Categories
Commentary

Daily Brief For May 23, 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 probed outside of the prior day’s large trading range but quickly rotated back inside. Overall, the major indexes and commodities were higher. Volatility was bid.

In the news was President Biden’s remark that the U.S. would intervene with the military to defend Taiwan from a China invasion.

This is just as the administration unveiled a 13-nation economic pact to assert Asia leadership. In response, China’s Foreign Minister Wang Yi said the pact was “doomed to fail.”

In other news, the U.S. got its first 70,000 pounds of baby formula to ease shortages. Beijing saw the most cases of a new COVID-19 outbreak, and Russia may ease key FX limits.

Ahead, there is no data scheduled to be released. Today’s commentary will be lighter.

Graphic updated 6:35 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: A shortened commentary to start our Monday.

JPMorgan Chase & Co’s (NYSE: JPM) Chief U.S. economist Michael Feroli notes that as the Federal Reserve gains traction in cutting financial conditions, the U.S. is, indeed, likely to grow slower in 2H22 and 2H23. 

Graphic: Via Bloomberg.

“A stronger dollar, lower equity prices, and higher mortgage rates will weigh on demand,” The Market Ear said in their summary of Feroli’s remarks.

“Over time weaker output demand should lead to weaker labor demand.”

Positioning: Wrote an explainer on market weaknesses, from a positioning perspective, via Benzinga. Check out, if interested. Alternatively, read Friday’s in-depth letter, also.

Mainly, we’re in an environment characterized by volatility suppressing activities and an “observed divergence in the volatility realized, versus that which is implied by options activity.”

Graphic: Via Tier1Alpha. May 18’s “-4% close ended up being the first three-sigma event since 2020, and the most significant daily drawdown while the VIX is still under 35, since 2011. This is only the 6th time ever SPX has had this large of a drop with the VIX at this level, with the past dates highlighted in the chart below.”

Moreover, OPEX coincided with the removal of a lot of put delta (i.e., exposure to direction).

Those who are on the other side (e.g., liquidity providers or market makers), who were short these puts (a positive delta trade) protecting investors to the downside, are to buy back their short stock and futures hedges (a negative delta trade, initially) to re-hedge.

That means markets have less pressure (negative delta) to contend with in their attempts up. 

Ultimately, options analysis service SpotGamma thinks that “[a]ny ultimate rally off of OPEX [is] subject to swift reversals.”

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 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 $3,943.25 high volume area (HVNode) puts in play the $4,061.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,095.00 overnight high (ONH) and $4,119.00 VPOC, or higher.

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

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

What People Are Saying

Definitions

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

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

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

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

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 20, 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

Ahead of a $1.9 trillion options expiration, which we unpack later in the letter, the equity index and commodity futures, as well as yields, were bid.

This activity was on the heels of good news coming from overseas. China lowered prime rates on the five-year by a record to boost mortgages and loans amid an ongoing pandemic slump.

In other news, China warned the U.S. over a ‘dangerous situation’ forming over Taiwan, and the U.S. is set to block Russian debt payments, raising concerns of default. 

This is as Russian forces, per Michael Horowitz of Le Beck Int’l, broke “Ukrainian defenses west of Popasna in the Donbass, … a tactical success for Russia, the first in a very long time.”

Ahead, there is no data scheduled for release. Enjoy your Friday!

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

What To Expect

Fundamental: Fundamentally, the narrative remains the same, albeit there has been a rise in concern over global growth given persistent supply chokepoints and a commitment to reducing liquidity and credit.

Moody’s Corporation’s (NYSE: MCO) Mark Zandi explains “the odds that the economy will suffer a downturn beginning in the next 12 months at one in three with uncomfortable near-even odds of a recession in the next 24 months.”

Graphic: Via The Macro Compass. “Analyst consensus for the 2022 US real GDP growth has been consistently revised down this year.”

Per Bloomberg’s John Authers, U.S. housing is slowing down in the context of still-heightened sales. Data on home building suggests builders “aren’t running scared” while chokepoints still are feeding into support for house prices.

“Now, with inflation rising, the Fed is more concerned about wealth effects,” Authers explained. 

“The rise in asset prices has made a lot of people wealthier and encouraged them to spend accordingly. It’s also stoked inequality. A fall in home values would be helpful at this point,” and it’s something the Fed is keen on “pursuing,” as talked about in letters earlier this week.

Graphic: Via Bloomberg.

Positioning: Friday marks the roll off of $460 billion of derivatives across single stocks and $855 billion of S&P 500-linked contracts, according to a Bloomberg report quoting Goldman Sachs Group Inc (NYSE: GS) research.

Graphic: Via Goldman Sachs Group Inc. Taken from Bloomberg.

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

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

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

“If a meaningful volatility event has recently transpired [e.g., COVID-19], implied volatility demand tends to be high,” as sellers of it were liquidated in previous declines and “buyers have been rewarded with profits and demand for their services.”

Graphic: Via Bloomberg. “2022 is shaping up to be the busiest year for option trading. Almost 40 million contracts have changed hands daily on average, 6% above last year’s record, data compiled by Bloomberg show.”

“Market participants are thus overly hedged going into the second move, resulting in the suppression of implied volatility and skew along with a dampening of realized volatility.”

Graphic: Commentary published by Kai Volatility.

Given the aforementioned supply and demand dynamic, as well as illiquidity, we continue to observe a “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says.

Graphic: Via @ftx_chris. “The relationship between illiquidity & volatility is a critical market driver for traditional markets now. In simple terms: lower liquidity creates increased volatility.”

“For some of these reasons – tempered measures of implied volatility – the market’s missing a lot of the ‘stored energy’ or ‘vanna fuel’ that’s helped support it in past periods of turmoil.”

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

So, barring changes in fundamentals, the catalysts to a potential rally are few and far between, and we elaborated on this in an earlier commentary.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

Heading into Friday, Bloomberg quotes the $4,000.00 S&P 500 (INDEX: SPX) strike having “93,000 open positions set to run out, … includ[ing] 41,024 calls and 52,269 puts.”

Graphic: Via SpotGamma.

An open well below $4,000.00 means that this expiration will coincide with the removal of a lot of in-the-money put-delta. That means, post-expiration, per SpotGamma, “market makers will be free to buy back stocks to cover the short exposures that are no longer needed.” 

“Any ultimate rally off of Opex, we’d consider to be short covering, and subject to swift reversals into the end of next week.”

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

In the best case, the S&P 500 trades higher; activity above the $3,943.25 high volume area (HVNode) puts in play the $4,061.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,095.00 overnight high (ONH) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,908.75 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $3,862.75 and $3,836.25 low volume areas (LVNodes), or lower.

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

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

Such traders often lack the wherewithal to defend retests.

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

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

Definitions

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

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

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

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

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 16, 2022

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

What Happened

Overnight, equity index futures auctioned lower after a failed attempt to solicit strong buying on a break of Friday’s regular trade high. 

Coincidentally, after a test of an anchored volume-weighted average price level, some measures from China had traders concerned about global growth, and that fed into a risk-off sentiment and probe further into Friday’s range.

Moreover, ahead is data on Empire State Manufacturing (8:30 AM ET).

Today, we add light context to our narratives with an aim to elaborate further in letters later this week. Take care!

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: Data from China shows contraction in light of COVID-19 troubles.

Graphic: Via Bloomberg

Bloomberg’s John Authers explains that a contracting China “would be a deflationary force for the rest of the world.”

Graphic: Via Stenos Signals. “China imports vs. Commodities – the most important macro chart in the world right now.”

Andreas Steno Larsen, of the Stenos Signals letter, recently talked about this “lack of economic activity in China,” as well as “slowing demand in the West,” both of which are to “lead inflation expectations lower.”

Graphic: Via CrossBorder Capital. “Latest weekly Fed liquidity injections and the S&P 500. Bigger the bull, the harder they fall? Fed trying to crash [the] economy to kill inflation [and] Wall Street is the victim.”

Notwithstanding, the Federal Reserve (Fed) remains on track “to deliver substantial QT and rate hiking,” all the while investors “hold a relatively risk-friendly position in equities and credits.”

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear.

Steno Larsen explains: “That disconnect [between sentiment and exposure to risk] will have to wane before I truly dare to re-add risk asset exposure to my list of recommendations.”

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

Pursuant to that remark, Authers notes that the latest Chinese data emboldens the risks of a recession which Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar explains is not enough.

“[T]he risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects, and signs of a recession might not mean immediate rate cuts to ramp demand back up.”

“Rallies could beget more forceful pushback from the Fed – the new game.”

Graphic: Via @TheBondFreak. “2/10s spread has delivered its message. The long end is beginning to trend lower. NOW…it’s time to start watching the 3m/10yr spread, which will likely invert as the Fed continues with its rate hikes to kill demand, cause a recession, but “us” from inflation.”

Per Goldman Sachs Group Inc (NYSE: GS), baseline forecasts assume “no recession” and imply the S&P 500’s P/E ends unchanged at 17x. 

“A recession would see the index fall by 11% to $3,600.00 as the P/E drops to 15x.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear. A recession brings S&P 500 to $3,600.00.

Positioning: Early on Friday morning, we approached trade too optimistically but, to our credit, we focused on participating with as little risk as possible, via the use of complex strategies, as validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “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.”

Heading into Monday’s regular trade, little has changed and indexes are holding well, relative to some constituents.

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

Kai Volatility’s Cem Karsan hypothesizes: “If a meaningful [volatility] event has happened within the last year, participants are more likely to be prepared for the move. So the ‘2nd event’ dramatically underperforms [implied volatility] skew expectations.”

“Take Jan/Feb 2016, Oct-Dec 2018, &…Sep 2020? All these ‘2nd Events’ ended up being as meaningful as their 1st events, if not more, for markets, but were much more orderly [and] accompanied by poor [volatility] performance.”

Graphic: Via Bloomberg. “For all the recent declines — the S&P 500 is down more than 13% from its high on March 29 — stress indicators also aren’t at levels seen during comparable slumps. Fewer than 30% of the benchmark’s members have hit a one-year low, compared with nearly 50% during the growth scare in 2018 and 82% during the global financial crisis in 2008.”

Given the aforementioned supply and demand dynamic, we continue to observe “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says. 

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

For “divergences in volatility realized and implied to resolve, it would likely take forced selling. Liquidity providers’ response to demand for protection would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

All else equal, SpotGamma adds, there is no catalyst to rally until the May 20, 2022 options expiration (OPEX). Till then, rallies are subject to failure.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

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

In the best case, the S&P 500 trades higher; activity above the $4,013.25 micro composite point of control (MCPOC) puts in play the $4,036.00 regular trade high (RTH High). Initiative trade beyond the $4,069.25 high volume area (HVNode) could reach as high as the HVNode and $4,119.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,013.25 MCPOC puts in play the $4,3978.50 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,943.25 HVNode and $3,899.00 VPOC, or lower.

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

Definitions

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 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 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!

What Happened

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

Notable is how orderly the selling has been, particularly in the equity space. That’s due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

The fundamental narrative has changed little. Chief among participants’ worries are growth and inflation, the monetary response to the two, as well as chokepoints not limited to supply chains.

Ahead is data on jobless claims and the producer price index (8:30 AM ET), as well as Fed-speak by Mary Daly (4:00 PM ET).

Graphic updated 7:15 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: In Wednesday’s morning letter, we talked about the expectations for annual inflation to have peaked and month-on-month inflation to have risen a small amount.

Per Bloomberg, “the broader CPI rose 0.3% from the prior month and 8.3% on an annual basis, a slight cooling but still among the highest readings in decades.”

Stocks were sold, after, on the limited change to the broader fundamental outlook. The hardest hit was growth and technology, including cryptocurrency. 

“Now that central banks are unwinding monetary support, growth stocks’ valuations have further to fall,” Citigroup Inc (NYSE: C) strategists including Robert Buckland said

Notwithstanding, “any stabilization in nominal yields should eventually help to stabilize real yields and hence equity valuations.” 

This is because higher rates play into bigger discounts on future profit.

Graphic: Via Bloomberg.

Positioning: Orderly selling continues.

Despite falling about the same distance (peak to present low) during the equity market rout of 2020, selling, this time around is steady and there is no panic, and that’s partly the result of there being “plenty of put-buyers, but nearly as many sellers,” according to SqueezeMetrics.

Accordingly, using off-exchange short sales as a proxy for buying activity, we see implicit buying support, and that’s due in part to “passive flows” which ultimately end up “supporting the largest stocks,” hence the index’s strength versus smaller (and much weaker) constituents.

Taken together, some metrics this letter often looks to for insight into the potential distribution of future returns, carry less weight; it’s odds and when the largest stocks succumb to fundamental weaknesses, for lack of a better way of expressing it, that likely takes the indexes with it.

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.

Moreover, with the S&P 500’s break of $4,000.00, an area around which there is a lot of open interest, particularly on the put side, “increases capitulation risk” in the case participants start reaching for protection and indirectly taking from market liquidity as liquidity providers sell into weakness to hedge.

Notwithstanding, 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.

Ways to participate in upside, while limiting downside, markedly, were discussed on May 10. Making money is one thing. Not losing money is another.

Lose less when wrong. Make more when right.
Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

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

In the best case, the S&P 500 trades higher; activity above the $3,907.75 micro composite point of control (MCPOC) puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 HVNode could reach as high as the $4,011.00 untested point of control (VPOC) and $4,069.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,907.75 MCPOC puts in play the $3,862.75 LVNode. Initiative trade beyond the $3,862.75 LVNode could reach as low as the $3,816.75 and $3,780.75 LVNodes, or lower.

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

What People Are Saying

Definitions

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 6, 2022

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

What Happened

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

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

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

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

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

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

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

What To Expect

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

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

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

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

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

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

Graphic: Via Toggle.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: The VVIX via Physik Invest.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 27, 2022

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

What Happened

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

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

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

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

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

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

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

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

What To Expect

Positioning: Markets are positioned for continued volatility. 

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

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

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

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

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

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

Graphic: Via Physik Invest. Data via SqueezeMetrics.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via Bloomberg.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 25, 2022

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

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

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

What Happened

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

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

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

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

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

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

What To Expect

Fundamental: A push-and-pull, continues.

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

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

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

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

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

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

Graphic: Via ICI. Taken from The Market Ear.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via Physik Invest. Data via SqueezeMetrics.

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

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

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

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

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

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

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

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

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

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

What People Are Saying

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 30, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to lower while most commodities and the ten-year yield were higher.

The bullishness of the past days, driven in part by breakthroughs in Russia and Ukraine peace talks is threatened by new updates. Now, the Kremlin said that its talks with Ukraine yielded no breakthroughs. Geopolitical matters and supply chain issues are major headwinds for markets.

Ahead is data on ADP employment (8:15 AM ET), GDP revision, gross domestic income, and corporate profits (8:30 AM ET), as well as Fed-speak. Tom Barkin speaks at 9:15 AM ET and Esther George speaks at 1:00 PM ET.

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

What To Expect

Positioning: Buying the March 14 S&P 500 low would have yielded you nearly a 12% gain. Buying and holding the Nasdaq 100 low would have yielded you about 17%.

Graphic: Via Bloomberg.

The forward returns when the 10-day S&P 500 return crosses above 10% are mixed. 

From 2000 to 2009, forward returns are weak. From 2009 and beyond, returns are strong.

Graphic: Via @HalfersPower. “Every time the $SPY has a 10-day return crossing above 10%, and fwd returns from those dates.  2000-2009 weak forward returns, 2009 fwd, strong fwd returns.”

These powerful moves are due in part to the “reflexive dynamic coming from structural flows,” explains The Ambrus Group’s Kris Sidial who sees a lot of opportunity in the “front of the term structure.”

Sidial and I have spoken a couple of times regarding the implications of increased derivatives exposures and the transmission of those risks associated to underlyings. 

Mainly, counterparties, as a result of regulatory frameworks, among other things, lend to cascading reactions that exacerbate underlying price movements.

Graphic: Via VIX Central. Shorter-dated implied volatility is sold aggressively at the front end. The steepening of this curve bolstered a near-vertical price rise as options counterparts bought back stock and futures hedges to downside (put) protection they were short.

Further, this recovery is in the context of geopolitical tension and monetary uncertainties that have lent to volatility spikes across other asset classes. Though fear tends to spread across markets, it is not, today, as discussed in past commentaries.

Basically, the equity market’s pricing of risk, which we use the CBOE Volatility Index (INDEX: VIX) as a proxy for, is not moving in lockstep with that of measures in FX and rate markets. 

Notwithstanding, as SqueezeMetrics explains, there are no “hardcore vol[atility] sellers in the SPX right now,” and this may actually be a good thing.

As SqueezeMetrics explains in their Implied Order Book paper, “Selling options is a tough business, since you’re on the wrong end of a derivative with a convex payoff.”

“In terms of gamma [an option deltas sensitivity to direction] and vanna [delta hedging flow with respect to changing levels of implied volatility], crash risk is a function of how many investors have sold puts [which] … are, quite literally, a bunch of huge buy limit orders below the market, and then a bunch of liquidity-taking stop-losses further down.”

Graphic: Via SqueezeMetrics. Learn the implications of volatility, direction, and moneyness.

Heading into the early-to-mid March reversal period, this newsletter revealed the forecasted returns distribution of a comparison of proxies for buying (DIX) and gamma exposure (GEX). 

At the time, the returns distribution was skewed positive given a deeply negative GEX and strong DIX.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

The bullishness of those metrics was taken with a bit of a discount, given the aforementioned cross-asset divergences, as a result of geopolitical conflict, among other things.

In hindsight, the right call would have been to buy hand over fist.

A bout of speculative demand (expressed through short-dated options highly sensitive to direction), as well as the compression of ultra short-dated volatility heading into and through the Federal Open Market Committee (FOMC) meeting and large March monthly options expiration (OPEX) bolstered strong buying support and lent to the market’s resolve higher.

The price rise, now, has likely reached a climax. The S&P 500, in particular, is at an overbought level: the concentrations of call open interest at and around $4,600.00.

As SpotGamma explained well, recently, “customers are short calls up top (to finance put options, or bets on the downside, down below). As underlying SPX prices rise, the call (put) side solicits more (less) hedging.” 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for the S&P 500 SPY ETF on 3/29/2022.

“Since counterparties’ call positions provide positive exposure to direction (positive delta) and profits are amplified to the upside (positive gamma), counterparties must sell into higher prices and buy into lower prices, thereby adding liquidity and supporting the market.”

Participants’ selling of volatility at these higher levels suggests increased odds of sideways, rather than up or down; as time and volatility trend to zero for these options, their gamma increases, and the reaction to this will result in the promotion of pinning.

Thereafter, the clearing of this options exposure likely opens the door to underlying breadth which has improved markedly since early March. 

Though today’s market is unprecedented, so to speak, improvements in breadth support a historical case for sideways-to-higher through tightening cycles.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM).

In opposition to this narrative (i.e., higher prices through the tightening cycle) are some Bank of America Corporation (NYSE: BAC) strategists.

“The worsening macro backdrop and market-unfriendly Fed make sustained U.S. equity gains unlikely,” Bank of America strategists said in a statement that recommended investors sell upside (call) protection to hedge downside. 

If Bank of America is correct, it’s possible that, given the recent clearing of puts, participants’ demand for protection, and the hedging of this exposure, would add velocity to the move lower.

SqueezeMetrics’ remark on hardcore volatility selling, however, has us a little less concerned (about some sort of armageddon situation).

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 $4,597.00 untested point of control (VPOC) puts in play the $4,611.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,631.00 regular trade high (RTH High) and $4,641.75 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,597.00 VPOC puts in play the $4,574.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 Spike Base and $4,533.00 VPOC, or lower.

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

Definitions

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

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

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

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

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

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

Options Expiration (OPEX): Traditionally, option expiries mark a reduction in dealer gamma exposure.

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.