good times will return soon. 

Pursuant to that belief, we have firms like Klarna and Bolt, who just began laying off employees, preparing for slower growth and focusing on “short-term profitability.”

A chief concern, among participants at the World Economic Forum, beyond a global recession and inflation, is the potential for ongoing conflicts to cause “mass starvation” and “political instability around the world.”

Today we get updates on jobless claims, real gross domestic product, and income, as well as final sales to domestic purchasers (8:30 AM ET). Later, pending home sales (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: As was suggested could happen in Wednesday’s pre-market letter, the Federal Reserve (Fed) indicated potential policy flexibility, later this year.

Per the most recent FOMC minutes, officials are determined to achieve price stability with “50 basis-point increases in the target range … at the next couple of meetings.”

“Many participants judged that expediting the removal of policy accommodation would leave the committee well-positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments.”

Graphic: Via Bloomberg. “​​The swaps market and consensus forecasts to Bloomberg Economics both imply considerably faster rate hikes, while Bloomberg’s own forecast is more hawkish still.”

Accordingly, finalized were balance sheet reduction plans. Starting June 1, 2022, Treasury holdings will decline by $30 billion per month, rising to $60 billion per month in September. 

Mortgage-backed securities (MBS) holdings will shrink by $17.5 billion per month, ultimately rising to $35 billion, in accordance with our post-FOMC letter published May 5, 2022.

As stated, previously, with QT, central banks remove assets from their balance sheet either through outright sales or the non-reinvestment of the principal sum of maturing securities.

“QT is a direct flow of capital to capital markets” and the prospects of withdrawing this liquidity, when revealed in December’s FOMC meeting minutes, was what fed into a retreat from risk.

Graphic: Via Reuters.

Overall, the minutes left the tone unchanged and reaffirmed the Fed’s commitment to stable prices.

Bloomberg’s John Authers concludes, well: “If inflation should look as though it might fail to get down even to the revised forecast of 4.3% by the end of the year, there’s still a possibility that the Fed will have to be more hawkish than it currently intends, not less.”

“But at least the path until the end of summer looks clear.”

Graphic: Via Bloomberg.

Positioning: We’re carrying forward remarks from notes earlier this week as there has been a limited change in tone.

Based on current positioning, most products we monitor continue to trade in an environment that solicits more volatile hedging of put open interest and realized volatility (RVOL). This is because, naively, we look at participants as mainly owning protection to the downside. 

So, they have asymmetric (positive gamma) exposure to the downside (negative delta). On the other side, liquidity providers have a negative gamma and positive delta that they must sell into weakness and buy into strength underlying to hedge.

It is at a certain juncture, far above current prices (i.e., Zero Gamma), that the volatile effects of hedging this put open interest begin to cool. It is above these levels that participants’ exposure to calls solicits increased hedging activities which promote stability and less volatility.

Graphic: Via Tier1Alpha. “Spot SPX is currently over -8.55% below the gamma flipping point, a distance similar to the drawdown at the end of 2018. We’ll have to see quite a reverse in trend before a substantial regime shift can take place.”

It’s because, naively, we look at participants as financing their bets on the downside with call exposure. On the other side, liquidity providers, then, have a positive gamma and delta trade they hedge by buying into weakness and selling into strength.

We’re definitely not there yet but, based on remarks in past letters (e.g., stretched market and investors bidding “skew on the call side” amid their “fear of missing on the upside”), this letter’s author continues leaning toward strategies that have little to lose in case of further implied volatility (IVOL) compression or weakness into the June FOMC and OPEX.

Graphic: Via SpotGamma. “[C]all positions were added [above] $4,000.00, with $4,100.00 [and] $4,200.00 adding 10k + 15k [in open interest] respectively. That’s not huge, but it was enough to kink the gamma curve in an interesting way.”

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 upper part of a positively skewed overnight inventory, nearly 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 $3,951.00 VPOC puts in play the $3,997.75 RTH High. Initiative trade beyond the RTH High could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,951.00 VPOC puts in play the $3,909.25 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,863.25 LVNode and $3,831.00 VPOC, or lower.

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

Definitions

Overnight Highs And Lows (ONH and ONL): 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 value tests 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 May 25, 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!

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What Happened

Overnight, equity index futures were steady alongside commodities and bonds. This is ahead of the release of minutes from a Federal Reserve (Fed) policy meeting. 

In the news were advertising and social media firms. Snap Inc (NYSE: SNAP) warned of slower growth and deterioration in the macro-environment. Its peers Meta Platforms Inc (NASDAQ: FB), Alphabet Inc (NASDAQ: GOOGL), and Twitter Inc (NYSE: TWTR) also saw weakness.

China’s COVID Zero commitment likely nudges it off a path to achieve economic targets “by a large margin for the first time ever,” as Bloomberg explains. 

This is as China and Russia have conducted one of their largest joint air drills “to send their own political, economic and military message to the international community,” much of which is at Davos, Switzerland doing thought exercises.

In a recent podcast, Pippa Malmgren, who is a former White House adviser and economist, well said, particularly in reference to some of the tension abroad, that “autocracy is not working well,” and “[y]ou go to war because … you have a domestic objective.”

Thought it was interesting. Give it a listen, here.

And, finally, Michael Burry of the “Big Short” sent a cryptic tweet alluding to what is likely the risk of another financial collapse. 

Moreover, ahead is data on durable goods and core capital equipment orders (8:30 AM ET). Later, the Fed publishes the minutes of its last policy meeting (2:00 PM ET).

Graphic updated 6:10 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 Fed will issue policy meeting minutes that may provide clarity with respect to its intent to hike and reduce the size of its balance sheet.

In focus, per ex-Fed insider Ellen Meade, is “the rate path, the expected economic conditions, and what policymakers want to see from the data before they slow the pace of tightening.”

“The minutes may tell us they see the tightening in conditions this time around as greater than in earlier cycles. If that’s the case, then they may judge that they don’t need to raise the funds rate by as much this time around.”

Graphic: Via Morgan Stanley (NYSE: MS) research.

John Authers notes, however, that “inflation tends to move in waves” and it doesn’t, usually, “plateau and stay there.”

Graphic: Via Bloomberg.

“That suggests that even though the focus is already shifting to whether there is evidence of a growth slowdown,” he added, in a statement echoed by Meade who is betting on slower “GDP growth, below its longer-run rate, and a rise in the unemployment rate, perhaps to its longer-run median rate or slightly above.”

Graphic: Via Bloomberg.

Pursuant to those last remarks, the Fed’s Raphael Bostic is already floating a pause to rate hikes near September if inflation falls more than expected over the summer.

As Diane Swonk of Grant Thorton explains, “Policy works with a lag. The Fed wants to catch up but not outrun the market in its effort to tighten credit market conditions.”

Graphic: Via Bloomberg.

Futures First analyst Rishi Mishra, who is also the author of the “On Another Note” newsletter, suggests the Federal Open Market Committee may, rather, hone in on monthly changes with annual inflation still elevated.

“This brings down inflation expectations into a range where the Fed feels comfortable about de-anchoring risks,” Mishra said.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from Bloomberg. Though, potentially, “premature,” JPM’s model tracking the S&P 500, credit spreads and yield curve implies a 40% chance of a recession.

JPM’s Marko Kolanovic adds: “We have gone from a situation where both stocks and bonds were sold on the back of de-leveraging, to a situation where bonds rallied as stocks fell, nudging stock/bond correlations toward a more normal (negative) level.”

“We do indeed think this is where things could be gradually heading, but we acknowledge this is not likely to play out in a linear way.”

Graphic: Via @MrBlonde_macro. “Stock/bond correlation negative over the last 10 days. Some ‘normalization’ in cross-market relationships can be a source of relief.” The flip happened with 10-year yields at or above 3%.

Positioning: In yesterday’s in-depth write-up, we talked about the underperformance of implied volatility (IVOL), relative to that which is realized (RVOL).

Dennis Davitt of Millbank Dartmoor Portsmouth had explained that the “RVOL of the underlying S&P 500 is above 27% … with IVOL of options trading between 24%-27%,” which translates to a VIX at 30%.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear.

So, essentially, it makes more sense to have exposure to underlying markets, synthetically (i.e., own options). 

This, though, merits a bit more clarification (as I do not want it to be construed as if I was buying, systemically, bets on the downside). The opposite, actually.

Moreover, this was stated in the context of a market that is “(1) stretched and (2) near a critical inflection which we see at $3,700.00 SPX,” per SpotGamma. Separately, investors are bidding “skew on the call side” amid their “fear of missing on the upside.”

That’s when it makes sense to buy closer to at-the-money (ATM) and sell farther from ATM, or out-of-the-money (OTM). For instance, a margin intensive but low cost call +1 [ATM] x -2 [OTM] ratio spread. 

Note, however, that width and timing are everything. Too much time or too narrow may result in asymmetric losses when the demand for upside bets further out in price and time bids the skew that you’re short, relative to the at-the-money volatility you own. 

I’m willing to talk through this via email, if interested. Ping me at renato@physikinvest.com. I’m mindful that if I do post actual trade ideas, people may take them without knowing how to size and manage them, accordingly. Big yikes!

Goldman validates this thesis: “Even though the VIX’s reaction to recent spot downside has been mild, its high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

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.

Further, though SpotGamma assigns an edge to lower prices until the June FOMC and OPEX, “markets (which are already ‘fully loaded’ with puts) [are likely] pressured by liquidity providers’ hedging [at most] down to $3,700.00,” the area where that added pressure from hedging cools.

Graphic: Via SpotGamma.

Technical: As of 6:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a balanced overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,969.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,917.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,863.25 LVNode and $3,831.00 VPOC, or lower.

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

Considerations: 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 very active.

Such traders often lack the wherewithal to defend retests.

Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.

Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.

Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.

Definitions

Overnight Highs And Lows (ONH and ONL): 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 value tests 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 May 24, 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!

Subscribe

What Happened

Overnight, equity index futures softened after what appeared to be continued covering of shorts into Monday’s close. Commodities were mixed, bonds higher, and implied volatility higher.

In the news the amount of money parked at major Federal Reserve facilities climbed to another all-time high, passing $2 trillion. JPMorgan Chase & Co’s (NYSE: JPM) CEO Jamie Dimon said recently that the Fed must do quantitative tightening since there’s too much liquidity in the pipes.

Adding, the Fed’s Raphael Bostic said policymakers may hike rates by 0.50 basis points after their next two meetings before pausing in September to allow for observation. This is as banks UBS Group AG (NYSE: UBS) and JPMorgan Chase & Co cut their expectations for growth here and abroad.

Ahead is data on S&P Global Inc (NYSE: SPGI) manufacturing and services (9:45 AM ET). Later, participants get updates on new home sales (10:00 AM ET) and Fed-speak by Chair Jerome Powell. Later this week, on Wednesday, participants will receive minutes of the Fed’s most recent meeting which may provide further insight into the central bank’s intent to tighten.

Graphic updated 6:15 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: So long as market participants are using JPEG images of rocks as collateral for debt, it is likely we have not reached a more permanent bottom in the broad market. 

Kidding – just trying to lighten the mood, haha! Sorry to my crypto friends! 

For real, though, maybe the destruction of that market is what we’re to watch for.
Graphic: Via Corey Hoffstein. “You call it ‘tulip mania,’ but I’m gonna need to see evidence that the Dutch set up lending markets where they used paintings of rocks as collateral.”

Support of market excesses was liquidity in the financial system, a lot of which is now piling into the Fed’s overnight reverse repurchase agreement facility (RRPs).

Graphic: Via Bloomberg. Per the Federal Reserve Bank of New York: “A reverse repurchase agreement conducted by the Desk, also called a “reverse repo” or “RRP,” is a transaction in which the Desk sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the transaction.”

Since the start of the year, however, the anticipation and pricing in of the removal of some of this liquidity have fed into market weaknesses.

Per the Damped Spring Advisors’ Andy Constan, the “Fed will reduce their balance sheet by choosing not to reinvest the proceeds of maturity payments of existing holdings back into the market. The U.S. Treasury will need to find new buyers for the bonds it issues.”

Please read our Daily Brief For May 5, 2022, here, for more on the Federal Reserve’s updates.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, about double the maximum pace of $50 billion a month in 2017-2019.

Constan adds: “In June, that supply those markets will need to absorb will be $50 billion USD and will grow to $95 billion (of which some will be outright sales of mortgages by the Fed).”

Accordingly, “[j]ust as USD strength occurred as global investors chased U.S. assets, as the U.S. economy led the global economy out of the Covid chasm, the next leg of asset returns is more likely in countries that remain relatively easy and where the economy is still lagging.”

Goldman Sachs Group Inc’s (NYSE: GS) Vickie Chang notes: “Using history as a guide, in order for equities to come off their recent lows (and stop declining), this kind of monetary-tightening induced contraction is most likely to end when the Fed itself shifts.” 

“It may be that the market needs to see signs of the inflation deceleration that our US economists expect in the second half of the year in order to see sustained relief.”

Positioning: Pursuant to comments established last week, Dennis Davitt of Millbank Dartmoor Portsmouth explains that the “realized volatility of the underlying S&P 500 is above 27% … with implied volatility of options trading between 24%-27%,” which translates to a VIX at 30%.

“It is profitable to own options with such an active and volatile cash market. This is the opposite of 2017 where the VIX was at 10% and the realized was 7%,” a trade that leverage poured into and resulted in the spectacular short-volatility ‘Volmageddon’ blow-up in February of 2018.

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

What does this mean?

Davitt concludes that “18 months” out there are “elevated option prices which may foretell an increase in the volatility of the equity market through this time next year.”

Though the Cboe Volatility Index (INDEX: VIX) may print higher, it is likely that it does not spike and point to an immediate market bottom, all else equal, like it has in the very near past.

Graphic: Via Millbank Dartmoor Portsmouth.

How to play?

It makes more sense to have exposure to underlying markets, synthetically (i.e., own options). This is based on the current relationship between realized and implied volatility.

Graphic: Via Robson Chow, founder at Tradewell. “The spread between IV and RV remains quite low relative to the past 50 trading days and 1st decile in the historical data.  It is printing where, historically, the most forward realized volatility and the weakest relative mean returns over the next 60 days can be expected.”

This is in contrast to the thesis that “long volatility is a poor equity hedge” because, on average, it’s overpriced and has less than a 100% negative correlation with the equity market.

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

Given fundamental contexts, many foresee continued weaknesses. Notwithstanding, markets are stretched to the downside and the path of least resistance, based on prior comments, is up.

This is with the caveat that traders should look at the current window of time as a period during which markets have less pressure to rally against. Per SpotGamma, this is due to the put-heavy options expiration (OPEX), Friday. 

Still, the rally into Monday “pulled forward some of the energy from [those] options that were to roll off,” and now, participants are “much less hedged than they were.” Should demand return, that will bid options prices and likely solicit liquidity provider pressures which, all else equal, start to cool into the $3,700.00 S&P 500 area.

Graphic: Via SpotGamma.

Technical: As of 6:15 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 negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,969.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,908.75 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,862.75 LVNode and $3,831.00 VPOC, or lower.

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

Considerations: 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 very active.

Such traders often lack the wherewithal to defend retests.

Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.

Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.

Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.

Definitions

Overnight Highs And Lows (ONH and ONL): 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.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 6, 2022

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

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What Happened

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

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

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

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

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

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

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

What To Expect

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

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

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

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

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

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

Graphic: Via Toggle.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: The VVIX via Physik Invest.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 5, 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!

Subscribe

What Happened

Overnight, equity index futures took back a small chunk of Wednesday’s post-Federal Open Market Committee (FOMC) advance. Both bonds and equity indexes were lower while most commodities and the dollar were bid.

The Federal Reserve hiked interest rates by 50 basis points while knocking the odds of a larger hike (~0.75 or above) later this year, all else equal. The Fed’s holdings of U.S. Treasuries (UST) and mortgage-backed securities (MBS) are set to fall starting June 1.

As expected, the Fed will cut $95 billion a month from its holdings, split between $60 billion of USTs and $35 billion of MBS, per Reuters, in the span of three months.

Heading into the FOMC event, markets were sold and protection, particularly that which is shorter-dated, was demanded. This was evidenced via metrics like the VIX’s term structure which had short- and mid-term VIX futures prices higher than those that are longer-term.

The compression of implied volatility after the event affecting existing concentrations of options positioning, particularly at the short-end, coupled with lackluster options buying and selling at the index level, has us questioning the rally’s sustainability.

Ahead is data on jobless claims, productivity, and unit labor costs (8:30 AM ET).

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

What To Expect

Fundamental: The Fed is raising rates and reducing the size of its balance sheet in light of the economy’s “strong underlying momentum,” as Nordea Bank (OTC: NRDBY) research puts it, a hot labor market and elevated inflation.

During a press conference after the release of meeting statements, the Fed’s Jerome Powell assuaged participants of their fears regarding a 75 basis point hike in later meetings.

Instead, it’s likely the fed tightens twice more by 50 basis points before scaling back to 25 basis point hikes, helping bring inflation down to the 2% target.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, “roughly double the maximum pace of $50 billion a month targeted in the 2017-2019 cycle.”

With QT, central banks remove assets from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities,” as JH Investment Management explains. 

Since March, the Fed’s balance sheet was at $9 trillion, steadied by the reinvestment of proceeds from maturing securities. After a small run-up, starting in September, the Fed will allow for a maximum of $95 billion to roll off without reinvestment.

Per MarketWatch, “In this cycle, one key to markets is when the Fed might actually sell some of its holdings of mortgages $2.7 trillion. This will ripple out through U.S. debt markets.”

This, however, “would be announced well in advance,” enabling “suitable progress toward a longer-run … portfolio composed primarily of Treasury securities.”

When bonds fall in value, their yields rise. This may have the effect of driving yield-hungry investors into relatively less risky asset categories.

Graphic: Via Reuters.

Positioning: There was a large squeeze, post-FOMC. 

The prevailing narrative is that participants’ fears, with respect to how aggressive the Fed would tighten, were assuaged.

Per Standard Chartered’s (OTC: SCBFY) Steve Englander, at its core, “it is fair to say that positioning and excess pessimism reflect a big part of the market reaction.” ​​

“Overall, the tone was much more balanced than at the January and March FOMC meetings.”

As discussed in the past few letters, markets were stretched and participants were demanding protection in size. To quote the May 2 letter:

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

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

That’s precisely what happened. The question now is whether there’s a sustained reversal. 

Based on SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO), participants’ reaction to the FOMC was lackluster and capital was not committed to bets further out in price and time at higher or lower prices. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. Capital was not committed to bets further out in price and time at higher or lower prices. 

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 indexes, after a short-term relief, will succumb to fundamental weaknesses.

According to Kai Volatility’s Cem Karsan, the rally was purely a function of “structural buyback” and the baseline is that the bear trend holds.

This is because Fed is expected to continue withdrawing liquidity, and this will prompt risk assets to converge with fundamentals as “QT is a direct flow of capital to capital markets.”

https://twitter.com/TDANetwork/status/1521940372787716099?s=20&t=niBUbjcqo_pSuG_d4KjCOw

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, 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 $4,260.25 overnight low (ONL) puts in play the $4,303.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,260.25 ONL puts in play the $4,177.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,142.75 RTH Low and $4,123.00 VPOC, or lower.

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

Considerations: Strong advance, yesterday, characterized by very supportive breadth.

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

The weaker of the indexes we monitor – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – just retook a major VWAP anchored from the lows of March 2020. 

That indicator denotes the level at which the average buyer/seller is in. In other words, that’s the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called supply zone, the level ought to, again, be looked at as a demand area. 

What’s next? Looks like there are some key areas where supply is likely to show. Mainly the $340.00 and $360.00 areas in the QQQ are of significance. In the SPY, those areas include $435.00 and $445.00.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 4, 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!

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What Happened

Overnight, equity index futures were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

A check on some naive measures suggests we’re in for an expansion of range (i.e., heightened realized volatility) in the coming session(s). Key, today, are Federal Open Market Committee (FOMC) updates (2:00 PM ET) and a news conference (2:30 PM ET). 

The expectation is a 50 basis point hike and balance sheet contraction with run-off caps of $95 billion. If the action is in line with expectations (priced in), the reaction is likely to be positive.

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (10:00 AM ET). 

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

What To Expect

Fundamental: Expected is front-loaded tightening, by the Federal Reserve (Fed), today.

The consensus is anchored around a 50 basis-point hike in May and no adjustments to the Reverse Repo Rate (RRP) or Interest on Reserve Balances (IORB), says Nordea Bank (OTC: NRDBY) research. The Fed may opt, also, to initiate a 75 basis-point hike in June.

“We believe that after the FOMC hikes by a half-point in May and presents a detailed plan to reduce the Fed balance sheet,” imminently, says Anna Wong, Yelena Shulyatyeva, Andrew Husby, and Eliza Winger of Bloomberg. 

“Powell will avoid definitive guidance about the size of future hikes, as policymakers assess how the runoff is affecting the economy in coming months.”

Graphic: Via Nordea research. Heightened inflation, exacerbated by sticky supply pressures and the conflict in Ukraine, and trends in demand have played into a tough talk on monetary policies.

As noted before, the key (risk) is the statements on the Fed’s balance sheet and the (imminent) process to shrink it through quantitative tightening (QT).

Graphic: Via Mish Talk. “The Fed expanded QE aggressively for years. But nearly all of that expansion was longer-dated securities as the [] chart shows. If the Fed had short-term securities it could reduce its balance sheet simply by runoff. Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

Per Nordea, QT is likely to consist of a 3-month phase-in period and run-off caps of $95 billion (i.e., $60 billion on U.S. Treasuries [USTs] and $35 billion in mortgage-backed securities [MBSs]), effectively lowering the Fed’s balance sheet by $670 billion by year-end.

Graphic: Via Bloomberg and Mitsubishi UFJ Financial Group Inc (NYSE: MUFG) U.S. Macro Strategy.

This is alongside the realization that “1Q may be the last good quarter of earnings as higher costs and increased recession risks weigh on future growth,” Morgan Stanley’s (NYSE: MS) Mike Wilson explains.

Graphic: Via Royal Bank of Canada (NYSE: RY) U.S. Equity Strategy and Bloomberg.

Market weakness in the past weeks was the result of “growing evidence that growth is slowing faster than most investors believe,” Wilson adds, and “the market is currently so oversold, any good news [such as Fed action being as expected] could lead to a vicious bear market rally.”

“We can’t rule anything out in the short term but we want to make it clear this bear market is far from complete.”

Positioning: Borrowing from yesterday’s letter, as little has changed, bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and highly sensitive to changes in implied volatility and direction.

Graphic: SqueezeMetrics on “how IV, direction, and moneyness cause option dealers to buy or sell the underlying.”

This exposure’s roll-off and compression in volatility ought to coincide with liquidity provider support to markets (i.e., relief of pressure from hedges to concentrated options positioning).

Per Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Validation of the latter (move) ought to be confirmed by participants’ new concentration of bets. In other words, if participants start to concentrate their bets at higher prices, further out in time, that confirms (changing sentiment) and (improves) 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 7:00 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,157.00 VPOC puts in play the $4,123.00 VPOC. Initiative trade beyond the $4,123.00 VPOC could reach as low as the $4,055.75 and $3,978.50 low volume areas (LVNodes), 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

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 3, 2022

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

Subscribe

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 27, 2022

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

Subscribe

What Happened

Overnight, equity index futures probed higher, essentially negating Tuesday’s end-of-day, knee-jerk liquidation.

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

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

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

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

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

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

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

What To Expect

Positioning: Markets are positioned for continued volatility. 

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

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

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

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

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

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

Graphic: Via Physik Invest. Data via SqueezeMetrics.

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

Well-hedged means that customers (i.e., you and I) own protection against long equity exposure. So, that could mean customers own puts and/or are short calls. One of the most dominant flows is the long put, short call.

Such trade offers customers positive, yet asymmetric (gamma), exposure to direction (delta). In other words, negative delta and positive gamma. 

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

If prices reverse and move higher, these counterparties will re-hedge and buy underlying.

Normally, as seen over the bull run of 2020 and 2021, markets are in an uptrend and there’s a strong supply of volatility. Often, customers sell more calls than puts and, in an uptrend, those calls solicit more active hedging than the put options.

Recall that the customer is short the call. That means the counterparty is long the call (a positive delta and gamma trade) and will make money if prices rise, all else equal. 

The hedging of this particular exposure (i.e., sell strength, buy weakness), in an uptrend, occurs slower (i.e., counterparts will allow their profits to run), and that’s what can help the market sustain lower volatility trends for longer periods.

When prices reverse and underlyings trade lower, put options solicit increased hedging activity. Given the nature of counterparty exposure to those puts, that hedging happens quickly and can take from market liquidity as to volatility (i.e., buy strength, sell weakness).

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

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

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

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

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

Graphic: Via Bloomberg.

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,217.25 overnight high (ONH) puts in play the $4,267.75 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,303.75 ONH and $4,337.00 VPOC, or higher.

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 26, 2022

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

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What Happened

Overnight, equity index futures auctioned sideways-to-lower ahead of an earnings season that’s set to accelerate.

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

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

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

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

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

What To Expect

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

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

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

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

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

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

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

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

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

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

Graphic: SpotGamma’s Delta Tilt.

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

SpotGamma explains: 

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

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

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

Graphic: Via Bloomberg.

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

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

In the worst case, the S&P 500 trades lower; activity below the $4,272.00 HVNode puts in play the $4,233.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,195.25 regular trade low (RTH Low) and $4,129.50 overnight low (ONL), or lower.

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

Considerations: The market is weak and all major indexes covered by this newsletter are trading below their 20-, 50-, and 200-day simple moving averages.

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

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

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

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

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

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

What People Are Saying

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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