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Commentary

Market Commentary For The Week Ahead: ‘To The Moon’

Key Takeaways:

  • Positive earnings revisions nearing records
  • Equity mutual funds attract strong inflows.
  • Multi-asset funds raising equity allocations.

What Happened: U.S. stock indexes resolved a week-long trading range, Friday.

What Does It Mean: As the new administration looked to advance the status of coronavirus relief, U.S. stock index futures established record highs.

This comes as stock indexes, particularly the S&P 500, traded sideways after a rapid de-risking event associated with the GameStop Corporation (NYSE: GME) crisis, and subsequent v-pattern recovery.

More On The V-Pattern: A pattern that forms after a market establishes a high, retests some support, and then breaks above said high. In most cases, this pattern portends continuation.

As stated on Friday, the tight trading range is most likely attributable to the large February monthly options expiration (OPEX), after which, the interest at the $3,900.00 S&P 500 option strike will roll-off. 

Graphic 1: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust (NYSE: SPY), for the week ending February 12, 2021. Activity in the option market was primarily concentrated in short-dated tenors near $390, a strike that corresponds with $3,900.00 in the cash-settled S&P 500 Index (INDEX: SPX).

Why’s this? Most funds are committed to holding long positions. In the interest of lower volatility returns, these funds will collar off their positions, selling calls to finance the purchase of downside put protection.

As a result of this activity, option dealers are long upside and short downside protection.

This exposure must be hedged; dealers will sell into strength as their call (put) positions gain (lose) value and buy into weakness as their call (put) positions lose (gain) value.

Now, unlike theory suggests, dealers will hedge call losses (gains) quicker (slower). This leads to “long-gamma,” a dynamic that crushes volatility and promotes momentum, observed by lengthy sprints, followed by rapid de-risking events as the market transitions into “short-gamma.”

If the interest near $3,900.00 S&P 500 is not rolled up in price and out in time, then option hedging requirements will change.

However, it is important to note that, in recent days, some exposure has been rolled up in price and out in time. This suggests an inclination by participants to maintain long exposure through OPEX, a day that would mark an end to pinning (which we’ve seen over the past weeks).

One such example can be seen below.

Graphic 4: Purchase of call positions higher in price and farther out in time in the cash-settled S&P 500 Index

What To Do: In coming sessions, participants will want to pay attention to the $3,919.75 spike base and $3,928.25 balance-area high.

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

Balance-areas make it easy to spot change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).

Given the spike out of balance, the following frameworks ought to be applied. 

In the best case, the S&P 500 opens and remains above the $3,919.75 spike base, confirming last week’s higher prices. In the worst case, the S&P 500 auctions below the $3,919.75 spike base.

Trade below the spike base would be the most negative outcome and may trigger a new wave of downside discovery, repairing some of the poor structures left in the wake of the aforementioned advance.

Graphic 5: Profile overlays on a 30-minute candlestick chart of the Micro E-mini S&P 500 Futures.

Conclusions: The go/no-go level for next week’s shortened holiday trade is $3,919.75. Trade below this level suggests markets are not yet ready to rally.

Levels Of Interest: $3,919.75 spike base.

Cover photo by Pixabay, from Pexels.

Categories
Commentary

Market Commentary For 2/12/2021

Notice: To view this week’s big picture outlook, click here.

What Happened: As the new administration pushes approval of a $1.9 trillion coronavirus relief plan, alongside the approval of another $14 billion for pandemic-hit airlines and signs of improve in the labor market, U.S. stock index futures traded sideways, in prior-balance and -range.

What Does It Mean: Market’s were range-bound after a rapid de-risking event associated with the GameStop Corporation (NYSE: GME) crisis, and subsequent v-pattern recovery.

Pictured: 4-hour profile chart of the Micro E-mini S&P 500 Futures

The tight trading range is most attributable to the large February monthly options expiration (OPEX), after which, the interest at the $3,900.00 S&P 500 option strike will roll-off. Why’s this? Most funds are committed to holding long positions. In the interest of lower volatility returns, these funds will collar off their positions, selling calls to finance the purchase of downside put protection.

As a result of this activity, option dealers are long upside and short downside protection.

The exposure must be hedged: dealers sell into strength as their call (put) positions gain (lose) value and buy into weakness as their call (put) positions lose (gain) value.

Now, unlike theory suggests, dealers will hedge call losses (gains) quicker (slower). This leads to “long-gamma,” a dynamic that crushes volatility and promotes momentum, observed by lengthy sprints, followed by rapid de-risking events as the market transitions into “short-gamma.”

If the interest near $3,900.00 S&P 500 is not rolled up in price and out in time, then option hedging requirements will change.

The absence of strong fundamentally-driven buying (as we’ve seen with such things as DIX), can have serious implications on price action.

More On 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.
Pictured: DIX by Squeeze Metrics

However, it is important to note that, in recent days, some exposure has been rolled up in price and out in time.

One such example can be seen below.

Pictured: Purchase of call positions higher in price and farther out in time in the cash-settled S&P 500 Index

What To Expect: Friday’s regular session (9:30 AM – 4:00 PM ET) will likely open inside of prior-balance and -range, suggesting limited potential for immediate directional opportunity.

Given dynamics discussed in the prior section, the odds of substantial change are low, so long as broad market indices, like the S&P 500, remain in balance (i.e., range-bound).

Also, trading in a prominent area of high-volume ($3,900.00) will likely make for a volatile session as such areas denote the market’s most recent perception of value and offer favorable entry and exit, hence the two-sided trade.

More On Volume Areas: A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). 

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

Going forward, participants will look to the overnight rally-high at $3,928.25, and low-volume structure beneath the $3,880.00 HVNode, which offered responsive buyers favorable entry during Wednesday’s intraday liquidation break.

More On Overnight Rally Highs: Typically, there is a low historical probability associated with overnight rally-highs ending the upside discovery process.

More On Liquidation Breaks: The profile shape in the S&P 500 suggests participants were “too” long and had poor location.

That said, the following frameworks apply.

In the best case, the S&P 500 remains rotational, at or above the $3,900.00 HVNode. In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below the $3,880.00 HVNode, would favor continuation as low as the $3,830.75 HVNode.

As stated yesterday, major change will be identified with trade above the $3,928.25 overnight rally-high, and below the $3,878.50 regular-trade low.

Levels Of Interest: $3,928.25 overnight rally-high, $3,900.00 HVNode, $3,878.50 regular-trade low.

Categories
Commentary

Market Commentary For The Week Ahead: ‘The Flow Won’

Key Takeaways:

What Happened: Amid a volatile, news-heavy week, after a slew of earnings reports by heavily weighted index constituents, and an FOMC meeting that made no change to existing monetary policy, financial markets experienced a rapid de-risking, similar to what transpired prior to the sell-off in February 2020.

What Does It Mean: After extending the S&P 500’s rally, as well as establishing acceptance near the $3,850.00 price extension, an upside target, and excess (i.e., a proper end to price discovery), participants auctioned back into range, repairing poor structures left in the wake of initiative buying.

The action found acceptance below the $3,824.00 – $3,763.75 balance-area, invalidating the prior week’s break-out to new highs.

Since then, market participants were witness to violent two-sided trade, a result of the market transitioning into a short-gamma environment (Graphic 1).

In such case dealers hedge derivatives exposure by buying into strength and selling into weakness. This, will exacerbate volatility.

Graphic 1: SpotGamma data suggests S&P 500 has entered short-gamma environment

In a conversation for a Benzinga article to be released this coming week, I spoke with Kris Sidial, co-chief investment officer at The Ambrus Group, a volatility arbitrage fund, regarding GameStop Corporation (NYSE: GME) share price volatility, market microstructure, and regulation.

According to Sidial, the dynamics that transpired in GameStop can be traced back to factors like Federal Reserve stabilization efforts, and low rates, which incentivize risk taking (see Graphic 2).

“The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently, than not,” are all part of a regime change that’s affected the stability of markets, Sidial notes. 

“These dislocations happen quite frequently in small windows, and it offers the potential for large outlier events,” like the equity bust and boom during 2020. “Strength and fragility are two completely different components. The market could be strong, but fragile.”

The aforementioned regime change is one in which dealer exposure to direction and volatility promotes crash up and down dynamics. Last February, the market was heavily one-sided with participants, like target date funds (e.g., mutual funds), selling far out-of-the-money puts on the S&P 500 for passive yield, and investors buying-to-open put options in an increasing amount for downside exposure, thus exacerbating volatility. 

Graphic 2: Newfound Research unpacks market drivers, implications of liquidity.
Graphic 3: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

Last week, per Graphic 4, the SPDR S&P 500 ETF Trust, the largest ETF that tracks the S&P 500, saw a rise in purchases of downside protection with time, which will likely lead to an increase in implied volatility and sensitivity of options to changes in underlying price.

These risks will be hedged off by dealers selling into weakness (see Graphic 3), thereby exacerbating downside volatility.

Graphic 4: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust, for the week ending January 30, 2021.

The activity was most concentrated in put options with a strike price of $361, corresponding with $3,610 in the cash-settled S&P 500 Index (INDEX: SPX). This, alongside the market’s entry into short gamma, and an inversion of the VIX futures term structure (see Graphic 5), in which longer-dated VIX expiries are less expensive, is a warning of elevated near-term risks for equity market stability.

Graphic 5: VIX Futures Term Structure per vixcentral.com.

What’s more? Aside from breaking technical trend (Graphic 6) is DIX, a proxy for buying derived from short sales (i.e., liquidity provision on the market making side) declining, and the presence of divergent speculative flows and delta (e.g., non-committed buying as measured by volume delta).

Graphic 6: Cash-settled S&P 500 Index experiences technical breakdown.
Graphic 7: DIX by SqueezeMetrics suggests large divergence between price and buying on January 27.
Graphic 8: Divergent Delta in the SPDR S&P 500 ETF (NYSE: SPY), the largest ETF that tracks the S&P 500.

What To Expect: In light of the technical breakdown U.S. stock indexes are best positioned for downside discovery.

As a result, participants ought to zoom out, and look for valuable areas to transact.

Graphic 9: 4-hour profile chart of the Micro E-mini S&P 500 Futures.

In Graphic 9, the highlighted zones denote high-volume areas (HVNodes), which can be thought of as building blocks.

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

If participants were to auction and find acceptance into areas of prior low-volume, as they have in the week prior, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.

Additionally, it’s important to remember what the market’s long-term trajectory is: up.

Late last year, JPMorgan Chase & Co. (NYSE: JPM) strategist Marko Kolanovic suggested equities would rally short-term with the S&P 500 auctioning as high as $4,000 on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. Since then, Kolanovic has downgraded growth and suggested the limited potential for further upside despite odds of a sustained economic recovery.

Note, Kolanovic has not called for an implosion in equity markets. Instead, the market is due for some downside discovery given a moderation in the recovery.

Given the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 takes back Friday’s liquidation and auctions above the $3,727.75 HVNode. Expectations thereafter include continued balance.

In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below the $3,689.50 HVNode, would favor continuation as low as the $3,611.50 and $3,556.00 HVNodes. Note that the second to last HVNode corresponds with the $361 SPY put concentration, which may serve as a near-term target, or bottom, for this sell-off, given last week’s activity at that strike.

Graphic 10: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures.

Conclusions: Participants ought to look for favorable areas to transact, such as those highlighted areas in the S&P 500, featured in Graphic 9.

Big picture, the sell-off ought to be bought, just not yet. Per Graphic 11, euphoria is still too high.

Graphic 11: Bank of America Corporation (NYSE: BAC) sentiment indicators.

Levels Of Interest: $3,727.75, $3,689.50, $3,611.50 and $3,556.00 HVNodes.

Cover photo by Pixabay from Pexels.