Categories
Commentary

Daily Brief For August 2, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 700+ that read this report daily, below!

Graphic updated 6:30 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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.

Fundamental

The U.S. Treasury upped its borrowing estimate by $262 billion as federal revenue projections shifted.

Here’s why this matters.

Per Damped Spring’s Andy Constan, on an “overwhelming high issuance in Q1,” markets sold, and on “light issuance, once QT start[ed], plus some crazy tax receipts in Q3,” markets rallied.

With the Treasury’s debt managers seeking to borrow more than $400 billion through September, compared to the original estimate of $180 billion or so, anticipated is added borrowing through new marketable debt issuances.

“This is the reason I dumped my long equities after 3:00 when the news hit,” Constan added.

Overall, this news is important because it has an impact on the money available for circulation.

To explain, after the Federal Reserve (Fed) bean upping the size of its balance sheet (BS) in an unprecedented way in 2020, the deployment of this money – liquidity – boosted risk-asset prices and the cost of living.

We can measure the availability of this liquidity, as well showcased by Max Anderson, online. 

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

So, what’s going on, now?

To rein inflation, and undo some of its intervention, the Treasury issued fewer short-dated T-bills, and the Fed raised rates on Reverso Repo (RRP), “the next best low-duration-risk alternative.”

This has sucked over $2 trillion out of the economy, “six times more than ever done before.”

That said, unlike in the past, however, “relative changes in [the] Treasury General Account (TGA) and RRP” are way bigger than changes in the size of the BS. 

As a result, the game changes. 

The “changes in TGA and RRP have taken over as the primary drivers [of] Net Liquidity,” the money available to circulate in the economy. “[S]ince 2020, the Treasury and Reverse Repo [control] that. Not the size of Fed’s balance sheet.”

That’s per the tight correlation between Net Liquidity and the S&P 500. Offsetting the two by two weeks (i.e., using the path of Net Liquidity to forecast the path of the S&P 500 by two weeks in advance) reveals a tight correlation.

As Anderson puts it, “when there’s a change in Liquidity, it takes two weeks to propagate out into the economy and impact asset prices. And that change in Liquidity predicts next two week’s change in asset prices with 95% correlation.”

See a file containing the data and charts, here. We’ll work to improve the charts in subsequent letters.
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

Positioning

As of 6:30 AM ET, Tuesday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.29%. Net gamma exposures increasing may promote tighter ranges.

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of complex options structures (e.g., back spreads).

The reason why? 

Pursuant to our comments on monetary policymakers ditching forward guidance, which, per the Macro Compass’ Alfonso Peccatiello leaves “no anchor for bond markets, … and higher volatility,” bolsters risk premia “everywhere else.”

As stated Monday, this does more to support our recent positioning analyses and the case for an “untethering” in equity IVOL, “one of the most supportive things into the decline,” per statements by Kai Volatility’s Cem Karsan.

Here’s some context.

As well explained in the Daily Brief for July 21, 2022, heading into the 2022 decline, institutions repositioned and hedged, even allocating to “commodity trend following,” per our Daily Brief for July 15, 2022, which worked well the first two quarters.

The monetization and counterparty hedging of existing customer hedges, as well as the sale of short-dated volatility, particularly in some of the single names where there was “rich” volatility, into the fall, lent to lackluster performance in IVOL and index mean reversion.

This trend is coming to an end as entities are squeezed out of trades that aren’t working (i.e., participants rotate out of volatility and commodities).

Per Karsan, as “volatility itself, on the equity side, becomes less and less hedged on the customer level, … [the] market can really begin to respond to the core macro factors.”

Should markets experience a shock (e.g., China and U.S. tensions escalate), the new demand for hedges may result in an “untethering” in IVOL, which was “one of the most supportive things into the decline,” Karsan said, adding that now is the best time to rotate into call options which are outperforming “their delta to the upside.”

Accordingly, given the macro risk, IVOL is likely at a lower bound (as validated by the S&P 500 trading higher and downside skew holding a bid) and, per The Ambrus Group’s Kris Sidial, “if you wanted to go out and hedge, the opportunity is still there in the equity space.”

Through downside protection (e.g., butterfly and back spreads) you can position yourself to monetize on the sort-of non-linear repricing in volatility we’re alluding there is potential for. The bid in skew is helping those structures maintain their value better, essentially.

Graphic: Time-lapse skew on the S&P 500 (INDEX: SPX) for Monday, Friday, and one week ago. Retrieved from Interactive Brokers Group Inc’s (NASDAQ: IBKR) Trader Workstation.

Technical

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

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

Any activity above the $4,117.75 MCPOC puts into play the $4,149.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,164.25 RTH High and $4,189.25 LVNode, or higher.

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

Any activity below the $4,117.75 MCPOC puts into play the $4,073.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,040.75 and $4,015.25 HVNodes, or lower.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For July 12, 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!

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. 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.

Fundamental

The top headlines are on the inflation conjectures, the depth and breadth of the energy crisis, supply constraints, EUR/USD parity, geopolitical unrest, and global economic slowing.

Graphic: Via Bloomberg. Dollar surge, European growth path, waning demand, and increasing supply weigh on copper, a bellwether of the world economy.

A boiling point, if not already, is soon to be reached, in short.

For instance, the energy crisis, which is, in part, the result of earlier capacity erosion, short-term triggers, and panic, is expected to worsen according to the International Energy Agency (IEA).

Per Goldman Sachs Group Inc (NYSE: GS), a “full interruption to Russian flows to Europe would be equivalent to a 35% supply shock to the European gas market.” 

Graphic: Retrieved via The Market Ear. Via Goldman Sachs Group Inc (NYSE: GS). “[W]e estimate bills would increase by c.65% from here in this event, bringing the total household cost for power and gas to nearly €500/month, creating a meaningful affordability problem. Versus the summer-2020 trough, we estimate that gas/power bills would have increased by nearly 300% on this basis.”

What does this mean for the markets we’re focused on day-to-day in this letter?

Well – and this is pursuant to the Daily Brief for Monday, July 11 – markets have only suffered through compression in multiples. Does it stop or is there a looming earnings compression?

Most likely there is an earnings compression. For now, it is only sentiment that is taking the hit. 

Graphic: Retrieved via The Market Ear. Taken from FactSet Research Systems Inc (NYSE: FDS). 

When will the turn occur?

As stated yesterday, it will be the earnings season that is likely to shed clarity on the answer all the while – what is known right now – a strong dollar is for sure to translate into a headwind for S&P 500 earnings growth.

Graphic: Via Bloomberg. The “Fed is still perceived as having more room to hike rates going forward, also on the back of the strong US jobs report for June,” Unicredito SPA (OTC: UNCRY) analysts explained. “On the other hand, other central banks, such as the ECB and the BoE, might be forced to become more prudent, given the more direct exposure their respective economies have to the gas and energy crisis.”

What’s lending to the dollar’s strength?

Let’s start with the following. Participants were extending moneyness to nonmonetary assets, given easy monetary policies and an environment of ample debt and leverage (which cuts into asset price volatility). 

Graphic: Retrieved from The Market Ear. Via Morgan Stanley (NYSE: MS).

When the reverse happens – tighter liquidity and credit – and volatility eventually rises, the demand (and competition) for money (or cash) deflates assets.

Graphic: Via Citigroup Inc (NYSE: C). According to Joseph Wang, amidst asset price volatility and bank deposits to drain about $1 trillion or so by year-end, investors will “continue to lower their selling prices to compete for the cash they want.”

It is a deflationary pulse manifesting disinflation in consumer prices, that will prompt the Fed to reverse itself on rates and quantitative tightening (QT).

What does this mean?

Depends on the timeframe. 

Though the policy pivot may come alongside a peak in the de-rate markets are experiencing, now, longer-term there are multi-decade trends brewing on the back of the de-globalization pulse, for instance, and a tendency to spend wealth, instead of creating it (as supply chains are replicated here at home), is inflationary which makes the context for a more two-sided market in the future (rather than straight up or down).

Read: Former Bridgewater Associate talks recession odds, capturing a macro edge.

What about the dollar?

With the Fed “still perceived as having more room to hike rates going forward,” per Unicredito SPA (OTC: UNCRY), all the while “other central banks, such as the ECB and the BoE … [are] more prudent, given … the[ir] gas and energy crisis,” short-term dollar strength does more to diminish the global reliance on the U.S.

This is explained even better by Lyn Alden of Lyn Alden Investment Strategy.

The dollar is the dominant currency for carry primarily due to easy monetary policies removing the risk of an ultra-strong dollar. Accordingly, the dollar is “the currency that most offshore debt is denominated in all over the world,” as explained by Bankless, who interviewed Alden.

“Non-US entities make dollar-based loans and transactions in pretty much all markets everywhere because it’s considered more trustworthy than native fiat,” they add. “When there’s a disruption in global cash flows, there’s effectively a short squeeze on the dollar.”

“The stronger the dollar gets in comparison, the less tenable it becomes as a global reserve,” and that is a pressure on the long-term trajectory of that currency.

Positioning

Yesterday’s letter was spot on with respect to positioning.

We can speculate as to where the market may move next, after the release of inflation figures, this week. What’s likely is that, even if the print is hot, the first move is to be structural, per Kai Volatility’s Cem Karsan.

“A function of 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).”

Rising inflation probably bolsters the Fed’s backing of a 75 basis point rate hike on July 27. So, don’t fight the Fed. Rising rates and the withdrawal of liquidity prompts a continued de-rate.

Knowing this, the “flattening in the downside fixed strike skew, while the upside wings [are] more smiley,” as described by JPMorgan Chase & Co (NYSE: JPM), has made for attractive low-cost spread opportunities, as talked about yesterday and in the July 8, 2022 letter.

The moral is as follows: own volatility where the market is likely to not expire. Sell it where the market is likely to expire. Just because implied (IVOL) volatility is at a high starting point does not mean it should be sold, blindly.

Read: Explanations and Applications – Moontower on Gamma.

Technical

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

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

Any activity above the $3,830.75 MCPOC puts into play the $3,867.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $3,909.25 MCPOC and $3,943.25 HVNode, or higher.

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

Any activity below the $3,830.75 MCPOC puts into play the $3,800.25 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,774.75 HVNode and $3,755.00 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: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active. 

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

Example: The below 65-minute S&P 500 chart with volume profiles was included in the July 8, 2022 edition of the newsletter. Prices were near an inflection (micro-composite point of control and two key volume-weighted average price levels). From thereon, selling surfaced.

This is what is meant by responsiveness near key-technical areas.

Graphic: Updated 7/2/22. 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 27, 2022

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

What Happened

Overnight, equity index and commodity futures were higher while bonds were lower. Volatility measures were bid, too.

In the news is Russia’s default on foreign debts. Quarterly repositioning may bolster attempts higher, per JPMorgan Chase & Co (NYSE: JPM), while Morgan Stanley (NYSE: MS) strategists see the potential for lower with base cases calling for a soft economic landing.

Ahead is data on goods orders (8:30 AM ET) and pending home sales (10:00 AM ET).

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

What To Expect

Fundamental: Very short, today.

Later this week, I’m excited to share some insights I gleaned from a veteran trader and macro strategist. As a preview, this person thinks that we are in a recession. However, a recovery in equity markets is not off the table with 2022 likely being a 1% total GPD year with 4% inflation.

Stay tuned for that.

Positioning: We’ve been speaking on the demand for protection and the still-strong supply of it lending to tameness in Wall Street’s preferred “fear gauge,” relative to those gauges tracking markets like rates and commodities.

Graphic: Via Bloomberg.

“The current behavior is playing out similar to the 2000-2002 dot-com bear market, with no big sudden shocks but sustained high realized volatility,” explained Talal Dehbi of PrismFP.

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

Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

Anyways, noteworthy is the sale of short-dated volatility, and this has played into generally poor performance in skew. In light of that, it makes sense to lean toward owning volatility, rather than selling it.

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

The note to point out, here, is – and this is in accordance with some very recent notes – that a “higher starting point” in IVOL, and a still-present right-tail, makes it so we may position, for less cost, in shorter-dated spread structures with attractive and asymmetric payouts.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). Multi-expiry skew in the Invesco QQQ Trust Series 1 (NASDAQ: QQQ). Notice the v-shape in the shorter maturity and smirk in the longer maturity. Here’s what that means.

Heading into the end of the quarter is the expected rollover of large options positions. These are hedges to customer long-equity exposure, which the liquidity providers are short. A front-running of this repositioning flow is (and is expected), in part, to add to the equity market upside.

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.”

Per SpotGamma, after expiration, “it is more likely the [bearish] tone [all else equal] remains unchanged at least from a positioning perspective,” albeit many metrics appear a tad stretched.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from Callum Thomas’ Weekly S&P 500 ChartStorm.

Technical: As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, 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 $3,943.25 HVNode puts in play the $3,982.75 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,016.25 HVNode and $4,055.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,909.25 MCPOC. Initiative trade beyond the $3,909.25 MCPOC could reach as low as the  $3,889.00 VPOC and $3,821.50 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.

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

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

Definitions

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.

Also, MCPOCs 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 June 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!

What Happened

Overnight, equity index futures resolved a multi-day consolidation and auctioned higher, far beyond the prior day’s range. Commodities were mixed while bonds were lower.

The break from consolidation is one of the most bullish happenings in weeks. We’re monitoring whether participants add to their recent short volatility bets against direction, or whether there is repositioning and this bolsters the initiative probe.

Ahead is data on University of Michigan consumer sentiment, inflation expectations, and new home sales (10:00 AM ET), as well as some Fed speak (7:30 AM and 4:00 PM ET).

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

What To Expect

Fundamental: To start, I want to apologize for any confusion, yesterday, with respect to the /GE Eurodollar quote. This newsletter said the peak of the Fed-rate-hike cycle – terminal rate – sat near December 2023. 

That’s wrong. It’s December 2022.

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around DEC 20[22].

Okay, moving on, now!

New data is pointing to a “remarkable” drop in demand for goods and services during June, compared to months prior. 

“US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” S&P Global (NYSE: SPGI) Market Intelligence’s Chris Williamson explained.

“The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”

Graphic: Via S&P Global Inc. “This is a sizeable miss and evidence of a quick slowdown in demand, though it’s still in positive territory (above 50). This report is consistent with a shifting narrative away from inflation worries and towards growth worries.”

Businesses (particularly in retail) are way “more concerned about the outlook” of costs and demand, as well as the path in monetary policies and deterioration in financial conditions. 

Graphic: Via Bloomberg. “Supply constraints, exacerbated by Russia’s war in Ukraine this year, account for about half of the surge in US inflation, with demand currently making up a third of the increase, according to new research from the Federal Reserve Bank of San Francisco.”

That’s validated by Tesla Inc’s (NASDAQ: TSLA) CEO Elon Musk speaking about the carmaker’s losses from new plants, supply chain problems, and the like. 

Graphic: Via Bloomberg. “Long-term ocean freight rates between China and the US West Coast are higher than spot prices for the first time since April 2020.”

“The past two years have been an absolute nightmare of supply chain interruptions, one thing after another,” Musk said.

“We’re not out of it yet. That’s overwhelmingly our concern is how do we keep the factories operating so we can pay people and not go bankrupt.”

Graphic: Via Bloomberg. “Supply chains in Asia look to be on the mend,” though it will “ take a while for supply and demand to rebalance.”

It’s a global move into recession all at once, as Jeffrey Snider of Alhambra Investments says

Read: Daily Brief for May 18, 2022

“​​Combine the potential for break in repo collateral with economy heading toward recession, no wonder the Euro[dollar] curve inversion is spreading as rapidly as it has. Possibility of something big going wrong, therefore ending rate hikes, is huge now.”

“Euro[dollar] squeeze, collateral shortage, deflationary potential in money, and now demand destruction in global real economy.”

Graphic: Via Alhambra Investments.

Over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted innovation and, by that token, deflation, ultimately creating “unimportance to cash flows,” as well put by Kai Volatility’s Cem Karsan. 

Now, there’s a strong commitment to reducing liquidity and credit, all the while there are chokepoints monetary policymakers have little control over. 

This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay. A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s poor sentiments and economic data reflects this.

At the same time, “bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang puts it. 

Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”

Retail buyers, who, according to Michael Wang of Prometheus Alternative Investments, “were a significant driver of the inflated valuations we saw in tech and crypto,” are capitulating in stocks, all the while froth in housing markets is soon to abate, likewise.

Notwithstanding, Mark Zandi of Moody’s Corporation (NYSE: MCO) does not see “the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values,” just as prices of raw materials are retreating as inventories are bloating.

As put forth, partially, earlier this week, one has to wonder about the likelihood that inflation is near its high and whether the de-rates have played their course.

Let’s keep an open mind and follow up on this, in detail, next week.

Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”

Positioning: Keeping this section short. 

As stated yesterday, a feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL) given that participants are hedged and volatility remains in strong supply. 

Read: Daily Brief for June 23, 2022.

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

Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

As I said in SpotGamma’s note, last night, given “the high starting point in IVOL, as well as its place in relation to [RVOL], it makes sense to own structures that benefit either from sharp changes in underlying price or an abrupt repricing in volatility.”

Cutting into the realization of a sharp change in underlying price or a far-reaching rally, however, are short-volatility bets across shorter maturity periods (and the associated hedging), as well as big (and popularized) positions set to roll off at the quarter-end.

Liquidity providers, per SpotGamma, all else equal, will have to sell to re-hedge, and we will talk about this further, next week.

Graphic: Taken 6/22/2022. SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator points to selling of put and call options in the S&P 500 (INDEX: SPX) and S&P 500 ETF (SPY). Those liquidity providers, who are on the other side, are more exposed to long volatility, which they hedge by buying (selling) into weakness (strength) underlying.

Technical: As of 6:40 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, 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 $3,821.50 LVNode puts in play the $3,843.00 RTH High. Initiative trade beyond the RTH High could reach as high as the $3,911.00 VPOC and $3,943.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,821.50 LVNode puts in play the $3,793.25 ledge. Initiative trade beyond the ledge could reach as low as the $3,770.75 HVNode and $3,735.75 HVNode, or lower.

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

Considerations: Recent trade has been lackluster and the overnight break is the most bullish happening in weeks. The go-to trade this week was short volatility. Participants responded to tests of key visual areas, and sold options, particularly in shorter maturities.

In the coming session(s), some of those participants will respond to the break in a manner that bolsters the initiative drive. Notwithstanding, the key to watch for is whether participants will use the bump as an opportunity to add to their most recent short volatility bets against the direction. 

Ultimately, the more time that is spent outside of the prior consolidation area, the likelihood that the breakout is a signal to look for dips to buy and play rotations to key areas up above.

Definitions

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

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

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

Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. 

Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator. 

Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 22, 2022

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

What Happened

Overnight, equity index and commodity futures were sideways to lower all the while bonds and volatility were bid. 

This is after participants, based on metrics included later in the letter, took the advance as an opportunity to sell at higher prices. Demanded was protection, and this bid implied volatility.

Big headlines include China sending warplanes near Taiwan after the U.S. rejected its strait claims. The Taiwanese Foreign Minister Joseph Wu wrote that the threat was “more serious than ever.” This is, also, ahead of Taiwan and U.S. officials talking about arms sales.

In other news, Congress was called on to pass a $0.184 per gallon gasoline tax holiday. Growth in job postings slowed as Q2 GDP forecasts have been revised lower, Chinese manufacturing orders declined by 20-30%, U.K. inflation hit a 40-year record, and sellers of homes are cutting prices in some of the hottest markets while the demand for adjustable-rate mortgages surges.

Ahead, the Federal Reserve’s (Fed) Patrick Harker speaks at 9:00 AM ET. Then, Jerome Powell testifies to the Senate Banking Committee at 9:30 AM ET. Later, Charles Evans speaks at 12:50 PM ET, followed by Harker and Barkin, again, at 1:30 PM ET.

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

What To Expect

Fundamental: For what it is worth when it comes to talking of theory and the economy, ARK Invest’s Cathie Wood has been spot on, in many ways.

Somewhat pursuant to our detailed analysis on May 18, 2022, which talked about the impact of reduced liquidity and credit on the real economy and asset prices, Wood explained that the U.S. fell into a recession during the first quarter.

Read: Daily brief for May 18, 2022.

“If massive inventor[ies] bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year,” she said. Last year, though badly timed, Wood said that inflation would be on its way out due in part to excess inventory which would be reflected in commodity prices.

Read: Walmart Inc’s (NYSE: WMT) inventory glut to reduce in a “couple of quarters” and how Target Corporation’s (NYSE: TGT) oversupply problem should scare all retailers.

Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”

“If inventories and stock prices are leading indicators for employment and wages, … then fears of cost-push inflation a la 1970’s should disappear during the next six months.”

To put it briefly, as we’ve talked about in the past, the recent market rout is a recession and the direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s sentiment and reducing demand for goods, among other things, reflect this.

And, with that, after a period during which capital was misallocated, the Fed is not in a position to control price stability “without bringing down the markets,” per Kai Volatility’s Cem Karsan.

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

In light of these efforts to control price stability, to remain is a continued reach for cash (or bank deposits) and the sale of non-cash assets.

Graphic: Via Redfin Corporation (NASDAQ: RDFN).

“Bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang, who was a trader at the Fed, puts it.

Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”

Graphic: Per Bloomberg, “[E]very $1 trillion of QT will equate to a decline of roughly 10% in stocks over the next 12 months or so.”

If it provides any solace, per comments by Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, the Fed, which “can only deal with nominal [and] not real chokepoints,” is likely to change course.

This is as “nominal balance sheet and liquidity trends will, at some point, clash with the realities of a garden variety of supply chain issues.”

Likewise, Andreas Steno Larsen explains that bond yields remain governed by demographics, and this is good news for stocks, in general.

“Just look at the growth rate of the working-age population (10 years forward) versus the term premium of US Treasury bonds. The current bond bear market is not standing on structural pillars.”

Graphic: Via Andreas Steno Larsen. “Bond yields remain governed by demographics over the medium-term. Low(er) for longer.”

Positioning: To preface, I encourage everyone to check out the Daily Brief for June 17, 2022.

Moving on. So, last week, we had a large monthly options expiration (OPEX). After this, liquidity providers’ re-hedging flows supported the market.

Over the weekend, into Tuesday’s U.S. close, equities, then, traded higher. The rally, however, was not confidence-inspiring and was indicative of short-covering.

Per SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, participants took the relief rally “as an opportunity to hedge/sell,” as I wrote for SpotGamma, yesterday.

Graphic: SpotGamma’s combined HIRO reading for the S&P 500 (INDEX: SPX) and SPDR S&P 500 ETF Trust (NYSE: SPY). Trade was responsive (i.e., buy dip, sell rip) up until 2:00 PM ET when demand for negative delta (i.e., put buying, call selling) outweighed that for positive delta.

This ultimately showed up in broad measures of implied volatility. As The Ambrus Group’s Kris Sidial said: “[I]n the final hour, spot [and] vol up.”

This plays into decreased odds for a far-reaching rally. Participants are positioned out in strikes that are lower and the activity in those strikes plays into a change in tone with respect to the non-linearity and strength of volatility and skew with respect to linear changes in asset prices.

As Karsan spoke to, last week, the spikes in short-dated -sticky skew – the “first we’ve seen since [the] secular decline began” – hints at a “critical change in dealer positioning.”

“We’re transitioning to a fat left tail, right-based distribution,” Karsan adds

So why does any of this matter?

There still appears to be a heavy supply of options, particularly those with less time to maturity, and skew remains poor-performing (hence comments in prior letters on the benefit of buying into implied skew convexity should volatility reprice).

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. Note historical or realized volatility (RVOL) versus that which is implied (IVOL).

Basically, participants are hedged and volatility remains well-supplied. 

If there was to be forced selling or demand for protection by a greater share of the market in ways not recently seen, then the repricing of the aforementioned structures would be a boon for those who own them.

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

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” as Mohamed Bouzoubaa et al explain well in the book Exotic Options and Hybrids.

“ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.”

In other words, by owning that protection – e.g., butterfly and back spreads – you are positioned to monetize on a continued non-linear repricing of volatility. The difficult part is cutting the decay of those spreads when nothing happens.

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

As an aside, despite the bearish tilt in positioning, there has been a notable uptick in index call buying per UBS Group AG (NYSE: UBS), presumably so that participants don’t miss out on a vicious reversal, should one transpire.

Graphic: Via UBS Group AG.

Adding, the “high starting point” in IVOL makes it possible to put on zero- and low-cost bets that deliver asymmetric payouts in case of violent and short-lived reversals. 

Read: Daily Brief for May 13, 2022.

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 (the inverse of a back spread).

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

In the best case, the S&P 500 trades higher; activity above the $3,696.00 low volume area (LVNode) puts in play the $3,722.50 LVNode. Initiative trade beyond the LVNodes could reach as high as the $3,735.75 and $3,770.75 high volume areas (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,696.00 LVNode puts in play the $3,675.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,639.00 RTH Low and $3,610.75 HVNode, or lower.

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

Considerations: Gap scenarios are in play, today.

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

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

Definitions

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 10, 2022

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

What Happened

Overnight, equity index futures continued lower after breaking a multi-day consolidation late yesterday afternoon.

This is amid growth concerns and the European Central Bank (ECB) decision to end asset purchases this month and commit to a 25-basis-point interest rate hike at its next meeting, setting the stage for further rate hikes, potentially 50-basis-points or higher.

Ahead are updates to consumer prices (8:30 AM ET), which may shed further clarity on the path of the Federal Reserve’s policies. Later are updates to consumer sentiment and inflation expectations (10:00 AM ET), as well as the budget balance (2:00 PM ET).

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

What To Expect

Fundamental: The CPI report is a driver of perceptions regarding future Fed activity.

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear. SocGen’s Kit Juckes explains that “the Fed put its foot down on the accelerator in 2020, harder than ever before, to keep the global economy going. Now it’s put its foot on the brake, equally hard but perhaps, a little bit late. How this plays out will become clearer in the coming weeks.”

Expected is an 8.2% rise year-over-year (YoY) and 0.7% month-over-month (MoM). In April, these numbers were 8.3% and 0.3%, respectively.

Core CPI (which excludes food and energy) is expected to rise by a rate lower than in April, 5.9% YoY and 0.5% MoM, respectively.

Graphic: Via Bloomberg. “For two straight months, fuel, power and grocery-store food have all been rising at double-digit annual rates—and tomorrow’s data is likely to show a further surge. Meantime, stocks fell with growth concerns in focus after the ECB moved to combat inflation.”

What matters most is the latter – core inflation – which the Fed has more control over. If lower than expected, that may warrant more appetite for risk.

“While inflation in some parts of the world [is] yet to peak, there are at least some signs emerging that we may not be too far off in terms of a turning point,” adds Khoon Goh of Australia & New Zealand Banking Group ADR (OTC: ANZBY).

Bloomberg reports semiconductor prices are now down 14% from the middle of last year. Also, the spot rate for shipping containers fell 26% while fertilizer prices are 24% below their record.

Still, the commitment to aggressive contractionary monetary policies is likely to remain. This reduction of liquidity and credit has consequences on the real economy and asset prices which rose and kept the deflationary pressures of monetary intervention at bay.

Positioning: It remains profitable to own options structures as implied (IVOL) underprices the volatility which is realized (RVOL).

This is the result of what options analytics service SqueezeMetrics suggests is an “absolute slamming” (i.e., sale of options) that’s compressing IVOL in shorter-dated tenors. 

It is “[o]nly rational to consider a bulk of them as put underwrites, because completely irrational otherwise.”

Important to note that this is in the context of next week’s large options expirations.

Into those events, typically, the frontrunning of delta hedging flows with respect to changes in time (charm), mainly, and volatility (vanna) provide an added boost. 

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

As stated Monday, however, the marginal impact of further volatility compression, since IVOL was falling from already low levels, was likely to do less to bolster equity upside. 

A lot of the supportive action happened in the days and weeks prior, hence the comments on owning options.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,016.25 HVNode puts in play the $4,055.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,071.50 BAL and $4,095.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,016.25 HVNode puts in play the $3,982.75 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,951.00 VPOC and $3,909.25 MCPOC, 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.

Standard Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. 

Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator. 

Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 13, 2022

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

What Happened

Overnight, equity indices probed higher, above Thursday’s trade, which established a new swing low. The Cboe Volatility Index (INDEX: VIX) fell while yields were bid and commodities mixed.

Today, we’ll get into some key narratives including crypto turmoil and financial conditions, as well as a validation of some of our trade theses.

Ahead is data on import prices (8:30 AM ET), University of Michigan consumer sentiment and inflation expectations (10:00 AM ET), as well as Fed-speak by Neel Kashkari (11:00 AM ET).

Take care and watch your risk.

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

What To Expect

Fundamental: In the news, panic in the cryptocurrency markets eased and Tether (CRYPTO: USDT-USD), the world’s largest stablecoin, backed by commercial paper and U.S. Treasuries, climbed back to par.

JPMorgan Chase & Co’s (NYSE: JPM) Teresa Ho said there would be little impact on traditional funding markets while, according to Barclays PLC’s (NYSE: BCS) Joseph Abate, redemptions in Tether, which has a market value just shy of $90-100 billion, would only “cause meaningful strains in money markets should they exceed half of the stablecoin’s total holdings.”

Graphic: Via Bloomberg.

Also in the news are rising interest rates (e.g., mortgage rates up to ~5.30%) and a weak equity market (e.g., S&P 500 lower ~20%), among other things, feeding into a tightening of financial conditions (which is how monetary policy impacts the economy).

Graphic: Via Bloomberg.

“Financial conditions for households and businesses wanting to borrow or raise capital tightened again last week and are the most restrictive since the first wave of the pandemic in 2020 and before that 2012,” Reuters’ John Kemp said.

Graphic: Via John Kemp.

This is as inflation has become “deeply embedded,” spreading from the energy and raw materials-intensive merchandise sector to services.

Graphic: Via John Kemp.

“Rapid service sector price increases usually signal the imminent arrival of a recession,” Kemp said, pointing to decisions by some public companies like Uber Inc (NYSE: UBER), Twitter Inc (NYSE: TWTR), and Amazon Inc (NASDAQ: AMZN) to slow growth and cut labor forces as a validation of slowing momentum.

Graphic: Via Bloomberg. “I think we’re primed for a big distressed supply surge,” said Phil Brendel, a distressed debt analyst for Bloomberg Intelligence. “Everyone gets comfortable and complacent on credit and then when it turns, you tend to see these massive spikes.”

The accelerated selling of equities (~$6.2 billion), bonds (~11.4 billion), cash (~$19.7 billion), and some commodities (~$1.8 billion in gold), over the last week, per Bank of America Corporation’s (NYSE: BAC) Michael Hartnett is capitulation. 

“The definition of true capitulation is investors selling what they love,” Hartnett said, gauging the prospects that stocks have hit a near-term bottom. “Fear and loathing suggest stocks are prone to an imminent bear market rally, but we do not think ultimate lows have been reached.”

Positioning: In past commentaries, we talked about ways to play a returns distribution that is skewed to the upside (albeit, with large negative outliers).

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

The following Goldman Sachs Group Inc (NYSE: GS) remark is a validation of what we’ve discussed:

“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 Goldman Sachs Group Inc. Taken from The Market Ear.

Mainly, zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals. 

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

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.

As stated before, 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.

Ten to fifteen days to expiration and 500-1000 points wide, in the Nasdaq 100 (INDEX: NDX), one of the hardest hit of the indexes, work well. 

An easy check is whether the spread prices for a debit or credit to close if the underlying moves to the long strike of the spread, all else equal.

Debits (which may run as low as $0.00, depending on trade location) can be offset with credits from put sales.

Graphic: Chart of the Nasdaq 100 (INDEX: NDX).

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

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume node (LVNode) puts into play the $4,011.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,069.25 high volume area (HVNode) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode puts into play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,899.00 VPOC and $3,862.75 LVNode, or lower.

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

Considerations: Gap scenarios are in play.

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

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

Definitions

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

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

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

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

About

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

Capelj also 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 11, 2022

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

What Happened

Overnight, index and commodity futures were bid while yields and the Cboe Volatility Index (INDEX: VIX) came in, little.

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

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

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

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

What To Expect

Fundamental: Shortened commentary, today.

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

Graphic: Via Bloomberg.

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

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

Graphic: Via Bank of America Corporation (NYSE: BAC). Taken from Bloomberg. “It’s straightforward common sense that higher inflation would lead to paying a lower multiple of earnings because you expect future earnings to be eaten into by inflation. And common sense is borne out empirically; all else equal, higher inflation does indeed tend to mean lower earnings multiples.”

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

Investors will get clarity on some of these issues in the coming sessions.

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

Barring a worst-case scenario, if markets do not perform to the downside (i.e., do not trade lower), those highly-priced (often very short-dated) bets on direction will continue to decay (i.e., removal of event premiums).

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

Accordingly, hedging flows with respect to time and volatility may, then, bolster sharp rallies.

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

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

Graphic: Updated May 10, 2022. The VVIX via Physik Invest. Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress. When realized volatility is as high as it has been, the VVIX typically trades closer to 150.

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

Presently, some of the largest index constituents (e.g., Apple Inc [NASDAQ: AAPL]) are starting to succumb to the fundamental situation, if we will, and that may feed into the indexes which are pinned due to passive and hedging flows.

In other words, fundamentals will trump this talk of positioning (i.e., it is only in the short-term does this positioning we’ve talked about have greater implications).

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

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

In the best case, the S&P 500 trades higher; activity above the $4,055.75 low volume node (LVNode) puts into play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,153.25 regular trade high (RTH High) and $4,212.25 micro composite point of control (VPOC), or higher.

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 10, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to higher, inside of the prior day’s range. Most other commodity and bond futures were bid while implied volatility metrics came in a bit.

Notable was the depth and breadth of Monday’s decline. Though the indexes were tame, some of which is attributable to suppressive hedging, single stocks expanded their ranges, greatly, to the downside, and this points to potential capitulation.

On the news front, a U.S. central bank report found that “the risk of a sudden significant deterioration [in liquidity] appears higher than normal” and stablecoin use to meet margin requirements in crypto trades makes them “vulnerable to runs.”

This is just as some algorithmic stablecoins have lost their peg (e.g., UST/USD ~$0.60).

Additionally, the report found elevated inflation, as well as the reaction to that “could negatively affect domestic economic activity, asset prices, credit quality, and financial conditions.”

Ahead is data on real household debt (11:00 AM ET).

Graphic updated 6:25 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

Context: We continue to build out the narrative.

A market-wide drop, Monday, pointed to signs of capitulation as “small-time investors offloaded a net of about $1 billion in equities, the most aggressive selling in 14 months,” per JPMorgan Chase & Co (NYSE: JPM).

Graphic: Via @TaviCosta. “Nasdaq has already declined almost as much as it did during the March 2020 crash. Back then, the Fed was all about saving the stock market and the economy. Today, it’s all about how much more they are going to hike rates.

Notwithstanding, the volatility divergences this letter has pointed to, in the face of pronounced realized volatility, continue.

Graphic: Via Topdown Charts. Wednesday (FOMC) price rise (right) versus Thursday (post-FOMC) liquidation.

As Pat Hennessy of IPS Strategic Capital explains, at-the-money implied volatility is high and term structure is in backwardation, which are reflections of uncertainty and demand for hedges.

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

“It’s just rare to see wingy short-dated puts like this so cheap relative to ATM.”

As explained in Monday’s letter (and in greater detail, Friday), a measure like the Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

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

Graphic: Updated May 9, 2022. The VVIX via Physik Invest.

What’s going on? 

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.

There are “plenty of put-buyers, but nearly as many sellers,” SqueezeMetrics explains

You “don’t have to protect what you don’t own. Some investors de-grossed. Short momo (e.g., CTA) wants to bet on a bleed (a la 2000), but not on a crash. Put underwriting! No carry trades elsewhere. Sell SPX vol!”

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, the SPDR S&P 500 ETF Trust (NYSE: SPY) was a recipient of heavy put selling and call buying on 5/9/22.

Why does this matter?

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

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

So, in all, it is a question of whether the reward is worth the risk (see below “How To Play”).

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options, particularly puts.

As The Ambrus Group’s Kris Sidial sums well: 

With an S&P 500 below $4,000.00, “I would expect more of an aggressive reach for hedges … that spot- vol correlation break (weakness) would not be as present.”

“Spot- vol correlation has sucked recently, but vol relative strength should kick in.”

How I’m Playing: Borrowing from May 3’s letter, here.

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

This letter’s author is concentrated on zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals.

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

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.

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, and, as explained, the risk has yet to meet the reward.

Read more about these strategies, here. The above is NOT a trade recommendation or advice.

Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the 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 $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode/gap boundary puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 could reach as low as the $3,907.75 HVNode and $3,862.75 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

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

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

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

Gamma: Gamma is the sensitivity of an option to changes in the underlying price.

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

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

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

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

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

Options Expiration (OPEX): Reduction of dealer gamma exposure.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 9, 2022

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

What Happened

Overnight, equity index, commodity, and bond futures were all lower while yields, and implied volatility metrics we monitor were bid.

This is as new fundamental data did little to disrupt the Federal Reserve’s (Fed’s) course to hike rates and reduce the size of its balance sheet, as well as the odds of further slowing as a result of actions to curb the spread of COVID-19 abroad, and geopolitical conflict.

Goldman Sachs Group Inc (NYSE: GS), among others, cut their equity market forecasts. Presently, they see an economic contraction playing into the S&P 500’s test of $3,600.00.

Notable is the market’s retest of a very key technical area ($4,055.75 in the E-mini S&P 500). This area, last week, likely solicited responsive buying by technically-driven market participants who often lack the wherewithal to defend retests, just days before the Fed’s decision on policy.

Now, the market is set to open below those key technical areas and that is the worst outcome.

Ahead is data on wholesale inventories (10:00 AM ET), as well as inflation (11:00 AM ET).

Graphic updated 6:35 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Positioning: Last week’s letters went in-depth on the implications of volatility divergences, the post-Fed rally, responses to key technical levels, and beyond.

On Friday, May 6, 2022, this letter essentially remarked the following:

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options.

Graphic: Via MarketWatch. “[B]ack-to-back swings in the internals on the scale seen this week are rare, with the last one occurring close to the COVID lows in stocks of March 2020. Indeed, investors had never seen a swing in internals as severe as Thursday’s before the financial crisis of 2008-09.”

How do you know whether the risk is worth the reward? 

A naive measure like the Cboe VVIX Index (INDEX: VVIX), which measures the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

Graphic: Updated May 6, 2022. The VVIX via Physik Invest.

We’re not there yet and the market remains well-hedged, as SpotGamma explains well:

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

Noting, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma.

Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

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

This is amid what is a front-running of the bullish flow associated with the delta decay of options with respect to changes in volatility (vanna) and time (charm), among other factors.

In other words, it is participants’ increased awareness of the implications of options and OPEX that has resulted in a front running. According to SqueezeMetrics, “People didn’t know about the OpEx week effect (in this case, largely charm). Now everyone and their mother knows about it.’”

So what?

Charm is a measure of an options delta’s change with respect to the passage of time. As time passes, delta “bleeds” as options decay. 

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

As most participants, at least at the index level, own protection, the counterparties to this trade are short protection. These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

Moreover, given the growth of options volumes, participants’ heavy demand for protection matters more, to put simply. Counterparties, in light of this recent drop, pressured markets with their hedging. The decay (and eventual expiry) of this protection marks options deltas down.

Graphic: Via Bloomberg. Rising put volumes coincide with early 2022 market sell-off.

To re-hedge, counterparties buy back short stock and futures hedges. This supportive action is what has been front-run. The bullishness of the event can happen in the days and weeks prior.

Technical: As of 6:35 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,055.75 low volume area (LVNode/gap boundary) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,153.25 regular trade high (RTH High) and $4,212.25 micro composite point of control (MCPOC), or higher.

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

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

Considerations: Last Tuesday, we discussed the response to a key technical level ($4,055.75).

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

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

Such traders often lack the wherewithal to defend retests.

Moreover, heading into last week’s Federal Open Market Committee (FOMC) event, large participants (who often move by committee) de-grossed and hedged resulting in poor reliability of our technical levels.

In the days leading up to the event, these larger had little to do with respect to repositioning. 

The market’s tests of key technical areas solicited responsive buying by these short-term traders, and this played into a rally that continued through FOMC. Post-FOMC, the market quickly succumbed to the initiative selling by longer time frame participants.

All else equal, Monday’s regular trade is expected to start somewhere below a key technical area that solicited strong responsive buying by shorter timeframes. 

Given capital constraints and tolerances, shorter timeframes may fuel an acceleration of the prevailing downtrend.

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

 Disclaimer

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