Categories
Commentary

Daily Brief For November 22, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

Graphic updated 9:30 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative:

Crazy morning! Coming in really late, today. Not the best letter. I know.

Positioning

To preface, trading is a lonely game and having people to speak with means a lot. So, I call up my trading partner, yesterday, and we chat markets and some other unrelated stuff. During the call, he said something I couldn’t shake. It was along the lines of the following: “Active traders (e.g., directional stock and futures bettors) are getting killed right now, and we are sitting on our hands not getting killed.”

This is a nod to context. We mustn’t look at the market from a single angle, in short.

Starting on the fundamental side of things, the 2022 market de-rate had much to do with participants’ repricing of assets in the context of monetary tightening (to stem structural inflation). As Joseph Wang wrote in one post, the “Fed’s rapid tightening markedly reduced the level of household wealth and thus potential demand.”

It’s “[o]ne of the Fed’s tools to impact aggregate demand [] by adjusting household wealth,” he adds. This “in turn impacts household spending power.” 

Adding: “The wealth effect was an explicit rationale for [quantitative easing or QE], where higher asset prices were thought to boost consumer spending. By the same logic, lowering household wealth can potentially lower consumer spending and dampen inflation.”

Graphic: Retrieved from Joseph Wang’s “Stock and Flow” post. “Public data suggests [the] top 20% of earners hold 70% of household wealth.”

With “the bulk of asset repricing … behind us,” markets have turned; support is fundamental, for one, and positioning, as we discuss in this letter, has added to market support.

A similar setup occurred late this summer; investors’ supply of protection added to the macro-type flows after elections and CPI. Following the last weeks, the pulling forward of the supportive hedging (linked to the decay of options with respect to the passing of time), in light of the holidays, would keep markets intact.

As some evidence, see the below graphic. Yesterday, the S&P 500 (INDEX: SPX) auctioned sideways (the bottom right) while breadth (the top left) was weak.

Graphic: Market Internals (Advance/Decline, Up-Volume/Down-Volume, Tick) as Peter Reznicek at ShadowTrader teaches. Though positive, readings were weak and supportive of responsive trade, similar to what market liquidity (via Bookmap) was showing.

As SpotGamma put forward yesterday, in addition to the “support coming from the time decay that’s likely being pulled forward due to the holidays, implied volatility compressed and provided the market with that Vanna boost we talk much about.”

Graphic: Retrieved from SqueezeMetrics.

Accordingly, “[w]hen investors supply protection,” hence lower IVOL, counterparties “hedge in a manner that reduces market swings,” SpotGamma explained.

How do we capitalize on this information? A few ways stick out.

First, interesting are trades that bet on less whipsaw over the short term (e.g., sell a short-dated option and buy a far-dated option).

You are betting against movement (-Gamma) over a span of time you don’t think the market will move. And, you are betting on movement (+Gamma) over a larger span of time. In theory, using a calendar spread strategy as just described would position you for market movement when the context develops to “catalyze increased whipsaw.”

Second, if you own the S&P 500, sell call skew to fund put skew. By doing so, you will put yourself into a protective collar. For reasons we won’t go into today, according to a recent posting by IPS Strategic Capital’s Pat Hennessy, collars are an “attractive trade for those who are worried about the performance of stocks over the next year but do not want to sell or try timing the market.”

Lastly, if guaranteed returns are desired, box spreads enable you to create “a loan structure similar to a Treasury bill.” Upon maturity, the box spread earns a competitive interest rate. Price some trades at boxtrades.com.

Technical

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

Our S&P 500 pivot for today is $3,965.25. 

Key levels to the upside include $4,000.25, $4,027.00, and $4,069.25. 

Key levels to the downside include $3,923.00, $3,871.25, and $3,838.25.

Click here to load today’s key levels into the web-based TradingView platform. 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: Bigger participants, some of whom move by a committee and seldom respond to technical nuances, are likely waiting for more information before entering and initiating an expansion of the range. For that reason, our key levels have held to the tick, per the below.

Our Daily Brief for November 18, 2022, went into why this type of push-and-pull occurs in detail.

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.

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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For November 15, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

Graphic updated 9:00 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 this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated 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. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Fundamental

S&P Global Inc (NYSE: SPGI) put it really well in a recent update comparing today to the events of the mid-to-late 1630s. Dutch tulip bulbs traded as high as $750,000 per bulb (today’s money) before collapsing to near-zero.

That’s akin to what happened with the non-fungible token (NFT) craze of the late 2010s and early 2020s. Pictures of rocks sold for millions as recently as last year. Those pictures are worthless, now, and this has done a bit to dent the ecosystem’s apparent value, as well.

Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via @LanceRoberts.

What’s going on to cause this:

It’s basically the case that easy money policies enabled market participants to borrow and fund longer-duration bets on ideas with (potential) promise in the future.

Financial asset investments, too, were far more attractive, and that’s why we saw the asset inflation accelerate, followed by goods and services inflation that was bolstered by chokepoints and trends (e.g., deglobalization via supply chain security and geopolitics) and, ultimately, prompted policymakers to pivot.

FTX (CRYPTO: FTT) is among the victims of this pivot. It’s apparent that the events surrounding the collapse of crypto ecosystems months back prompted a so-called “credit crunch,” an insider close to FTX’s leadership explained.

“Many loaners suddenly recalled all of their loans just to see who was still liquid. Alameda lost a lot from giving out loans to firms [that] defaulted. Alameda was now, also, on the hook for money they didn’t have since they had given a lot of the loan money to FTX or had lost it loaning to now bankrupt counterparties. [Founder and CEO Sam Bankman-Fried] had two choices at this point, let Alameda get liquidated or send user money from FTX to ensure Alameda’s survival.”

Bankman-Fried, a massive risk taker at heart, chose the latter.

The repercussions include the following:

Apart from “strong governance and transparency [to] grow in importance as the cryptocurrency industry attempts to reassure investors and customers, … regulation of cryptocurrency markets, which was already a matter of serious debate, could accelerate,” SPGI explained, noting that some “other areas of the decentralized finance [or DeFi] market may be affected. And lastly, these contagion effects are unlikely to ripple into traditional finance [or TradFi].”

Check out Reuters (FTX bankruptcy filings in, French central bank wants quick regulation) and The Information (Startups should prepare for ‘second order fallout’ from FTX collapse).

Simplify Asset Management’s Michael W. Green (who we quoted in the past for his perspective and belief that we are in “a dot-com type collapse” that’s happened “underneath the surface of the indices which is [a result of] … passive flows supporting the largest stocks within the index, whereas the smaller stocks can be influenced to a greater extent by [] discretionary managers”) said a likely result is a Central Bank Digital Currency (CBDC) and an “almost certain … change in the monetary system,” echoing what Kai Volatility’s Cem Karsan said a long-time ago: “I don’t see … a clear window where cryptocurrency is not subject to constraints and I think it’s highly likely that we move towards a digital dollar.”

CBDCs are highly controversial per my chats with the likes of Edge & Node’s Tegan Kline. She said they could “be used as a mass surveillance tool. Leaders have done little to invalidate her beliefs given their recent discussions on, for example, using CBDCs to derive “carbon footprint.” 

That means having a read on where people are “traveling, how are they traveling, what are they eating, what are they consuming … This is something we’re working on,” leaders have put forth.

The point of this all is as follows:

As many may know, “there’s no ultimate buyer” in spaces like crypto and DeFi, as ex-Goldman Sachs Group Inc (NYSE: GS) emerging market FX and yield trader Seraphim Czecker, who is now heading risk and product management at Euler Labs, said

It’s that and the persistent interest in illiquid products that leave the door open to manipulation. Barring illiquidity, “if there’s a 10 or 15 standard deviation move, the liquidity will allow for … you [to] offload those assets quickly.

However, that’s not the widespread case.

“For example, look at what happened in the UK with the pension funds and margin calls. That is a classic DeFi strategy. You take your bonds and borrow cash against them. Then, you put it back into bonds and loop it a couple of times. That way, you have a leveraged interest rate exposure. That’s the same principle of lending staked Ethereum (CRYPTO: ETH), borrowing ETH, and doing it a couple of times.”

So, there may be “second order fallout” amid all this tightening. Markets, everywhere, are to de-rate. Ultimately, there’s probably a pivot to happen, in the future, with many leaders and strategists in finance unable to agree whether that (pivot) is the result of a recession.

“To take the foot off the brake right now and not finish the job, I think it’s the absolute worst mistake that the Fed could possibly make,” Citadel’s Ken Griffin said at the Bloomberg New Economy Forum in Singapore. In spite of Citadel seeing a recession averted, Griffin said: “I am finding it a bit hard to believe we are not going to have a recession at that point of time, sometime in the middle to back half of 2023,” adding this year finishes with “modest growth.”

Those in agreement include Stanley Druckenmiller, who once managed George Soros’ funds. “You don’t even need to talk about Black Swans to be worried here. To me, the risk-reward of owning assets doesn’t make a lot of sense,” Druckenmiller said

“When you make a mistake, you got to admit you’re wrong and move on that nine or 10 months, that [policymakers] just sat there and bought $120 billion in bonds,” he added. The “repercussions of that are going to be with us for a long, long time.”

Positioning

From a positioning perspective, much of what we’ve discussed in past notes is still true. Among others, Goldman Sachs Group Inc calculates up to $40 billion in buying over the next weeks with more than $80 billion of buying in an up market.

Graphic: Retrieved from @LanceRoberts. “Goldman calculates a whopping $38 billion to buy over the next week and substantially more (green line) if the market is up big. The chart below shows that the bank expects more than +$79 billion of net buying over the month.”

This is pursuant to our statements on the compression of implied volatility (evidenced by a shift lower in the term structure, particularly at the front end where options are most sensitive) compounding macro-type repositioning, with follow-on support coming from the reach for “Deltas and leverage” to the upside (call options)

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).

As Alfonso Peccatiello of The Macro Compass puts it well: “incentive schemes drive people to be much more willing to pay and chase upside.” 

Preferred are “convex structures” that would benefit from rallies. 

However, in traders’ monetization of put protection they owned, as well as reach for upside calls (to not miss out on a potential reversal), skew is at its lows.

Graphic: Retrieved from The Ambrus Group’s Kris Sidial. “2017 is a year that is notorious for extremely low implied and realized vol. It is fascinating to see how insanely low the call-side volatility has been this year. There is low vol and then there is, in the gutter low vol.”

If the assumption is that “further tightening monetary policy and draining liquidity off the market might cause some problems down the road,” per Fabian Wintersberger, downside convexity (bets that trade non-linearly to changes in underlying price and volatility) are attractive.

Graphic: Retrieved from Banco Santander SA (NYSE: SAN).

Trades that may be attractive include collars, as well explained in a recent thread by IPS Strategic Capital’s Pat Hennessy. 

“[T]he combination of historically flat skew [and] the highest rates we’ve seen in 15 years makes longer dated collars an attractive trade for those who are worried about the performance of stocks over the next year but do not want to sell or try timing the market.”

Technical

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

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,069.25, $4,136.75, and $4,231.00. 

Key levels to the downside include $3,965.25, $3,913.00, and $3,871.25.

Click here to load today’s key levels into the web-based TradingView platform. 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.

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 journalist.

His works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, ex-Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For November 7, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1,190+ that read this report daily, below!

Graphic updated 11:00 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. 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.

Administrative

After a one-month hiatus, the Daily Brief by Physik Invest is back, albeit with new inspiration and direction.

Previously, the letter was focused on analyses of secondary and tertiary sources. New for the letter will be the inclusion of primary source information. It will be some time before these changes are most noticeable but that’s the general direction.

For instance, interviewing a country’s economic minister on policy and discussing how that policy impacts markets, at the end of it all, is on the table.

That said, apologies for not being there for the past month. I found a lot happened and I could not rid myself of the desire to unpack. This letter helps me structure trades through which real capital is at risk.

Not having the full picture did me a disservice, in short.

Going forward, I will try to feature a good mix of detail and pointedness. Take care and I look forward to learning and earning together!

Fundamental

Weekend news was centered around the tightening of financial conditions, the impact of central bank action, as well as geopolitics (e.g., Lithuania opening a trade office in Taiwan), and supply chokepoints.

By happenstance, I interviewed the Lithuanian Economy Minister Ausrine Armonaite, quoted by Bloomberg in the above story, last week in Lisbon. More on this, later.

Graphic: Provided by the Lithuanian Delegation. Left, Lithuanian Economy Minister Ausrine Armonaite. Right, Renato Leonard Capelj conducting an interview on behalf of Benzinga.com.

The One Big Thing:

With labor still tight, former New York Fed President Bill Dudley commented that “there’s a lot of work to do … [so] inflation expectations don’t become unanchored” and force “something really, really harsh later.”

Unfortunately, the impact of actions here, in the US, is not isolated.

US tightening pains the rest of the world, too. Stronger dollars pressure emerging-market economies with dollar-denominated debts. This, ultimately, works to upend the dollar’s role as a reserve.

Margin Compression, Dollar Debt:

Dollar strength feeds margin compression (just now filtering through, according to Kai Volatility’s Cem Karsan, and impacting dollar-denominated debt), adding to the “billion[s] less in demand for assets per day” via quantitative tightening (QT).

As a refresher, quantitative easing (QE) lowers interest rates and makes investments in financial assets more attractive. This bolsters asset inflation and deflation in the real economy.

Graphic: Retrieved from Bloomberg. The chart is an example showing “money-printing or ‘quantitative easing’ that [Ben Bernanke] pioneered seemed to prop up the stock market.”

QT Compounds Rising Rate Impact:

Moreover, in 2020, policymakers embarked on historic interventions.

Monetary authorities cut interest rates and bought bonds, all the while money was sent to people. Risk assets were the first to respond. Then, as the economy reopened, demand picked up, supply chains (that were slowed) tightened, and prices in the real economy inflated.

Threats to globalization and persistent supply chokepoints (e.g., Ukraine and Russia) have done little to help. Inflation remains a problem and investors are seeking safety amid Fed intervention. 

Financial assets are in less demand while real assets are in more demand; sticky inflation and the policymaker reactions are putting in jeopardy dollar carry (mentioned above) and the S&P 500, a focus point for this letter and a center of the global carry regime, among other things.

Responses Invoke Collateral Damage:

As Credit Suisse Group AG’s Zoltan Pozsar summarizes, inflation is a structural issue, and “we [have] to generate a round of negative wealth effects to lower demand such that it becomes more in line with the new realities of supply.”

That invokes “collateral damage to the US economy,” S&P Global Inc (NYSE: SPGI) economists have put forth “as households and businesses pull back spending and investment.” 

Ultimately, “[a]s demand erodes, businesses that changed inventory strategy to ‘just-in-case’ from ‘just-in-time’ are left with full shelves to unwind at a loss and less need for workers that were in high demand just a few months ago.” That’s a recession.

Positioning

Equity market implied volatility (IVOL) remains subdued and part of the blame rests on the (1) growth of derivatives and …

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS). Reposted by Rob Emrich III.

(2) a lower liquidity environment in which the hedging of these derivatives matters more.

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

To recap, equity IVOL remains subdued, in part, because traders hedged into the 2022 decline.

The liquidity providers’ response to the monetization of protection (i.e., trader sell put → liquidity provider buy put and stock and/or futures to hedge), as well as decreases in demand for equity exposure (and new protection), is keeping the Cboe Volatility Index (INDEX: VIX) tame while measures such as the Merrill Lynch Options Volatility Estimate (INDEX: MOVE) are surging.

Graphic: Retrieved from Bloomberg.

As well put in a recent Bloomberg article quoting QVR Advisors’ Benn Eifert, “[e]veryone was prepared for another jarring market crash, and that, in essence, is why certain categories of protective options have failed to pay off this year.”

Graphic: Retrieved from Bloomberg. Initially created by QVR Advisors. “When shares drop, demand for fresh protection remains subdued given the unusually thin positioning among big money. At the same time, put owners quickly book profits, often leading to a drop in implied vol. 

In support, IPS Strategic Capital’s Pat Hennessy puts forth that equity positioning is light and, “[I]f you have little to no equity exposure to hedge, why would you be buying puts?” That is all the while “[t]he last 5 years is still fresh in PMs heads though. This means that they have been quick to buy calls on any sign of a market bounce.” 

The first takeaways are that the above forces discussed have made for an orderly sell-off and the occasional quick reversal, particularly with more options activity spread across shorter-dated contracts where options (and hedging) are more sensitive.

Graphic: Retrieved from Bloomberg.

Another takeaway is that with skew at “near all-time lows, … [and] the highest rates we’ve seen in 15 years, [] longer dated collars [are] an attractive trade for those who are worried about the performance of stocks over the next year but do not want to sell or try timing the market.”

Graphic: Retrieved from Pat Hennessy of IPS Strategic Capital.

A last big takeaway includes some loss of structural support from hedging flows.

To explain, often, traders hedge into impactful events such as elections and Fed rate decisions. The demand for protection will pressure markets indirectly. After, however, the decay, as well as the removal of that protection, indirectly supports the market.

Graphic: Retrieved from Bespoke on Twitter. Into Fed days, traders often demand protection. Barring the worst case, traders’ closure of this protection bolsters a price rise, after. The same has been observed after elections (e.g., November 2020 election bottom).

As it sits, traders are hedged into events such as the elections. Per SpotGamma, “[i]f nothing bad happens, and traders close those puts, that would likely bolster a rally.”

This coincides with the market’s entry into a period of lower liquidity (i.e., the holiday season). It’s during this period the effects of decay accelerate and a lack of liquidity, per Karsan, makes markets sensitive to those positive positioning flows.

Ultimately, the very poor hedging that’s going on, heading into the next rally, is going to set the stage for a large tail, Karsan adds. Traders, who aren’t as well hedged, will seek protection and this will pressure markets, adding to any macro-type selling.

More explanation in the coming letters.

Technical

As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to 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.

Any activity above the $3,806.25 LVNode puts into play the $3,845.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $3,874.25 HVNode and $3,909.25 MCPOC, or higher.

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

Any activity below the $3,806.25 LVNode puts into play the $3,773.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,727.00 and $3,685.00 VPOC, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.

Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Considerations: Futures tied to the S&P 500 are trading within close proximity to a blue line in the above graphic. This blue line depicts a volume-weighted average price (VWAP) anchored to price action following the release of consumer price data on September 13, 2022.

The VWAP metric is highly regarded by chief investment officers, among other participants, for the quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

Should the S&P 500 auction away from this level, and come back to it, a prudent response is to fade. If the price is above the VWAP, and it auctions lower, into the VWAP, traders would buy. On the other hand, if the price is below the VWAP, and it auctions higher, into the VWAP, sell.

At this time, S&P 500 prices are near VWAP offering traders lower (directional) opportunities.


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.


Categories
Commentary

Daily Brief For September 22, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 950+ that read this report daily, below!

Graphic updated 8:00 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. 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.

Administrative

An easy read, today. For more complex, see the September 20 and 19 letters. Also, there will not be a letter published for Friday, September 23, 2022. See you next week, team!

Fundamental

Equity markets traded down, yesterday, on the heels of the Federal Reserve’s (Fed) decision to raise interest rates by 0.75% and “keep at it” for longer, eyeing a 1.25% jump, in sum, by 2023.

This puts the current target rate at 3.00-3.25%.

Separately, if the “keep at it” quote sounds familiar, that’s because it is. The Fed Paul Volcker’s memoir is titled “Keeping at It.”

Graphic: CME Group Inc’s (NASDAQ: CME) FedWatch Tool shows higher odds of a 75 to 100 basis point rate hike in November, along the lines of what the futures market was pricing heading into the event.

The Fed Chair Jerome Powell admitted there may be below-trend growth and the potential for unemployment to reach 4.4% next year, up from the current rate of 3.7%. Projected increases, as of yesterday, show interest rates at 4.4% by 2023, and 4.6% in 2023, before moderation in 2024 to 3.9%, as well summarized by Bloomberg.

Graphic: Retrieved from Bloomberg.

Moreover, economists suggest that raising rates to 4.5% would cost the economy nearly 1.7 million jobs while rates at 5% would bring that number to 2 million. A higher savings rate and increased funds at the state level would likely cushion the blow, however.

In response, the likes of Ark Invest’s Cathie Wood, who we quoted recently regarding her thoughts on why the Fed needs to lower the pace of tightening and/or cut, said:

“Most disappointing about the Fed’s decision today was its unanimity. None of those voting on the Federal Reserve is focused on the significant price deflation in the pipeline. The Fed seems to be making decisions based on lagging indicators and analogies.”

She adds that the Fed is setting the stage for deflation:

“The Fed is solving supply chain issues by crushing demand and, in my view, unleashing deflation, setting it up for a major pivot.”

Graphic: Initially retrieved from Bloomberg. Taken from Ophir Gottlieb who concludes costs are dropping, as observed via shipping, gasoline, manufacturing, cars, and rent measures.

Moreover, it’s the case that “[a]s rates rise and debt servicing costs increase, ‘many zombie institutions, zombie households, corporates, banks, shadow banks, and zombie countries are going to die,’” said economist Nouriel Roubini, who predicted the 2008 financial crisis. 

Prior to the Fed event, Roubini forecasted a 75 basis point hike in September, followed by a 50 basis point hike in November. The market is pricing more than what Roubini thought the Fed would probably do after Wednesday’s Fed meeting.

In his opinion, stay “light on equities and have more cash, … [as] equities and other assets can fall by 10%, 20%, 30%.”

Positioning

In short, unexpected was the post-event response. In recent times, post-Fed moves have been positive, driven by the “rebalancing of dealer inventory,” per Kai Volatility’s Cem Karsan.

That didn’t happen and let’s unpack why.

Basically, into the event, traders demanded protection and bid implied volatility (IVOL). The assumption is that counterparties, who are likely on the other end, have exposure to positive Delta and negative Gamma, which they hedge through negative Delta trades in the underlying.

Should fears have been assuaged, the supply of that protection once demanded, would have decreased IVOL (and options Delta), providing the markets a boost.

Graphic: Retrieved from SqueezeMetrics.

That didn’t happen. Instead, traders added protection, as shown by this SpotGamma graphic tracking changes in put open interest on the S&P 500 (INDEX: SPX).

Graphic: Retrieved from SpotGamma. Updated September 22, 2022.

This bid some basic measures of IVOL into the close.

Graphic: Retrieved from VIX Central. Updated September 21, 2022.

That’s as these particular options, which were added at much lower prices, as I explained in a SpotGamma note, recently, “are far more sensitive to changes in direction and IVOL.”

These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly. “If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”

Graphic: Retrieved from SqueezeMetrics.

Notwithstanding, it’s still the case that a “reload on fresh short-dated downside” flows heighten the risk of a “negative Delta squeeze … into month end,” said Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

Therefore, “you have to consider a move up [to] $4,000.00 as part of your distribution of outcomes to the upside,” as that is near where “market makers are ‘long,’” as part of an impactful collar trade many are aware sits.

As an aside, some online conversation was sparked around placing cash into riskless trades for some small, but guaranteed, rates of return. In that conversation, Box Spreads were put forth as a solution to lend cash and earn a competitive interest rate.

For context, “Boxes allow market participants to create a loan structure similar to a Treasury bill. T-bills are ‘discount’ instruments that are purchased at a value less than the stated face value. Upon maturity, bills call for the return of the stated face value.”

“For example, one might buy a $1 million 90-day T-bill for $998,000. Ninety days later, the $1 million face or principal value is returned and the $2,000 discount is earned as interest. One may represent the rate on this transaction as a 0.80% or 80 basis point discount yield [= (360/90) x ($2,000/$1,000,000)]. The effective rate on a box represents a ‘discount yield’ similar to a quoted T-bill rate.”

Graphic: Retrieved from boxtrades.com.

IPS Strategic Capital’s Pat Hennessy explains that SPX boxes “typically yield[] 20-40 bps above [the] corresponding maturity risk-free rate.” Additionally, there are tax advantages to using the S&P 500’s 1256 contracts. 

For easier fills, use the “3K/4K line in an AM settled expiry,” Hennessy noted. “Helps if you know where the broker market is.”

Technical

As of 8:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper 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.

Any activity above the $3,826.25 HVNode puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as high as the $3,893.00 VPOC and $3,936.25 ONH, or higher.

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

Any activity below the $3,826.25 HVNode puts into play the $3,770.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,722.50 LVNode and $3,688.75 HVNode, or lower.

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

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, ex-Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, among many others.

Disclaimer

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

Categories
Commentary

Daily Brief For 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 10, 2022

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

What Happened

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

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

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

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

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

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

Graphic updated 6:25 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Context: We continue to build out the narrative.

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

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

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

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

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

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

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

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

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

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

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

What’s going on? 

There is really negative sentiment and emotion, both of which are playing into market weaknesses and realized volatility. However, that realized volatility is not priced in.

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

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

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

Why does this matter?

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

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

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

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

As The Ambrus Group’s Kris Sidial sums well: 

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

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

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

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

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

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

Graphic: Via Banco Santander SA (NYSE: SAN) research, the return profile, at expiry, of a classic 1×2 (long 1, short 2 further away) ratio spread.

The concern with these strategies is the width and time to expiry. Should either of those be wrong, then spreads initially positive gamma turn negative, meaning losses are amplified.

For instance, in the Nasdaq 100, to put in short, 500-1000 points wide ratio spreads (buy the closer leg, sell two of the farther legs) expiring in ten to fifteen days work well.

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk, and, as explained, the risk has yet to meet the reward.

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

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

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

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

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

Definitions

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

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

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

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

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

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

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 9, 2022

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

What Happened

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

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

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

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

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

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

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

What To Expect

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

So what?

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

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

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

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

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

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

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

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

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

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

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

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

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

Such traders often lack the wherewithal to defend retests.

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

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

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

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

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

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

 Disclaimer

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