Categories
Commentary

Daily Brief For December 2, 2022

Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.

Graphic updated 7:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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

We will issue a content calendar revealing the dates letters are likely to be published and the content that may be covered.

Separately, due to the writer’s travel commitments, from 12/6 to 12/16 there will likely be little to no commentary. If any queries, or if you are local to New York City or Paris, ping renato@physikinvest.com or Renato Capelj#8625 on Discord.

Please check out the Daily Brief for November 29 and 30, as well as December 1.

On 11/29, we unpacked the context for a trade to take. On 11/30, we took that trade. On 12/1 we dissected the performance of that trade.

Given a time crunch, today’s letter will be lighter – really sorry!

Fundamental

Many headlines and increased alertness surround employment gauges, housing, and currency markets (e.g., yen sensitivity to U.S. Treasury yields; yen up and the dollar down after the Federal Reserve’s Jerome Powell suggested an easing in the pace of tightening). If interested, read Physik Invest’s letters on the yen and carry trades.

As an aside, an interesting quote comes from BlackRock Inc’s (NYSE: BLK) Gargi Chaudhuri, if yields were to hit “6.5% or 7%,” investors’ “fixed income will do so much of the hard work … that they don’t actually need as much of the equity exposure.” To add, however, the terminal rate sits around 5.2%.

Graphic: Updated December 1, 2022. Via Charles Schwab Corporation’s (NYSE: SCHW) TD Ameritrade thinkorswim. Observed is the Eurodollar, the interest offered on U.S. dollar-denominated deposits held at banks outside of the U.S. (i.e., participants’ outlook on interest rates).

Positioning

Per SpotGamma, recent action has been “dominated by very short-dated options”; on November 30, implied volatility (IVOL) measures for the same day’s expiry rose, pointing to demand for protection across options with the least time to expiry.

These options are highly sensitive and, if traded in a large enough size, can impact markets markedly (e.g., provide a big boost to bullish-type macro repositioning when the IVOL of soon-to-expire options finally compresses).

Graphic: Retrieved from Bloomberg via Michael J. Kramer.

That said, a trend is intact.

Traders’ fears continue to be assuaged, as evidenced by a general “supply of call options,” per SpotGamma, and further “implied volatility compression”; investors’ counterparts (i.e., liquidity providers) are recipient to increased positive exposure to movement (i.e., +Gamma), as evidenced by the below graphic. If movement is beneficial, and the counterparty is not interested in realizing that benefit, it may hedge in a manner that can eat away at realized volatility (RVOL), resulting in tighter ranges. SpotGamma adds that “barring big changes in positioning into 12/14 FOMC and 12/16 OPEX,” expected is more of the same (i.e., sideways to higher).

Graphic: Retrieved from Physik Invest.

Technical

As of 7:45 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Our S&P 500 pivot for today is $4,069.25.

Key levels to the upside include $4,093.00, $4,122.75, and $4,136.75.

Key levels to the downside include $4,049.25, $4,024.00, and $4,000.25.

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: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.

If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

POCs: 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: Denote areas where two-sided trade was most prevalent over numerous 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

In short, an economics graduate working in finance and journalism.

Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.

Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.

Past works include conversations with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.

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 30, 2022

Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.

Graphic updated 7:20 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 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

For the first time in a while, I am able to catch up to and focus more on active trading, hence the earlier letter, today. What a crazy past few months. Almost back to normal!

We will issue a content calendar, soon, revealing the dates letters are likely to be published and the content that may be covered.

That said, due to the writer’s travel commitments, from 12/6 to 12/9 and 12/12 to 12/16 there will be no commentaries. If any queries, or if you are local to New York City or Paris, ping renato@physikinvest.com or Renato Capelj#8625 on Discord.

Fundamental

In many ways, the opposite of what happened to bolster a rally across risk assets like equities and crypto is happening, now. As unpacked in detail across letters including our Daily Brief for October 5, 2022, liquidity measures are in a near-lockstep fall with the S&P 500 (INDEX: SPX).

The correlation between so-called net liquidity described further below, and the S&P 500, over the past ten years is about 0.70 and explains more than half of the movement in price-earings multiples over the past decade.

Graphic: Retrieved from Bloomberg.

Detailed in previous letters was how processes like quantitative tightening manifest themselves as less demand for assets; per Fabian Wintersberger, central bankers must “recycle bonds into the markets on an unprecedented scale, which could easily lead to lower bond prices/higher yields” causing a “reflux of capital to safe-haven assets, like treasuries.”

Alfonso Peccatiello of The Macro Compass details more on the impact of more or less financial sector money in a post titled “All They Told You About Money Printing Is Really, Really Wrong.”

Adding, “the Fed has [only] reduced its holdings by 1.5% by letting bonds mature on its balance sheet. If they want to reduce the balance sheet back to the level of 2020, it needs to reduce it by 41%; … [therefore], [i]f history is any guide, the stock market has yet to face its most significant problems in such a scenario.”

Morgan Stanley’s (NYSE: MS) trading team agrees, per a recent Bloomberg article on a looming bear case for the S&P 500.

Though “rate increases get all the blame for this year’s bear market” and a projected “slowdown in the pace of rate hikes” helping “equities emerge from the yearlong bear, … the S&P 500 will drop as much as 15% by March, based on historic patterns and projected money flows,” which major inputs include “changes in the Fed’s balance sheet (BS); the Treasury General Account (TGA), or Treasury cash held at the central bank; and Reverse Repo Facilities (RRP), or cash parked at the Fed by money market funds and others.”

Graphic: Retrieved from Bloomberg. Inflation increases are easing.

In other words, net liquidity is the Fed’s BS less TGA and RRP. See the below graphic.

Accordingly, “a rise in Fed’s balance sheet means an expansion in liquidity that bodes well for stocks, while an increase in TGA or RRP suggests a contraction in liquidity.” 

Based on the QT pace ($95 billion per month) and forecasts the Treasury cash balance will “rise by $200 billion into yearend, … [amounting] to a squeezing of liquidity that alone implies an 8% drop for the S&P 500 by the end of December.”

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

In summary, “there’s no longer enough money to finance [the] production of those goods and to support a stock market that’s still far from cheap.”

Graphic: Retrieved from VettaFi. “If the supply of money (in aggregate, M2) is higher than the demand for money (represented by nominal GDP), then there is “excess” liquidity that can and will find its way into asset prices.  Furthermore, if the growth of money supply exceeds the growth of GDP, that excess liquidity builds, and there is more of it to find its way into more asset prices.  In theory, the inverse would also hold true.  If the growth of GDP exceeds the growth of money supply, then excess liquidity is being consumed by the demand for money.  In this scenario, the real economy is feeding on liquidity that was once flowing into asset prices.”

Positioning

As we said earlier this week (November 29, 2022, and November 28, 2022), it’s not a terrible time to hedge, and selling volatility, blindly, on either side of the market, is not a great trade.

As SpotGamma put well, yesterday, implied volatility (IVOL) is at a low meaning “it makes sense to buy volatility and put on trades that make money if the market moves” but leverage the skew to sell “options to cut down the cost of waiting for that movement to happen.”

In our letter, yesterday, we highlighted Nasdaq 100 (INDEX: NDX) volatility skew and showed it was smile-shaped, rather than the typical smirk-shaped reverse pattern, making for some great trades to the upside. Through steeper call volatility skew – a result of traders positioning for an upside move – we can use the richness of further away calls to reduce the cost of our bets on the market upside.

Graphic: Updated 11/28/2022. Retrieved from Interactive Brokers (NASDAQ: IBKR). Nasdaq 100 (INDEX: NDX) volatility skew resembles the so-called smile.

For instance, low-cost 500-1000 points wide call ratio spreads (buy the closer leg, sell two of the farther legs) expiring in fifteen days may work well (e.g., SELL -1 1/2 BACKRATIO NDX 100 16 DEC 22 [AM] 13425/13925 CALL @.20 CR LMT). The immediate concern with these strategies is your exposure to Delta (i.e., direction) and Gamma (i.e., does movement make you money).

The required reading is Dynamic Hedging: Managing Vanilla and Exotic Options!

Graphic: Retrieved from the Charles Schwab Corporation-owned (NYSE: SCHW) thinkorswim platform. Nasdaq 100 options prices.

If you are exposed to +Delta and +Gamma, your trade makes money in an increasing way as the market rises, barring any other changes (e.g., passage of time, increases in volatility, etc).

If you are exposed to -Delta and -Gamma, your trade loses money in an increasing way as the market rises, barring any other changes. Should the movement happen quickly, and volatility rise, which is not likely, then that worsens the situation. 

The required reading is Dynamic Hedging: Managing Vanilla and Exotic Options!

This is not advice but a framework for how to act on the theory we talk about on a daily basis. In short, don’t sell calls and puts blindly. Adding, the above trade may not provide safe exposure to the market upside or downside. Given the sideways trade and contraction in ranges, we aim to be well-positioned for a move from low to high volatility. Stay safe and watch your risk.

Noting, should you sell IVOL, the market trade lower, and the demand for IVOL rises, you may be left in an awkward position; big market drops statistically add to the likelihood of more drops.

Read The Second Leg Down: Strategies for Profiting after a Market Sell-Off!

Graphic: Retrieved from SqueezeMetrics.

Technical

As of 7:15 AM ET, Wednesday’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.

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

Key levels to the upside include $3,997.00, $4,024.00, and $4,051.00. 

Key levels to the downside include $3,923.00, $3,909.25, 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: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.

If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

Gamma: The sensitivity of an option’s Delta to changes in the underlying asset’s price.

Volga: The sensitivity of an option’s Vega to changes in the underlying’s implied volatility.

POCs: 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: Denote areas where two-sided trade was most prevalent over numerous 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

In short, an economics graduate working in finance and journalism.

Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.

Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.

Past works include conversations with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.

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 29, 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 6:50 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 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.

Positioning

Aksel Kibar of Tech Charts said it well: There are two types of trades.

1) Trades that you take moving from low volatility to high volatility [and] 2) trades that you take in high volatility while moving to low volatility.”

Graphic: Retrieved from Aksel Kibar, CMT.

Like Kibar, we aim to be well-positioned for a move from low to high volatility. In short, that is where we are today. After an expansion of range to the upside, markets are trading sideways, in a tight range, and traders’ recent activities are likely to keep the status quo intact a bit longer.

Notwithstanding, we are likely nearing an expansion of realized volatility (RVOL), per the implied volatility (IVOL) bid; on Monday, some IVOL measures, such as the Cboe Volatility Index (INDEX: VIX), shifted up, as did term structure. Markets sold a bit, too.

Quick aside:

Changes in IVOL are a byproduct of supply and demand (i.e., demand rushes in → IVOL rises → option prices adjust higher).

When protection is demanded by investors, counterparties may pressure markets (a naive take, if we will, for the purpose of breaking things down).

To explain further, say the market is in balance and trading sideways, and traders seek to protect against potential downside movement by purchasing put options.

This new demand will bid put options prices, causing counterparties to hedge in a manner that pressures the market (i.e., a trader buys put and bids IVOL → the counterparty sells that put and futures to hedge that put), as we’re seeing (i.e., IVOL higher and market lower ahead of updates to measures like the Personal Consumption Expenditures [INDEX: PCE], the Fed’s go-to inflation reading).

Back to the letter:

Upon some new information, participants will enter and reprice the market.

Counterparties’ re-hedging could add to the movement up or down (e.g., traders sell their put hedges → IVOL compresses → counterparties buy back futures hedges and support the market).

If you’re betting on lower prices, recommended is a quick reference of Physik Invest’s Daily Brief for November 28, 2022. In short, according to SpotGamma, “there’s less to be lost owning protection down below,” given the performance of skew, relative to topline measures such as the Cboe Volatility Index (INDEX: VIX).

“On the contrary, if you buy [protection] and nothing happens, that [protection] may very well hold its value better than in the past.”

Graphic: Retrieved from TradingView. Top, S&P 500 (INDEX: SPX). Middle Nations SkewDex (INDEX: SDEX). Bottom Cboe Volatility Index (INDEX: VIX). According to one paper from Nations Indexes, “SkewDex tells market participants how expensive out-of-the-money options are in relation to at-the-money options and thus, how risk-averse investors are.”

On the call side, the story is similar; selling volatility blindly is not a good trade. 

To explain, incentive schemes drove “people to be much more willing to pay and chase upside,” and this is, in part, evidenced by historically low skew. There is also stock replacement, among other things, due to the opportunity cost of buying stock being higher in the current interest rate environment (i.e., “higher call options premium when interest rates are high is the ‘opportunity cost’ of forgone interest”).

Graphic: Retrieved from Charles Schwab Corporation (NYSE: SCHW).

In the interest of brevity, this environment has resulted in a smile-shaped volatility skew pattern, rather than the typical smirk-shaped reverse volatility skew pattern. 

Graphic: Retrieved from Interactive Brokers (NASDAQ: IBKR). Nasdaq 100 (INDEX: NDX) volatility skew resembles the so-called smile.

Skew has steepened on the call side – a result of traders positioning for an upside move – and we can use the richness of out-of-the-money calls to reduce the cost of our bets on the market upside.

Graphic: Retrieved from the Charles Schwab Corporation-owned (NYSE: SCHW) thinkorswim platform. Nasdaq 100 options prices.

For instance, low-cost 500-1000 points wide call ratio spreads (buy the closer leg, sell two of the farther legs) expiring in fifteen days may work well.

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

A 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 upside market movement hurts the position and losses are amplified.

Technical

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

Our S&P 500 pivot for today is $4,997.00. 

Key levels to the upside include $4,024.00, $4,051.00, and $4,069.25. 

Key levels to the downside include $3,965.25, $3,923.00, and $3,909.25.

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.

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 23, 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 6:45 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.

Team, it’s been insane on my end. Physik Invest’s Daily Brief will be paused through the end of this week (November 24 and 25). Wishing you happy holidays!

Hopefully, clearer notes and consistent releases to resume, after the break.


Crypto Turmoil Persists:

The FTX (CRYPTO: FTT) debacle has induced even more illiquidity.

Bloomberg’s Matt Levine wrote that the fall in liquidity “has been dubbed the ‘Alameda Gap,’” noting that “[p]lunges in liquidity usually come during periods of volatility as trading shops pull bids and asks from their order books.”

Turmoil and Opportunity:

You may take advantage of the aforementioned uncertainties through arbitrage (i.e., buy at a lower price at one venue and sell at a higher price at another venue). Notice the ~$500 spread on BTC/USDT, for instance.

Graphic: Retrieved from Shift Search at 6:53 AM ET on November 23, 2022.

Elsewhere, the Grayscale Bitcoin Trust (OTC: GBTC) is trading at a ~43.00% discount to the value of the Bitcoin (CRYPTO: BTC) it holds.

Per Bloomberg, “US regulators have repeatedly denied applications to convert GBTC into a physically-backed exchange-traded fund,” and that means the fund is not “able to redeem shares to keep pace with shifting demand.”

To note, the discount pales in comparison to the 101.00% premium to the net-asset value achieved in December 2017. The average net-asset value is a 12.00% premium.

Graphic: Retrieved from Bloomberg.

Anyways, in greater detail, we discussed the crypto turmoil on November 9 and 10. Those notes may be of interest if the context is desired. Though this is not a crypto-focused letter, crypto is “tied up in the liquidity bubble that exists across all assets.”

Graphic: Retrieved from Physik Invest’s Daily Brief posted on November 10, 2022.

As an example, during the week of November 8, when the narrative surrounding FTX’s demise was at its peak, the S&P 500 (INDEX: SPX), Bitcoin (CRYPTO: BTC), and FTX Trading token (CRYPTO: FTT) slid lower, bottomed, and rallied in sync.

Uncertainty, Correlation, and Positioning:

This is a part of the letter that may appear somewhat similar. We continue carrying forward and building on past analyses.

At its core, breakages in correlations some may have observed are accentuated by positioning forces we have talked about recently, as well as the above. These forces are important as you may have noticed the S&P 500’s tendency in responding to areas quoted by this letter.

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

In a nutshell, in light of a “de-grossing of ‘shorts’” per Nomura Holdings Inc (NYSE: NMR), the sale of the volatility investors owned, after events such as elections and CPI, boosted markets indirectly (i.e., counterparty exposure to risk declines as the market rises and investors sell volatility → counterparty reduces the size of their negative Delta hedges → this reduces market pressure and bolsters a rally).

Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR) via ZeroHedge.

Investors’ continued supply of protection, all the while markets were rising, resulted in further indirect support and, later, prompted responsiveness to key areas at which the options activity was concentrated. This was better detailed on November 16 and 18.

Graphic: Retrieved from Bloomberg.

While this activity is happening – the S&P pinning – underlying constituents are swinging far more amid traders’ own “uneasiness” in stocks and the crypto turmoil; if there are forces pinning and supporting the S&P, all the while there are constraints connecting it to wild(er) components, then something (e.g., correlation) has to give.

Expecting More Of The Same For Now:

Nonetheless, it’s likely for this wild activity under the surface to continue, and for the S&P 500, itself, to be the recipient of even more supportive flows.

For example, the buyback related to the pulled-forward decay of options’ Delta with respect to time (Charm) and continued sale of volatility (Vanna), in a lower liquidity environment, likely results in hedging flows enforcing seasonality and masking the wild(ness) mentioned above.

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

Risks Building Under The Surface:

However, what is happening right now may set the stage for persistently high realized volatility (RVOL) when something bad does happen and those flows we talked about do less to resist that underlying volatility and weakness.

To explain, implied volatility (IVOL) has performed poorly in the context of 2022’s far-reaching decline. That’s in part the result of proactive hedging and monetization of protection (i.e., supply) into the decline.

Graphic: Retrieved from Bloomberg. Measures of equity IVOL tame relative to bonds and FX.

Investors, with IVOL performing poorly, are pushed into better-performing strategies. That includes selling IVOL which does less and less to boost the markets more and more (i.e., per SpotGamma, “the marginal impact of added volatility compression is far lower” at this juncture).

Accordingly, the market is left in a more precarious, less well-hedged position, and that’s concerning given some of the cracks that have appeared including the Credit Suisse Group AG (NYSE: CS) debacle covered in October, the UK liability-driven investment funds covered in September, interest rate swap risks, and beyond.

SCT Capital’s Hari Krishnan talked about some of these risks on a recent podcast.

In Essence, It’s Cheap To Hedge:

According to SpotGamma, “if you wanted to hedge, … it is historically cheap.”

Graphic: Cboe VVIX (INDEX: VVIX) measuring the expected volatility of the 30-day forward price of the VIX. Retrieved from TradingView. Via SpotGamma: “The VVIX is a naive check of participants’ exposure to the volatility of volatility itself (i.e., the non-linear sensitivity of an options price to changes in volatility or Vega convexity). This goes back to the point about the marginal impact of much more volatility compression; the marginal impact of volatility (expansion) compression would have a (bigger) smaller impact, comparatively.”

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma or positive exposure to directional movement).

When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga or positive exposure to IVOL changes).

If there’s a large change in direction (RVOL) or IVOL repricing, you may make money.

As an example, in mid-June, a trading partner and I noticed a change in tone in the non-linearity of volatility and skew with respect to linear changes in the price of the market (or S&P 500). The prices of ratio spread structures (i.e., long or short one option near-the-money, short or long two or more further out-of-the-money) changed by hundreds of percent for only a few basis points of change in the indexes.

At the time, Kai Volatility’s Cem Karsan noted this was “a spike in short-dated -sticky skew, [the] first we’ve seen since [the] secular decline began and it hints [at] a potentially critical change in dealer positioning [and] the distribution of underlying outcomes.” 

“We’re transitioning to a fat left tail, right-based distribution,” he added. 

So why does any of this matter?

In essence, it’s cheap to hedge and the context is there for you to do so, at least from a volatility (not directional) perspective. 

Here is an excerpt from Mohamed Bouzoubaa et al’s book Exotic Options and Hybrids to support some of the earlier statements.

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” Bouzoubaa et al explain. “ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.” 

In other words, by owning protection that’s far from current prices, you are positioned to monetize on a non-linear repricing of volatility, something we saw earlier this year and may continue to see.

Doing this in a manner that cuts decay (when nothing happens) is the difficult part.

Calendar and diagonal spreads come to mind (i.e., sell a short-dated option and buy a far-dated option). You are betting against movement (negative Gamma) over a span of time you don’t think the market will move (e.g., Thanksgiving). And, you are betting on movement (positive Gamma) over a larger span of time (e.g., after Thanksgiving) where decay may not be as accelerated.

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

Ultimately, counterparties’ response to new demands for protection, if something bad happens later, would exacerbate movement and aid in the repricing of IVOL.

At that new IVOL level, there would be more stored energy to catalyze a rally and this letter would express that.

To sell downside volatility (or puts) at this juncture (with time) is a poor trade. To sell downside volatility as part of a larger, more complex structure could be a good trade (e.g., sell a call spread to finance an ultra-wide SPX put ratio spread).

It all depends on structure and management.

Technical

As of 6:45 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a positively skewed overnight inventory, outside of the 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 $4,027.00, $4,051.00, and $4,069.25. 

Key levels to the downside include $3,985.00, $3,965.25, and $3,923.00.

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 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 18, 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.

Administrative

A short commentary today after Wednesday’s detailed letter. Take a look at that letter and, some of the below, for context on what we are likely to discuss next. If you are pressed for time, focus on the bolded statements. Have a good weekend!

Positioning

Keeping with the spirit of Wednesday’s ultra-detailed newsletter.

A key point in that letter was traders’ increased activity across short-term options and “anchoring to key areas such as $4,000.00 in the S&P 500.” This activity, in the face of a multi-week price rise, told us a lot about the state of the market. In short, the bigger participants, some of whom move by a committee and seldom respond to technical nuances, were probably waiting for more information before entering.

For that reason, our key S&P levels, quoted in recent letters, are holding.

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

That’s part of the big point we have attempted to get across, recently. Traders “have been flocking to short-dated contracts to cope with the market whiplash of late, an activity that has exerted outsize impact on the underlying equities,” per Bloomberg. Per data shown by SpotGamma, concentrations in these options have prompted pinning near key areas like $4,000.00 in the S&P, before its descent on Thursday.

You can go to Wednesday’s letter for the detailed explanation but, in short, the reach for positive exposure to the upside (+Delta) lent to recent market relief. Then, per the sales of volatility, just this last week, the sentiment changed to a wait-and-see stance.

Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM).

As already stated, this wait-and-see stance was expressed through short-dated options that are highly sensitive to changes in direction (i.e., these options can go from having a lot of value or Delta to little, over a short window of time). This sensitivity is expressed via the higher Gamma of near-the-money options.

Graphic: Retrieved from Bloomberg.

For a quick check of how sticky these areas may be, one has to look at the level of +Gamma which has been on an uptrend.

As traders wait for more information and take bets against the market movement (i.e., volatility is sold or -Gamma) counterparties take on more +Gamma (i.e., their side of the bet does better when the market moves).

In hedging this +Gamma, counterparties reduce market movement (i.e., counterparty buy call and sell [buy] futures into price rise [dip]).

The shorter-dated the options, the more sensitive they are; options values (or Delta) can rise or fall quickly as Gamma increases when time passes. That may mean that the reaction results in movement reducing (further), and pinning near key areas.

Again, see Wednesday’s ultra-detailed newsletter for more detail.

Graphic: Taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading. 

Another consequence, as picked up by individuals online including Darrin John, the S&P 500’s realized volatility (RVOL) “is so high” with “a basket of 500 of the ‘best’ stocks in the US [wildly] swing[ing] +5% in a single day,” while the S&P 500 is relatively mute, or your letter writer sees it.

That’s because of the following:

If there are forces that are pinning the S&P 500, all the while there are arbitrage constraints connecting its wilder components (in which traders are more uncertain and actively betting on direction and hedging), then correlation must suffer.

Graphic: Retrieved from Bloomberg.

In the face of brewing uncertainties, reflected in index put options activity that has translated “to an uptick in open interest at $3,900.00 and $3,950.00” in the S&P 500, per SpotGamma, -Gamma has increased.

Graphic: Retrieved from Bloomberg. Via Goldman Sachs Group Inc (NYSE: GS). “Broadly, hedge funds’ net leverage, a gauge of risk appetite that measures the industry’s long versus short positions, sat in the 24th percentile of a one-year range, Goldman data show.”

If you take the statements about +Gamma above and reverse them, the opposite happens. With less +Gamma in the market, the result is less dislocation and index movement that is more in line with its wilder underlying components, hence the measured whipsaw, yesterday.

Anyways, today there’s a “$2.1 trillion options expiration” that will clear the deck of some of that sticky +Gamma we talked about earlier. Per SpotGamma, dealers are likely to react in a manner that “allows the market to move more.”

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

One could construe that as bearish but it may pay more to not do so. The market is trading in a period during which there’s less liquidity. That may mean this hedging, for one, may result in continued support. The Holiday period pulls forward Delta buyback linked to options’ decay with respect to the passage of time (Charm). Therefore, per SpotGamma, weakness after expiration likely is contained.

“The potential for more violent downside (i.e., new YTD lows) increases into the end of the month and early December due to the large December options expiration.”

Graphic: Retrieved from SpotGamma.

For that reason, with “[l]​​ow skew and vol-of-vol,” entering trades that are convex and change non-linearly with respect to changes in underlying implied volatility (IVOL) and direction, are attractive.

That’s because of the following dynamics:

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma). When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga). If there is a large enough change in direction (RVOL) or IVOL, you may make money.

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

Technical

As of 9:00 AM ET, Friday’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 $4,027.00, $4,069.25, and $4,136.75. 

Key levels to the downside include $3,965.25, $3,923.00, 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 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 16, 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 7:15 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 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

There will be no Daily Brief published on Thursday, November 17, 2022.

Positioning

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to enter into such trades including protective collars (i.e., sell call, buy put), as stated in yesterday’s letter and explicitly discussed by the likes of Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

To quote McElligott: The “legacy ‘short skew’ trade that’s been the key US equities vol theme of 2022 is now at risk of its own ‘regime change’ reversal, too. This is, then, especially interesting when considering that ongoing VIX call [or] call spread buying … generally some pretty ‘tail-y’ stuff that is beginning to get loaded into.”

Graphic: Retrieved from The Ambrus Group’s Kris Sidial. This is “gutter low vol.”

Entering trades that change non-linearly with respect to changes in implied volatility (IVOL) and direction (Delta) exposes participants to convexity (Gamma).

A simple way to think about this is if the market was to shock lower by one, all else equal, the derivative’s value would change in excess of that. On the other hand, if one was short static (not dynamic) Delta, meaning they profit from that movement lower, profits realized would be one for one with the change in the underlying.

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

So, given the flat skew we mentioned earlier, it is attractive in price to hedge against the downside. Whether that downside materializes, is another story.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS). Equity skew is so depressed in the US that one could buy a multiple of the calls they sold in the S&P 500, elsewhere.

Food For Thought:

This is amidst the responsiveness near key technical areas provided in past letters. It suggests traders with short time horizons are very active and anchoring to key areas, such as $4,000.00 in the S&P 500. These same participants will often lack the wherewithal to defend retests, and big participants (some of whom move by committee) seldom respond to those technical inflections. 

Graphic: Retrieved from SpotGamma.

According to SpotGamma, a provider of data and written analyses on the options market, data shows the “$4,000.00 strike continu[ing] to dominate both in terms of position sizing” with calls, at that level most likely “being sold, which has helped maintain $4,000.00 resistance.”

The sale of IVOL leaves counterparties with long (+Delta) exposure to be hedged through sales (-Delta) of the underlying. As the market trades higher, these options, which are very close to current market prices, have a lot of Gamma, meaning they are very sensitive to changes in the price of the underlying (or convex and non-linear to direction). That means these options can go from having little value to a lot of value, quickly.

Graphic: Taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading. 

If the market is below $4,000.00 and trading higher, while at $4,000.00 there is a lot of this trade going on, then the counterparty will sell the underlying to offset gains in their options while the reverse happens if the market is trading down, as SpotGamma data showed, yesterday. When the market traded lower, positive Delta was firing off, which is supportive, hence the mean-reversion back to $4,000.00 into the close.

Graphic: SPY HIRO. Retrieved from SpotGamma’s Twitter. Posted 11/15/2022 at 1:42 PM ET.

A quick check of how sticky these areas may be, look at the level of positive Gamma.

As traders bet against the market movement, counterparties take on more exposure to positive Gamma. In hedging this positive Gamma, the counterparty does more to reduce market movement.

Couple this mean-reversion-type activity with the structural Delta buyback linked to the passage of time (Charm) and compression of volatility (Vanna), these conditions do more to bolster continued relief, as put forth by Goldman Sachs Group Inc.

Another consequence, as picked up by individuals online including Darrin John, the S&P 500’s realized volatility (RVOL) “is so high” with “a basket of 500 of the ‘best’ stocks in the US [wildly] swing[ing] +5% in a single day,” while the S&P 500 is relatively mute, as your letter writer sees it.

In general, something has to give. If there are forces that are pinning the S&P 500, all the while there are arbitrage constraints connecting the components and all, then correlation must break and dispersion must increase. In short, this is a trader’s market; data shows managers tend to “outperform the worst by more during periods of lower correlation,” as does “higher dispersion.”

Should traders continue to hone in on key areas, and add to the interest and volume near those areas, then the market is likely prone to more of the same. Expect pinning and sideways to up. If there were to be a decrease in positive Gamma exposures, that likely opens the door to more movement. Likewise, if traders’ bets are concentrated elsewhere (higher or lower), that can open the door to relief. A catalyst for that may be something fundamental.

The Key Takeaway:

Recent happenings mimic that of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).” 

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

Simple trades to protect (or capitalize on this) include collars, as stated earlier, as well as calendars. If you expect RVOL on the index level, at least, to be mute, then sell short-dated exposure and use those proceeds to purchase farther-dated exposure (e.g., sell weekly put to buy monthly put).

Why? 

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma). When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga). If there’s a large change in direction (RVOL) or IVOL repricing, you may make money. 

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of IVOL to levels where there would be more stored energy to catalyze a rally,” as we saw after elections and CPI … 

Graphic: Commentary published by Kai Volatility.

… alongside the Dollar’s (INDEX: DXY) weakness which is easing the burden on margins and global funding.

Per Morgan Stanley (NYSE: MS), “simple math on S&P 500 earnings from currency is that for every percentage point increase on a YoY basis, it’s [] a 0.5 hit to EPS growth.”

Graphic: Retrieved from Bloomberg.

Technical

As of 7:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

Key levels to the upside include $4,027.00, $4,069.25, and $4,136.75. 

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 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 11, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1,200+ that read this report daily, below!

Graphic updated 8:45 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

A light letter. We’ll go into far more detail to start next week. See you, then!

Positioning

Assets rallied following a downside surprise in figures for headline annual inflation. Some policymakers also expressed a view that the pace of rate hikes could slow.

Graphic: Retrieved from Bloomberg. It’s not a coincidence that the most-shorted stocks of 2022 posted their biggest rally since 2020.

Barring the worst case, the stage was set for relief. Traders sought protection, as evidenced by a persistent bid in implied volatility (IVOL), which compounded the pressures of de-grossing.

Graphic: Retrieved from Bloomberg.

There was a “clustering of vol[atility] demand to hedge” elections and CPI, per Kai Volatility’s Cem Karsan. On the back of that, “the potential Vanna flows that [would] come from these events” are very positive.

Per SpotGamma, when “nothing bad happen[ed], and traders close[d] those puts, that … bolster[ed] [upside].”

Graphic: Retrieved from SpotGamma. SPX prices X-axis. Option Delta Y-axis. When the factors of implied volatility (Vanna) and time (Charm) change, hedging ratios change. The graphic is for illustrational purposes, only.

Karsan adds the market is entering a period during which there’s less liquidity to absorb decaying protection with respect to time (Charm).

This may drive (bullish) seasonality.

Risks are brewing, though. The very poor hedging heading into this next rally may set the stage for a violent downside. Traders not well-hedged may seek protection when something bad happens, and this will compound macro-type sales, particularly if the activity is in options with less time to expiration (note the below graphic).

Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM) via Bloomberg. “There is indeed some market impact on the SPX from [ultra-short-dated options],” the team wrote. 

Technical

As of 7:45 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

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

Any activity above the $3,964.75 HVNode puts into play the $4,001.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,069.25 HVNode and $4,136.75 MCPOC, or higher.

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

Any activity below the $3,964.75 HVNode puts into play the $3,913.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,871.25 and $3,838.25 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

Volume Areas: A structurally sound market builds on high-volume (HVNodes) areas.

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 low volume, 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 November 9, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1,200+ that read this report daily, below!

Graphic updated 8:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

A crypto-market leader and a lender of last resort – FTX – co-founded by Sam Bankman-Fried (SBF) was little questioned by many. It appears, however, that the company had growing pain points.

Events are developing quickly, too add. Here is a note that SBF issued to investors after entering into a nonbinding agreement with Binance.

Graphic: Retrieved from @gurgavin on Twitter. Read the story on The Block.

In short, there’s little substance.

Let’s go through the motions and start unpacking this debacle. Should we have loose ends, we’ll address those in the coming days.

In late December of 2021, I spoke with SBF regarding his background and aims with FTX. The resulting work was published on Benzinga.com, where I continue to work part-time as a writer and project lead.

Graphic: Retrieved from Renato Leonard Capelj. On the top is Renato Leonard Capelj. On the bottom is SBF.

In short, SBF is an MIT alumnus who started in finance at Jane Street, a trading firm and liquidity provider. Eventually, he saw an opportunity elsewhere; there were spot price inconsistencies across cryptocurrency exchanges.

SBF then founded the firm Alameda Research in 2017. A focus, there, was to extract premiums to spot via arbitrage. SBF et al would purchase Bitcoin (CRYPTO: BTC) domestically, send it to foreign exchanges to sell at higher prices, and, then, convert and wire the funds back. 

​​“You do have to put together this incredibly sophisticated global corporate framework in order to be able to actually do this trade,” SBF said in one conversation. “That’s the real task, the real hard part.”

In light of some frustration with existing exchange offers, SBF founded FTX.com and FTX.US parent FTX Trading Ltd. As late as September 2022, FTX was seeking $1 billion at a value of $32 billion. The firm was looking to become a one-stop-shop for retail and institutional market participants such as FTX brand ambassador and spokesperson Kevin O’Leary who I talked to just prior to my interview with SBF.

“If you’re being compliant internally and also with regulators in each jurisdiction you operate in, you don’t have the option to be off-sides,” O’Leary explained to me on FTX building one of the larger infrastructures institutions’ compliance departments could easily “work with and external auditors can audit.”

Eventually, the exchange grew to become a major player.

FTX was a top-five exchange, adding market share through acquisitions of players like Blockfolio and LedgerX, as well as building a reputation of transparency, or so it appeared, through its work with regulators.

Adding, SBF said to me he wanted FTX to cater to other asset classes and “become a global liquidity venue across the board.” In mid-to-late this year, FTX added stock trading via no-fee brokerage accounts, a follow-through on his vision.

The expansion narrative cooled, however. There was the collapse of the TerraUSD stablecoin, Celsius Network, Three Arrows Capital, and Voyager Digital, which FTX’s subsidiary in the US, FTX.US, won assets to in an auction this year.

At the surface, it appeared FTX was “seemingly untouchable,” as Immutable Holdings’ Jordan Fried explained online. Check out my last chat with Jordan Fried, here.

However, “cracks started to appear [and] people in crypto were taking notice”; the CEOs of both Alameda Research and FTX.US stepped down. Fried added that the situation worsened when Alameda Research’s balance sheet was leaked.

The firm had $14.6 billion in assets (nearly $4 billion in FTT, which is FTX’s utility token, and about $2 billion in FTT token collateral) against $8 billion in liabilities.

“Binance owns a bunch of FTT themselves and, two days ago, Changpeng Zhao (CZ) [who is the] founder of Binance, [said] that SBF … could be lobbying to get regulators to help out FTX more than Binance.” In response, CZ was to “dump all $2 billion of FTT” Binance was holding.

This coincided with a large selling pressure on the FTX utility token. With Alameda Research having ~50% of their assets in FTT, Fried says, “they were dead in the water”. A run appeared likely and, with FTX and Alameda Research’s dealings so intertwined, “the failure of one meant the failure of another.”

On the heels of billions in withdrawals, users weren’t “getting their cash” and, ultimately, in SBF seeking to protect users’ assets, FTX entered into a strategic transaction with Binance.

The follow-on impacts of this week’s events, during which SBF saw a ~90% wipeout of his wealth, can be speculated on. Apparent losers include SoftBank Group Corporation’s (OTC: SFTBY) Vision Fund, the Ontario Teachers’ Pension Plan, and Tiger Global Management.

Some, including Arthur Breitman of Tezos (CRYPTO: XTZ), mulled the impact of FTX’s potential divestment from Solana (CRYPTO: SOL) which “took a drubbing Tuesday,” along with just about every other crypto token including Bitcoin.

Graphic: Retrieved from Bloomberg.

Noteworthy are the impacts of this crypto-market turmoil in equities. As I stated in a note to SpotGamma subscribers yesterday, following “news of a liquidity crunch at FTX, when the selling accelerated in FTT [] and Bitcoin, so did the selling in the S&P 500.”

“The bottom, in all three products, happened at 2:30 PM ET.”

Graphic: Retrieved by Physik Invest from TradingView.

I add that these products – S&P 500 (INDEX: SPX) and Bitcoin – have traded in sync and held positive correlations.

In short, both are recipients of the same risk-on and -off flows. Easy monetary policies cut financial asset volatility and pushed market participants into riskier investments. In short, it was easier to borrow and make longer-duration bets on ideas (e.g., crypto and Ponzi-like DeFi, growth, risky private equity investments) with a lot of promise in the future. 

Financial asset investments were more attractive. That’s, in part, why we saw asset inflation early on in 2020 when 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 tightened, and prices in the real economy inflated.

As we added on Monday, de-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. A disruption (or reversal) in these policies puts at risk the prevailing carry regime. A stock and crypto market drop is, in part, the result of an unwind in carry. 

The drop is a deflationary shock, precisely what policymakers are seeking, per Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar who says 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.” 

As we established on Monday, 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.” 

For example, just announced today, Meta Platforms Inc (NASDAQ: META), which became wrapped up in the speculativeness of the early 2020s reaching beyond the crypto markets, hence the name change from Facebook Inc, is seeking to cut 11,000 jobs.

Per Bloomberg, “the macroeconomic downturn, increased competition, and ads signal loss have caused [] revenue to be much lower than expected.”

Ultimately, a deflationary pulse manifesting disinflation in consumer prices may prompt the policymakers to reverse on rates and efforts like quantitative tightening (QT), the (out)flow of capital from capital markets.

We’re seeing demand erode and many businesses starting to suffer the effects of a switch to “just-in-case” from “just-in-time,” according to S&P Global Inc. Inventories (which are to be sold at a loss) are piling up and workers are needed less.

That’s a recession.

Graphic: Retrieved from Bloomberg. “The overhang is leading to canceled orders, a sharp slowdown in global trade growth and stagnating factory activity. On one hand, it’s good that logistics networks are seeing relief from the logjams that plagued the start of 2022 — ocean-shipping rates have tumbled close to pre-pandemic levels and delivery times are shortening.”

This said, the “risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects.”

“Rallies could beget more forceful pushback from the Fed,” which is a concern given the poor performance in implied volatility (IVOL) that’s resulted in participants’ disinterest in maintaining their hedges this year; equities’ left tail is growing.

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 summary, there’s no longer “a disinterest and unimportance to cash flows.” The commitment to reducing liquidity and credit has consequences on the real economy and asset prices which rose and kept the deflationary pressure of policies at bay.  

It is elevated volatility and persistent declines that are to prompt investors to lower their selling prices in risk(ier) assets (e.g., options bets, metals, cryptocurrency and stablecoins, equities, bonds), and compete for cash.

Positioning

Based on traders’ current positioning, the market, absent exogenous shocks, is more so prone to sharp upside reversals and a slow(er) grind lower.

As the former Bridgewater Associate Andy Constan explained to me once, therefore, you “want Deltas and leverage” via options trades that are defined risk and two-to-four months out in maturity.

We shall go more into this, later.

Technical

As of 8:45 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

If above the $3,828.75 HVNode, the $3,874.25 HVNode is in play. Initiative trade beyond the latter could reach as high as the $3,909.25 MCPOC and $3,936.25 ONH, or higher.

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

If above the $3,828.75 HVNode, the $3,806.25 LVNode is in play. Initiative trade beyond the latter could reach as low as the $3,787.00 VPOC and $3,727.00 VPOC, or lower.

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

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

Definitions

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

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

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

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

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 November 8, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1,200+ that read this report daily, below!

Graphic updated 9:15 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

This letter’s author is ramping up coverage and returning to speed after a short hiatus. Today’s focus will be on adding to the “Positioning” section of Monday’s letter.

Positioning

After some late-October weakness that is coinciding with the Federal Reserve’s (Fed) decision to raise rates, stocks are tame. This is heading into midterm elections, today, and inflation updates, Thursday.

Graphic: Retrieved from Bloomberg. Created by JPMorgan Chase & Co (NYSE: JPM).

Republicans are likely to add to their control of the House and Senate.

Having fewer Democrats in Congress would lower “the odds of fiscal measures [that would] embolden a hawkish Federal Reserve.” 

This is a boon for stocks.

Graphic: Retrieved from Bloomberg. “With things looking that bad, current polls show the Democrats appear to be headed for a drubbing, almost certain to lose control of the House and increasingly likely to see the Senate slip away.”

Indeed, Wells Fargo & Co (NYSE: WFC) strategists found a “GOP-controlled Senate historically is associated with superior equity returns.”

Graphic: Retrieved from Wells Fargo & Co (NYSE: WFC).

In spite of recessions, even, the S&P 500, a year after midterms, often netted positive 20% or so returns Citigroup Inc (NYSE: C) strategists add.

Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm. The “seasonal/cycle outlook is for a lower low or retest of the lows over the next three months as we are in the worst two months of the year and are smack dab in the *Weak Spot* of the 4-Year Cycle”

A post-election bump is on top of the general positiveness of equity performance during the earnings season and periods of strong pessimism as we have today.

Graphic: Retrieved from Mr. Blonde’s Stuck in the Middle letter.

Why all the potential positivity over this short period?

The aforementioned events are happening during a period wherein market liquidity eases (i.e., the holiday season).

It’s during this period, from a positioning perspective, the effects of decay (which we discuss more below) accelerate, and a lack of liquidity, according to Kai Volatility’s Cem Karsan, makes markets sensitive to positive-leaning flows.

Pessimism and hedging may indirectly give rise to bullishness. Why is that?

Demand for options exposures, especially across shorter time horizons, evidenced by heightened implied volatility (IVOL) at the front end (see below), has indirectly added to the pressures of de-grossing, as observed.

Graphic: Retrieved from Bloomberg.

Though positioning is generally thin, as we also talked about in yesterday’s newsletter, thus reducing the impact of the hedging of this positioning, demand remains “strong,” per Karsan, and “dealers are short that volatility.”

Derivatives strategists at the likes of the Royal Bank of Canada (NYSE: RY) agree with Karsan’s remarks; Amy Wu Silverman said that the Cboe Volatility Index’s (INDEX: VIX) elevation was the result of demand for hedges after October options expiry.

“Part of today’s move at least is a function of new positions. There is likely demand for future months since we just went through October options expiry,” she said. “Part of it is a function of the ‘floor’ of a new volatility regime.”

So, what’s the point to make?

For IVOL measures to remain wound, something bad needs to happen, in short.

Otherwise, per SpotGamma, a “decline in IVOL … can aid in a push-and-pull that actually serves to … resist far-reaching weakness” and keep selling orderly.

That’s because, from here, the removal of the protection that’s been demanded in the past days and weeks compounds the sped-up effects of Charm.

Graphic: Retrieved from SpotGamma. SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility (Vanna) and time change (Charm), hedging ratios change. The graphic is for illustrational purposes, only.

Charm, which is the change in options Delta (i.e., exposure to direction) with respect to changes in time, “drives a positive window or seasonality”; “the reduction in time” and “lack of liquidity” make markets more sensitive to those positive flows.

Graphic: Retrieved from SqueezeMetrics.

In the long term, however, weakness is here to stay. Poor IVOL performance and little skew also likely set the stage for a post-holiday tail. More on this, later.

Graphic: Retrieved from Corey Hoffstein on Twitter.

Technical

As of 6:45 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, just outside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

If above the $3,806.25 LVNode, the $3,845.00 VPOC is in play. Initiative trade beyond the latter 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.

If above the $3,806.25 LVNode, the $3,787.00 VPOC is in play. Initiative trade beyond the latter 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, the S&P 500 is 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.

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.

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 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.