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Commentary

Daily Brief For January 27, 2022

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What Happened

Overnight, equity index futures explored lower before later recovering the prior day’s weak close after hawkish statements from the Federal Reserve (Fed). 

This is as some metrics continue to show buying support and any compression in volatility may serve to bolster a move higher.

Ahead is data on jobless claims, gross domestic product, durable goods orders, and core capital equipment orders (8:30 AM ET), as well as pending home sales (10:00 AM ET).

Graphic updated 6:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: Comments shared by the Federal Open Market Committee (FOMC) revealed asset purchases would stop in March.

After, the Fed is likely to hike the fed funds rate, but this is in the face of an economy that’s stronger than at the start of the last hiking cycle.

Graphic: Per Topdown Charts, “the Fed has placed itself behind the curve, and needs to catch up.”

Still, despite expectations being met, the hawkish tone was enough to tip the equity market

Graphic: Per Bloomberg, “the message Powell gave in his press conference was clear and loud enough to drive a massive reversal.”

This wasn’t unexpected. 

On average, under Chair Jerome Powell, the market tends to give up its intraday gains after an FOMC announcement.

Graphic: “[S]tock markets don’t like listening to Jay Powell.”

With the flatter yield curve (spread of 10-year over two-year Treasury yields), per Bloomberg, this implies that “rates will need to rise in the short term but won’t have to stay high.”

“In other words, the bond market still thinks that the Fed will beat inflation without breaking anything, … and the words at the press conference were enough to engineer a noticeable tightening of financial conditions while still leaving stock markets close to their all-time high.”

Adding, per Goldman Sachs Group Inc (NYSE: GS), rate hikes are set to occur in March, June, September, and December with the balance sheet runoff starting July. 

As noted yesterday, an “abundance of excess liquidity could provide a cushion as the Fed drains liquidity, a cushion that did not exist in 2018.”

Perspectives: Interactive Brokers Group Inc’s (NASDAQ: IBKR) Chief Strategist Steve Sosnick suggests that “Even when we saw relatively higher short-term rates and a flattish curve, equities were able to push to what were then all-time highs. The risk of course is that those highs were about 30% below current levels.”

Also, per Grit Capital, opportunity in growth equities will occur as follows: 

“(1) Investing in free-cash-flow generative names that pull cash flows forward, shortening their duration (i.e., Microsoft Corporation [NASDAQ: MSFT] now trades at a lower P/E multiple than Retail Chain Costco Wholesale Corporation [NASDAQ: COST]). (2) Once the rebound takes hold, invest in high-growth companies that dominate their niche and are positioned in industries with rapid market expansion.”

Positioning: Expectations are for heightened volatility so long implied volatility is bid and markets continue to trade in a negative-gamma environment (wherein an options delta falls with stock price rises and rises when stock prices fall).

Factors that ought to support a counter-trend rally include the compression in volatility and strong buying support (measured by liquidity provision on the market-making side), after, as SpotGamma suggests, “markets have hit a ‘lower bound.’”

According to comments made by SqueezeMetrics, “traders (professional) bought tons of E-minis, and dealers facilitated.”

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

A compression in volatility marks down the positive delta (directional exposure) of options counterparties are short. The positive vanna flow – “covering” of short-delta stock/futures hedges – is what could drive markets higher. 

Conversely, volatility could expand and that would have the opposite effect.

We shall watch the CBOE Volatility Index (INDEX: VIX) and VIX term structure for clues. Backwardation (inversion) in the term structure points to continued fear, instability.

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

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). 

The spike base is at $4,381.00 /ES. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,346.75 high volume area (HVNode) puts in play the $4,415.00 untested point of control (VPOC). Initiative trade beyond the $4,415.00 VPOC could reach as high as the $4,449.00 VPOC and $4,486.75 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,346.75 HVNode puts in play the $4,263.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,212.50 RTH Low and $4,177.25 HVNode, or lower.

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

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.

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.

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

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.

Inversion Of VIX Futures Term Structure: Longer-dated VIX expiries are less expensive; is a warning of elevated near-term risks for equity market stability.

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 18, 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 lower alongside a surge in bond yields. Rate-sensitive sectors were weakest in pre-market trade, in comparison to the value and cyclical names. 

Earnings are now in focus. Participants shall use earnings updates to gauge how companies are performing in spite of omicron, among other challenges.

Ahead is data on the Empire Manufacturing Index (8:30 AM ET) and NAHB Home Builders Index (10:00 AM ET). 

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

What To Expect

Fundamental: Ahead of earnings releases from Goldman Sachs Group (NYSE: GS), Morgan Stanley (NYSE: MS), Bank of America (NYSE: BAC), and Netflix (NASDAQ: NFLX), as well as key rate decisions, indices sold heavy. 

The Nasdaq 100 led the decline after holiday-trade, Monday, as yields surged alongside concerns central banks would tighten monetary policy sooner than expected.

This is as higher rates have the potential to decrease the present value of future earnings, making stocks, especially those that are high growth, less attractive. 

“The rationale behind this is the trade-off,” Grit Capital put well in a recent newsletter

“Why would I park my money somewhere that is only yielding 1%, when I can invest in riskier assets that can raise my return?”

Graphic: Per Grit Capital, “A common proxy that a lot of people look at is the S&P500’s earnings yield (yellow) vs. the 10yr (white).”

At the same time, narratives around quantitative tightening (i.e., the reduction in the size of the Federal Reserve’s balance sheet) are growing louder.

Graphic: QT mechanics per The Macro Compass.

This is what Andy Constan of Damped Spring Advisors refers to as the QT drumbeat. 

This drumbeat is to intensify in spite of strong economic and earnings growth, as well as a moderation in inflation, Constan says

“The lack of additional liquidity provided by Fed purchase will also remove a damper for the market and the economy keeping asset volatility well bid, while also causing asset diversification benefit to fall, generating rising portfolio volatility and the risk demanded to hold assets.”

Note: Check out this Constan’s really interesting story, below!

Graphic: Via The Market Ear, “Temporary relief from Powell – slow reverse QE’ confirmed. Powell says Fed will stop replacing maturing bonds, but will not sell holdings: slow QT.”

“If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” Constan adds. “These risk premium expansions will generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Constan’s comments line up with that of Morgan Stanley’s which sees markets selling down 10-20% during H1 2022, as expectations call for five 25 bp hikes. History is in alignment, below.

Graphic: S&P 500 performance before and after rate hikes, via The Market Ear.

So, despite recent inflows and “light positioning,” taking all of the above comments together, the window for stocks to rally is closing.

Positioning: The coming January 19 expiration of options on the Cboe Volatility Index (INDEX: VIX) and January 21 monthly equity options expiration (OPEX) has major implications.

According to Constan, the “[o]ptions expiration which includes lots of LEAP contracts will be a catalyst for a squeeze rally and a post-OpEx sell-off.”

This is as, according to Kai Volatility’s Cem Karsan, there is a constant structural positioning that naturally drives markets higher.

“I use this analogy of a jet,” he explained, referencing the three factors – the change in the underlying price (gamma), implied volatility (vanna), and time (charm) – that are well known to impact an options exposure to directional risk or delta. 

“[T]he hedging vanna and charm flows, and whatnot will push the markets higher.”

To note, though, with narratives around higher rates and QT strengthening, so to speak, divergences between the S&P 500 and metrics like the Bond Closed-End Fund (CEF) Advance-Decline line have already appeared.

As McClellan Financial Publications explains, “liquidity has suddenly become a problem, and it is affecting the more liquidity-sensitive issues first. That can be a prelude to that same illiquidity coming around and biting the big cap stocks that drive the major averages.”

Graphic: Bond CEF A-D showing liquidity problems, via McClellan Financial Publications.

As an aside, some believe that the Fed’s removal of liquidity has the potential to prick the bubble, prompting a cascading reaction that exacerbates underlying price movements.

“It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration,” Karsan adds. 

“These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,593.00 point of control (POC) puts in play the $4,624.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,633.00 POC and $4,650.75 regular trade low (RTH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,593.00 POC puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,549.00 VPOC and $4,520.00 RTH Low, or lower.

Considerations: The S&P 500 remains above its 200-day simple moving average. The long-term trend remains up.

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction 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 is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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