Categories
Commentary

Daily Brief For January 19, 2022

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

What Happened

Overnight, equity index futures explored lower and hammered out a low. On that recovery, measures of implied volatility fell, and most commodity products and yields moved higher.

Ahead is data on Building Permits and Housing Starts (8:30 AM ET).

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

What To Expect

Fundamental: Narratives discussed, before, remain valid. 

Mainly, expected is strong economic and earnings growth, as well as cooling inflation.

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

Graphic: From Goldman Sachs (NYSE: GS). The Market Ear recaps: “Bigger moves in yields eventually spill over to SPX. We basically had the 2 sigma move in rates…and equities are behaving as they should.”

The Ambrus Group’s Kris Sidial made a great point, yesterday, too.

Basically, despite that the market is off about 5% from its highs, the go-to 60/40 portfolio and “diversified funds” are in turmoil.

This newsletter has touched on the “bonds down, equities down” dynamic in the past. 

In short, over the past 40 or so years, monetary policy was used as a crutch to support the economy. This promoted deflation, innovation, and the subsequent rise in valuations.

With rates near zero and lifting, that’s a headwind; coupled with participants’ increased exposure to rate and equity market risk, which can play into cross-market hedging and de-leveraging cascades, 60/40 turns into somewhat of a poor hedge.

Why? Higher rates have the potential to decrease the present value of future earnings, making stocks, especially those that are high growth, less attractive.

Putting it all together, per Constan, “If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” Constan adds. 

“These risk premium expansions will generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Morgan Stanley (NYSE: MS) strategists are in agreement.

“With our economic team’s new Fed forecast for the end of QE, 4 rate hikes, and the beginning of balance sheet normalization this year, our call for falling valuations is likely to happen faster and more broadly than our prior forecast.”

Also: “Companies have expedited supplies, they’ve hired a bunch of labor at higher prices and if there’s excess supply now in the first or second quarter, potentially temporarily that could lead to margin compressions.”

Graphic: Via comments made by Morgan Stanley’s (NYSE: MS) U.S. equity strategist Michael Wilson, “Our new Fed forecast simply brings forward our call for lower equity valuations and raises the risk in the first half of the year. The median stock remains expensive even though the most egregiously priced stocks have corrected.”

It’s looking like Ark Invest’s Catherine Wood hit the nail on the head with respect to her comments on inventory build-ups. 

Early in November, as this newsletter highlighted, the CIO said inflation was likely on its way out due to (1) productivity increases, (2) China housing and financial sector turmoil depressing commodity prices, (3) inventory build-ups, and (4) disruptive innovation.

“This is unsustainable,” she had said. “I’m wondering if even the housing market inflation is going to give way, here.”

Positioning: Despite elevated measures of implied volatility like the Cboe Volatility Index (INDEX: VIX) marking higher, the VIX term structure remains upward sloping. 

Graphic: VIX term structure via Vix Central. 

All that means is that we have yet to similar levels of destabilizing demand for protection. 

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. In buying a put, customers indirectly take liquidity as dealers, short the put, sell underlying to hedge. With higher levels of implied volatility, dealers’ exposure to direction increases. They hedge by selling more underlying.

Though conditions could worsen, taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics remain positively skewed, more so than before.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Any expansion in volatility, however, likely coincides with further weakness.

As a result, this, coupled with data that suggests “OPEX week returns peaked in 2016 and have trended lower since,” cautions us on trade into and after this week’s expiration of options on the VIX and equity products.

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

In the best case, the S&P 500 trades higher; activity above the $4,574.25 high volume area (HVNode) puts in play the $4,593.00 point of control (POC). Initiative trade beyond the POC could reach as high as the $4,619.00 HVNode and $4,650.75 extended trading hours low (ETH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,574.25 HVNode puts in play the $4,535.50 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,520.00 and $4,492.00 regular trade low (RTH Low), or lower.

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

Definitions

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

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

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

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

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

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

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 18, 2022

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

What Happened

Overnight, equity index futures auctioned lower alongside a surge in bond yields. Rate-sensitive sectors were weakest in pre-market trade, in comparison to the value and cyclical names. 

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

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

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

What To Expect

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

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

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

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

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

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

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

Graphic: QT mechanics per The Macro Compass.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 5, 2022

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

What Happened

Overnight, equity indices auctioned sideways to lower after a failed balance-area breakout resulted in a rotation back toward the most accepted (or traded at) price levels over two weeks.

Ahead is data on ADP National Employment Report (8:15 AM ET), Markit Services PMI (9:45 AM ET), and FOMC minutes (2:00 PM ET).

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

What To Expect

Fundamental: Today, participants ought to get further clarity around the timing of the Federal Reserve’s first interest-rate hike and its taper to the pace of asset buying.

The central bank doubled the pace of tapering in mid-December, setting the stage for rate hikes, later in 2022.

According to Bloomberg, expected are three quarter-percentage-point increases in the key federal funds rate target in 2022. 

Graphic: The “annual rate of change in the Fed Funds rate” via topdowncharts.com.

This expectation has coincided with a move higher in Treasury yields and weakness in the growth- and innovation-heavy Nasdaq 100. 

Recall that inflation and rates move inverse to each other. In defending against the pressures of inflation, higher rates have the potential to decrease the present value of future earnings making stocks, especially those that are high growth, less attractive.

Graphic: Via Bloomberg, “Fed Chair Jerome Powell at his press conference after last month’s meeting said that policy makers eventually ‘expect a gradual pace of policy firming.’ They don’t anticipate raising rates before ending the taper process, but could hike before reaching full employment, he added.”

Moreover, a concern is that “[t]he minutes could hint at a quicker start to shrinking the balance sheet than after the prior tapering.”

With the equity market rallying on the back of easy monetary frameworks and max liquidity, markets diverged from fundamentals.

Reductions in the balance sheet (i.e., removal of liquidity) may help prick the bubble. 

Additionally, with the use of leveraged products trending higher than in the past, cross-asset correlations increase with volatility and stress. This may result in “hedging and de-leveraging cascades that affect the stability of all markets,” as well put in one article I recently wrote.

In other words, the response by customers, as well as the dynamics of dealers’ risk exposure to direction and volatility, can cause violent crash dynamics to transpire, further cutting into liquidity, and aiding an unraveling.

“It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration,” Kai Volatility’s Cem Karsan once told me. “These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”

See the graphic below for implications of customers’ demands for downside protection.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. For instance, in selling a put, customers add liquidity and stabilize the market. How? The market maker long the put will buy (sell) the underlying to neutralize directional risk as price falls (rises).

Positioning: Pursuant to some of the comments made in yesterday’s commentary, expected is a continued compression in volatility. 

Monday saw the selling of upside (call) and downside (put) protection. Tuesday saw more of the former, and that promoted some of the reversion, for lack of better phrasing, seen yesterday.

Recall that the participant on the other side of this dominant trade is taking on more exposure to positive delta. 

Why? Well, with any price rise, gamma (or how an option’s delta is expected to change given a change in the underlying) is added to the delta. Counterparties are to offset gamma by adding liquidity (as can be approximated with thickening of book depth, below) to the market (i.e., buy dips, sell rips).

Graphic: Analysis of book depth for the E-mini S&P 500 futures contract, via CME Group Inc’s (NASDAQ: CME) Liquidity Tool. For more on the implications of participants’ options positioning and dealer hedging, read here.

The continued compression of volatility will only serve to bolster any price rise as “hedging vanna and charm flows, and whatnot will push the markets higher.”

Were participants to reach for downside protection, markets will tend toward instability. Not seeing this yet.

Graphic: The “Biggest tail risk to SPX isn’t any macro data/virus/war but its own options market.”

Technical: As of 6:40 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Balance (Two-Timeframe Or Bracket) Scenarios: Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

In the best case, the S&P 500 trades higher; activity above the $4,783.75 micro composite point of control (MCPOC) puts in play the $4,808.25 minimal excess high. Initiative trade beyond the $4,808.25 figure could reach as high as the $4,814.00 and $4,832.25 extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,783.75 MCPOC puts in play the $4,756.00 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,732.50 high volume area (HVNode) and $4,717.25 LVNode, or lower.

Considerations: The aforementioned trade in the S&P 500 marks a potential willingness to continue balance, and it is built on poor structure, a dynamic that adds to technical instability.

On a liquidation that finds acceptance (i.e., more than 30-minutes of trade at a particular price level) below $4,756.00, there is increased potential for a fast move lower to $4,732.50 or lower.

This is as there has been a persistence of responses to technical levels; weaker-handed participants (which seldom defend retests) are carrying a heavier hand in recent discovery.

With that, any penetration of low-volume pockets – voids like gaps that can be seen on a chart – there ought to be follow-through as the participants that were most active at those levels run for the exits.

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

What People Are Saying

Definitions

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

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

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

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

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

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

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.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

About

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

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

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For December 27, 2021

Notice: Up to January 3, 2022, any commentaries published will be lighthearted and, generally, shorter in length.

What Happened

Overnight, equity index and bond futures were divergent while most commodities traded lower.

In the face of “holiday-thinned liquidity,” the CBOE Volatility Index (INDEX: VIX) rose ~1.15; this week, the expectation is (A) flatlined volatility or (B) ugly, headline-driven intraday moves.

Ahead, there is no data scheduled for release.

Graphic updated 5:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Last week, on lackluster intraday breadth and market liquidity metrics, the best case outcome occurred via an expansion of range and separation of value, the levels at which participants found it most favorable to transact.

The aforementioned activity, which marks the continuation of a trend, is built on poor structure. 

That, ultimately, adds to technical instability.

Why? As explained, Thursday, given the persistence of mechanical responses to key technical levels, visually-driven, weaker-handed participants (which seldom bear the wherewithal to defend retests) carry a heavier hand in recent price discovery. 

Via volume profile analysis, we see a plethora of low-volume pockets – voids, if you will – that likely hold virgin tests. As stated, yesterday, successful penetration portends follow-through given the participants that were most active at those technical levels. Caution is still warranted.

Graphic: Divergent delta (i.e., non-committed buying and selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices may offer favorable entry/exit; the market is attempting to balance).

Context: In the face of a “stealth correction,” and an “off-loading of risk by professional speculators,” the S&P 500 closed beyond a visual resistance level, last week, on light volume.

Graphic: A multi-month divergence (and downtrend) in breadth metrics stabilize as participants attempt to discover higher prices in the S&P 500. 

This is as, according to Ryan Detrick of LPL Financial, the “official Santa Claus Rally starts this Monday (last 5 days of the year and the first two of the following year).”

Kai Volatility’s Cem Karsan echoes Detrick’s remarks.

“Since 1980, there have been 10 instances where the S&P 500 was up 20% or more going into the last stretch of trading, and in 9 of those years, it ended the final 6 days higher.”

Moreover, despite an eventual decline in fiscal support, negative adjustments to the EPS guidance of more index constituents, and revisions lower in growth forecasts, Morgan Stanley’s (NYSE: MS) saw flows shift in high-growth, rate-sensitive names – “flows have reversed in recent sessions as there have been small levels of net buying.”

The change in tone with respect to flows is seasonally-aligned, so to speak; per Goldman Sachs Group (NYSE: GS), January sees more inflows than all other months combined.

Graphic: Per The Market Ear, “January typically sees 134% of inflows (the rest of the 11 months -34%). And with every private wealth manager in the world right now pitching increased allocations into equities (out of cash and out of bonds), Goldman calculates that keeping 2021 pace, This would be $125BN worth of inflows quickly in January.”

Adding, in the face of this week’s weighty “Quarterlys” expiry, Goldman Sachs sees options selling attractive, near term; a commitment of capital on lower volatility likely results in counterparties to customer options trades taking on more exposure to sticky positive gamma. 

Note: As a position’s delta rises with stock or index price rises, gamma (or how an option’s delta is expected to change given a change in the underlying) is added to the delta.

This is while many products are in lower liquidity and short-gamma (wherein an options delta decreases with stock prices rises and increases when stock prices drop) in which moves are more erratic.

Therefore, coming into weighty options expiration, correlations may be off (as that is the only reconciliation in an environment where, at the index level, hedging pressures are sticky, whereas elsewhere they aren’t).

Thereafter, participants ought to monitor the sides and levels capital is committed for clues as to where we go next. 

Continued compression of volatility, as well as a commitment to options higher in prices and further out in time, supports upward price discovery.

Expectations: As of 5:45 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades sideways or higher; activity above the $4,717.25 low volume area (LVNode) puts in play the $4,732.50 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,743.00 regular trade high (RTH High) and $4,767.00 extension, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,717.25 LVNode puts in play the $4,690.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,673.00 untested point of control (VPOC) and $4,647.25 HVNode, or lower.

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

What People Are Saying

Definitions

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

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

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

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

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

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Methodology

Theory Applied: Contextualizing Recent Market Volatility

With SpotGamma, Physik Invest’s Renato Leonard Capelj unpacks recent market movements from an options positioning perspective.

Coverage includes the following:

  • Definition and application of first and second order options greeks.
  • Implications of the November and December options expirations.
  • How current positioning may dictate trade in Q1 2022 and beyond.
  • Expert commentary and much more!

Click below to learn more!

Categories
Commentary

Daily Brief For December 22, 2021

What Happened

Overnight, equity index futures were divergent while most commodity and bond products were sideways to higher. This is as traders position themselves for the less liquid holiday trade.

Ahead is data on gross domestic product and income (8:30 AM ET), consumer confidence, and existing home sales (10:00 AM ET).

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

What To Expect

On supportive intraday breadth and divergent market liquidity metrics, the best case outcome occurred; the S&P 500 auctioned away from intraday value, the levels at which participants found it most favorable to trade at.

Given the mechanical responses to key technical levels, visually-driven, weaker-handed participants (which seldom bear the wherewithal to defend retests) are very much in control.

Moreover, Tuesday’s activity, which was follow-through on Monday’s responsive buying, left low-volume structures in its wake. 

Virgin tests of the low-volume – a void of sorts – ought to hold. Successful penetration portends follow-through given the participants that were most active at those levels. 

Graphic: Divergent delta (i.e., non-committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: In light of elevated implied volatility and limited macro, and micro catalysts, Goldman Sachs Group (NYSE: GS) sees “options selling strategies as attractive in the near term.”

“We estimate there is a 12% probability of a 1-month 5% down-move in the SPX in this economic environment based on our GS-EQMOVE model. Options are pricing a 22% probability of that size move indicating that puts are overvalued.”

The commitment of capital on lower directional volatility results in counterparties taking on more exposure to positive gamma which they will offset by supplying the market with liquidity, thereby pressuring the price discovery process.

Note: As a position’s delta rises with stock or index price rises, gamma (or how an option’s delta is expected to change given a change in the underlying) is added to the delta.

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

“As volatility is compressed, those jets will keep firing because … the hedging vanna and charm flows, and whatnot will push the markets higher.”

Still, many products are in lower liquidity and short-gamma (wherein an options delta decreases with stock prices rises and increases when stock prices drop) in which moves are more erratic.

If the S&P were to further trend sideways, as a result of the aforementioned hedging pressures, a decline in correlation – among volatile constituents – would be the only reconciliation.

A post-holiday collapse in implied volatility, coupled with the management of massive S&P positions, and relentless, seasonally-aligned “passive buying support,” may bring in positive flows that would bolster any attempt higher.

Graphic: A compression in the VIX term structure would provide markets a boost.

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

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

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,623.00 point of control (POC) puts in play the $4,647.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,674.25 HVNode and $4,709.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,623.00 POC puts in play the $4,585.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,574.25 HVNode and $4,549.00 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. Learn about the profile.

What People Are Saying

Definitions

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

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

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

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

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

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 9, 2021

What Happened

Overnight, equity index futures auctioned sideways after the large move higher.

This comes alongside top news items including Evergrande’s default, omicron transmission, U.K. COVID-19 restrictions, among other things.

Ahead is data on jobless claims (8:30 AM ET), wholesale inventories (10:00 AM ET), as well as real household wealth and nonfinancial debt (12:00 PM ET).

Graphic updated 6:15 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 the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

On lackluster intraday breadth and supportive market liquidity metrics, the best case outcome occurred evidenced by sideways trade and overlapping value (i.e., the prices levels at which 70% of the day’s volume was transacted).

Notwithstanding, as stated in the past, though this activity marks participants’ willingness to discover and validate higher prices, the prior structure is poor; there is technical instability.

Specifically, both Monday and Tuesday’s sessions left gaps and p-shaped emotional, multiple-distribution profile structures (i.e., old-money shorts covering).

As said before, participants will look to revisit, repair, and strengthen – build out areas of high volume (HVNodes) via the cave-fill process – these areas of low volume (LVNodes).

Graphic: Supportive delta (i.e., committed buying as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap.

Context: Next week the Federal Reserve is likely to announce an acceleration in its taper.

“[T]he implicit expectation is that by moving more quickly and aggressively, the Fed will save itself from having to hike too far and make rates so expensive that they slow down the economy,” Bloomberg’s John Authers explained

Adding, William Dudley, a former New York Fed governor, believes there will be three 0.25-percentage-point rate increases next year. 

In 2023, Dudley sees four rate hikes that bring the median target rate to 1.8%, and then, the target rate will reach 2.5% in 2024.

Authers adds: “If we take broad ‘M2’ money as a yardstick for the amount of liquidity in the economy, it’s clear that the Fed has trodden on the accelerator for much longer than other central banks.”

Graphic: Via Bloomberg, while the strength of the U.S. recovery owes a lot to monetary responses, the Fed will have to work harder to “rein in liquidity and calm inflation down.”

Moreover, rising rates, among other factors, have the potential to decrease the present value of future earnings, thereby making stocks, especially those that are high growth, less attractive.

As the market is a forward-looking mechanism, the implications of this are staggering. 

Prevailing monetary frameworks and max liquidity promoted a large divergence in price from fundamentals. 

The growth of passive investing – the effect of increased moneyness among nonmonetary assets – and derivatives trading imply a lot of left-tail risks.

As Kai Volatility’s Cem Karsan once told me: “There’s this constant structural positioning that naturally drives markets higher as long as volatility is compressed,” or there is supply.

“At the end of the day, though, the higher you go, the further off the ground you are and the more tail risk.”

To put it simply, participants are more exposed to leveraged products, among other things, which increases the speed with which volatility is realized.

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

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

Despite today’s rates and earnings supporting validations better than in the ‘90s, an intent to moderate stimulus serves as a headwind.

That said, the S&P 500 typically rallies into the first hike. After, expect noise.

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

At present, the return distribution is skewed positive, but a lot of the punchy opportunity (based on how participants were positioned just a week ago) has disappeared.

The dynamics surrounding the collapse in volatility and expiry of extremely short-dated downside protection have played out; the market entered into positive-gamma wherein the counterparties to customer options trades add market liquidity and temper realized volatility.

Graphic: Per SpotGamma data, the S&P 500 is no longer in destabilizing negative-gamma (left). Instead, it is in stabilizing positive-gamma (right) territory.

If participants are assuaged of their fears at next week’s Federal Open Market Committee (FOMC) meeting, a collapse in event-related implied volatility ought to bring in positive flows as the long delta (from dealers’ exposure to short puts) decreases; the decrease in dealer supply (short delta), via covering of short stock/futures hedges, would bolster any attempt higher. See below.

Expectations: As of 6:15 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the bottom 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 sideways or higher; activity above the $4,691.25 micro composite point of control (MCPOC) puts in play the $4,705.75 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,716.75 LVNode and $4,740.50 minimal excess high, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,691.25 MCPOC puts in play the $4,674.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,647.25 and $4,618.75 HVNode, or lower.

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

What People Are Saying

Definitions

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

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

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

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.

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, helping develop insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not carry the right to provide advice. In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.

Categories
Commentary

Daily Brief For December 3, 2021

What Happened

Overnight, equity index futures auctioned in-sync, within the confines of yesterday’s recovery. 

This is as participants position themselves for Friday’s data dump that may shed light on how fast the Federal Reserve (Fed) intends to tighten monetary policy.

Ahead is data on nonfarm payrolls, the unemployment rate, and average hourly earnings (8:30 AM ET). Later is Fed-speak by James Bullard (9:15 AM ET), Markit services PMI (9:45 AM ET), as well as ISM services, factory orders, and core capital goods orders (10:00 AM ET).

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

What To Expect

In the face of strong intraday breadth, the best case outcome occurred, evidenced by the recovery of Wednesday’s value (i.e., the prices at which 70% of that day’s volume occurred).

This action negated the knee-jerk selling that coincided with COVID-19 variant news.

As a result, the S&P 500 is back inside of a short-term consolidation; participants had no interest in transacting the S&P 500 on prices advertised below the balance area.

Context: The Fed’s intent to moderate stimulus and uncertainty with regards to how a new COVID-19 variant will impact the global recovery.

In the face of it all, according to Bloomberg, “The market is again pricing June 2022 as the most likely timing for the first Fed rate hike, same as on Nov. 24. At various stages over the intervening days traders looked at July, or even as late as September.”

This is as an emerging trend from the Fed, confirmed by Chair Jerome Powell’s Congressional testimony – for weeks into this most recent equity – resulted in a re-pricing of bond market risk. 

That fear – demand for protection in the bond market – failed to appear in the equity market. 

Instead, there was an insatiable appetite for stocks, according to Bloomberg, with investors pouring more cash in 2021 than in the past 19 years, combined. 

That appetite for risk fed into the activity of some high-flyers like Tesla Inc (NASDAQ: TSLA), and, more recently Apple Inc (NASDAQ: AAPL). At the same time, the broader market was weakening, evidenced by a decline in breadth. 

With indices pinned, heading into the November monthly options expiration (OPEX), as a result of sticky and supportive hedging flows, correlations declined. 

Think about it. If heavily weighted index constituents are higher and the indices are pinned, then something has to give! 

After OPEX, the removal of certain hedging flows had the market succumb to fundamental forces. The addition of participants’ underexposure to downside put protection, according to SpotGamma, resulted in more rampant two-way volatility.

The reason being? The market quickly entered into an environment known as short-gamma. 

“What the heck is that? Please explain to me like I’m ten.” Okay, hold my beer.

Basically, funds holding long equity, in the interest of lower volatility returns, hedge. The S&P 500 is a benchmark and one of the best places to hedge, given liquidity, and so on.

These participants will sell calls against their long equity exposure. The proceeds from that sale will be put toward downside protection. Long equity, short call, long put. Get it?

The counterparty to this dominant positioning is a buyer (seller) of upside (downside) protection, a carry trade (i.e., long delta). 

This exposure is hedged, yes! However, this exposure will also decay, in time, all else equal. 

Volatility will slide down its term structure (vanna) and time will pass (charm); “as volatility ebbs and time passes, the unwind of these hedges brings in positive flows that can lead to lengthy sprints.” – Cem Karsan of Kai Volatility.

Now, within a certain range, said counterparties are, long-gamma also. Gamma is basically “the rate of change of delta per 1-point move in the underlying,” according to SqueezeMetrics.

As volatility and time to expiration decline, the gamma of at-the-money options rises; “option market-makers will hedge their positions in a fashion that stifles volatility (buying into lows, selling into highs).”

There are times, also, when the market is in a short-gamma; a “negative [gamma] implies the opposite (selling into lows, buying into highs), thus magnifying market volatility.”

With participants underexposed to downside protection, post-OPEX demand kicked the market into short-gamma; the conditions worsened when much of the activity was concentrated in shorter-dated tenors where the sensitivity of options to direction is higher, as stated.

Graphic: VIX term structure 11/25. Backwardation signaled an entry into an unstable environment with activity concentrated at the front-end of the curve.

Once that short-dated protection rolls off the table (and/or is monetized), counterparties will quickly reverse and support the market, buying to close their existing stock/futures hedges.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator on 12/2 shows positive options delta trades firing off, which likely had dealers buying stock/futures into the close.

This flow is stabilizing and may play into a seasonally-aligned rally into Christmas as participants see defenses rolled out against the new COVID-19 variant, and the positive effects of pro-cyclical inflation and economic growth, improvements in global trade, and continuity at the Fed, among other dynamics, play out.

We see participants opportunistically buying the dip, already, via metrics like DIX that’s derived from liquidity provision on the market-making side.

Graphic: Earnings are rising and helping support historic PE multiples, via Nasdaq

Notwithstanding, the market is still in short-gamma and unless participants began betting on the upside (i.e., committing increased capital to calls at strikes higher in price and out in time), and we cross over to long-gamma, volatility ought to remain.

To assuage fears, though, here is a quote from Goldman Sachs Group Inc (NYSE: GS): 

“We find that the market has already priced in a significant downgrade in the growth outlook off the back of Omicron concerns. While we don’t believe that the most extreme downside scenarios are fully reflected in current market pricing, there are clearly still scenarios that could prove better than anticipated by the sharp shift in pricing in recent weeks, in our view”.

Expectations: As of 6:45 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a 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 sideways or higher; activity above the $4,574.25 high volume area (HVNode) puts in play the $4,590.00 balance area high (BAH). Initiative trade beyond the BAH could reach as high as the $4,629.00 untested point of control (VPOC) and $4,647.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,574.25 HVNode puts in play the $4,551.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,526.25 HVNode and $4,497.75 regular trade low (RTH Low), or lower.

Click here to load today’s updated 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. Learn about the profile.

What People Are Saying

Definitions

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

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

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

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

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

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

Rates: Low rates have to potential to increase the present value of future earnings making stocks, especially those that are high growth, more attractive. To note, inflation and rates move inversely to each other. Low rates stimulate demand for loans (i.e., borrowing money is more attractive).

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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 December 2, 2021

What Happened

Overnight, equity index futures steadied at the prior day’s lows

There were signs of a shift in relative strength as the Russell 2000’s extended-day recovery outpaced that of the S&P 500 and (now) weaker Nasdaq 100. 

At the same time, yields on the ten-year rose while volatility came in. Still, the VIX futures term structure remained higher, a clear indication of stress, in the face of demand for protection.

Ahead is data on jobless claims (8:30 AM ET) with Fed-speak scattered throughout the day.

Graphic updated 6:40 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

On nonparticipatory breadth and weak market liquidity metrics, the worst-case outcome occurred, evidenced by the S&P 500’s spike away from the value (i.e., the prices at which 70% of the day’s volume occurred).

The knee-jerk selling, which coincided with news that a COVID-19 variant was spotted in the U.S., broke the S&P 500 out of a short-term consolidation (i.e., balance) area. 

The developing balance was a result of participants looking for new information to base a directional move. With new information, participants chose downside price exploration.

Adding, the knee-jerk selling and associated price action left behind poor structure (i.e., participants will look to validate [or invalidate] the move, spending time below [or above] the ~$4,574.25 spike base). Caution is warranted on overnight validation of the spike. 

Graphic: Supportive delta (i.e., committed selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of initiative trade (i.e., directional trade that suggests current prices offer unfavorable entry and exit; the market is seeking balance).

Context: A resurgence in COVID-19, a change in tone with respect to monetary policy, and last-minute tax-selling, in the face of seasonally-bullish buybacks and new month inflows.

The implications of these themes on price are contradictory. 

As stated, yesterday, the Federal Reserve’s Jerome Powell unexpectedly changed his tone around inflation, becoming more open to a faster taper in bond-buying and rate hikes. 

This is as policymakers look to tame price readings without inhibiting economic growth; fears of the aforementioned change in tone were clearly spotted by the bond market’s pricing of risk, so to speak, diverging from that of the equity market, weeks before current volatility.

Graphic: “The ICE BofA MOVE Index, which measures implied volatility for Treasuries, is close to the steepest level since April 2020,” via Bloomberg.

Rising rates, among other factors, have the potential to decrease the present value of future earnings, thereby making stocks, especially those that are high growth, less attractive to own.

As the market is a forward-looking mechanism, the implications of this are staggering. 

Prevailing monetary frameworks and max liquidity promoted a large divergence in price from fundamentals. The growth of passive investing – the effect of increased moneyness among nonmonetary assets – and derivatives trading imply a lot of left-tail risks.

Graphic: Via The Market Ear, “Bank of America estimates that corporate earnings used to explain half of equity market returns up to the financial crisis, but since then they only explain 21%. Meanwhile, changes to the Fed’s balance sheet explain 52% of market returns since 2010, it estimates. Buy what the FED buys. Sell what the FED stops buying.”

As Kai Volatility’s Cem Karsan once told me: “There’s this constant structural positioning that naturally drives markets higher as long as volatility is compressed,” or there is supply.

“At the end of the day, though, the higher you go, the further off the ground you are and the more tail risk.”

Eventually, the fear on the part of bond market participants fed into equity market positioning; breadth weakened for weeks into November’s large monthly options expiration, after which the absence of sticky and supportive hedging flows finally freed the market for directional resolve. 

Couple that with participants being “underexposed to downside put protection,” according to SpotGamma, there was an expectation that there could be a rough re-pricing of tail risk as participants, en masse, sought after highly “convex” downside options which had the counterparties to those trades exacerbating underlying price movement.

Per the VIX term structure graphic below, there is tons of movement in the front-end, a sign that participants are concentrating activity in shorter-dated tenors where the sensitivity of options to direction is higher.

Graphic: VIX term structure. 

So long as this dynamic remains, participants can expect instability.

In assuaging fears, however, Moody’s Corporation (NYSE: MCO) put out research that found “information about the variant and the policy actions taken to date do not yet support a material shift” in forecasts.

This is as S&P Global Inc (NYSE: SPGI), despite lowering growth forecasts a touch, expects GDP to reach a 37-year high in 2021. With odds that it will likely take the next few weeks to find out more with respect to the severity of new COVID-19 variants, attention moves to “cyclicals, commodities, and reopening themes,” according to JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic. 

Graphic: Via Bloomberg, “there is ‘plenty of liquidity available to drive stock prices higher as dip-buyers enter the market,’” strategists at Yardeni Research, wrote.

Expectations: As of 6:40 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

In the best case, the S&P 500 trades sideways or higher; activity above the $4,551.75 low volume area (LVNode) puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,629.00 untested point of control (VPOC) and $4,674.25 micro composite point of control (MCPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,551.75 low volume area (LNVode) puts in play the $4,497.75 regular-trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,471.00 and $4,425.00 VPOC, or lower.

Click here to load today’s updated 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. Learn about the profile.

Charts To Watch

Graphic: (NYSE: SPY). (S~$448, $438 and R~$454, $460). S is for support. R is for resistance.

Definitions

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

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

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

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

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

Price Discovery (One-Timeframe Or Trend): Elongation and range expansion denotes a market seeking new prices to establish value, or acceptance (i.e., more than 30-minutes of trade at a particular price level). 

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

Value-Area Placement: Perception of value unchanged if value overlapping (i.e., inside day). Perception of value has changed if value not overlapping (i.e., outside day). Delay trade in the former case.

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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 December 1, 2021

What Happened

Overnight, equity index futures traded sideways to higher, led by the once-weak Russell 2000. 

The shift in relative strength is one obvious change in tone in the face of hawkish news from the Federal Reserve (Fed) and COVID-19 uncertainty. 

Ahead is data on ADP employment (8:15 AM ET), Markit manufacturing PMI (9:45 AM ET), ISM manufacturing index, construction spending, as well as testimony by Federal Reserve’s Jerome Powell and Treasury Secretary Janet Yellen (10:00 AM ET). 

Later is a release of the Beige Book (2:00 PM ET).

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

What To Expect

On lackluster breadth and supportive market liquidity metrics, the worst-case outcome occurred, evidenced by an expansion of the S&P 500’s range, as well as increased participation at lower prices, as evidenced by lower value (i.e., the prices at which 70% of the day’s volume occurred).

Though yesterday marked a willingness to continue the trend lower, there are some caveats.

The first of which comes back to simple market profile principles. Value ended on the day overlapping lower. This suggests balance and an unchanged perception of value from Friday. 

This dynamic ties into what was discussed yesterday. Given a push-pull environment between the big indices (i.e., strength in Nasdaq 100 versus weakness in Russell 2000), in the face of lackluster breadth and market liquidity metrics, there were increased odds of sideways trade; “participants were likely to base for a directional move in anticipation of new information.”

Second, according to SpotGamma, “in the face of a massive -$8bn market-on-close order, dealers likely were covering their hedges to customers’ short-delta options exposure.”

The implications of the latter are staggering. Let’s unpack, below.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator shows positive options delta trades firing off, which likely had dealers buying stock/futures into the close.

Context: The Fed’s Powell changed his tone around inflation, yesterday, becoming more open to a faster taper in bond-buying and rate hikes. 

As Bloomberg’s John Authers put it: “This looks like inconsistency, and it also looks to some as if Powell has lost his nerve — just as he did three years ago, when the stock market’s horrified reaction to his statement that the Fed’s balance sheet would be reduced ‘on autopilot,’ meaning ever tighter money, prompted a U-turn. In market lore, the ‘Christmas Eve Massacre’ of a cathartic stock sell-off was followed by the ‘Powell Pivot.’”

Graphic: S&P 500 performance in tightening cycles via Ned Davis Research. 

Stocks have recovered markedly, since the news. 

At the outset, as we typically see with news, selling appeared knee-jerk; a b-shaped profile distribution suggested long liquidation (i.e., [1] participants who bought the dip, Friday, were unable to gather the financial and/or emotional wherewithal to defend a retest of local lows and [2] capitulation on the part of larger other time frame participants, potentially).

In regards to the latter, if funds were to sell the market, they would do so methodically, into strength, throughout a session.

Couple the aforementioned with a decline in volatility (despite S&P 500 prices reaching lower lows), it’s clear as to why I started off the commentary suggesting an “obvious change in tone.”

Last week, we saw the market enter into a destabilizing environment characterized by counterparties to options trades selling into weakness and buying into strength. 

Note: Options are so important. Volatility is a growing asset class. Its implications can’t be discounted (e.g., index pinned in the face of single-stock volatility and declining correlations).

After a brief exit from that environment, on Tuesday the market made another attempt lower. With options activity most concentrated in shorter-dated tenors where the sensitivity of options to direction is higher, then the expectation was that we would realize more volatility. 

That happened.

However, volatility, despite spiking, failed to breach Friday levels; in such a case, the short-dated, out-of-the-money protection participants were initially demanding bled.

Given decreased exposure to risk, at least for those participants (e.g., dealers) warehousing this risk, associated hedging flows (i.e., the buy-back of short stock/futures hedges) came onto the market. 

This is clearly visualized by SpotGamma’s HIRO indicator, above. 

In conclusion, should participants continue to markdown volatility, as well as commit more capital to the call side, fears will have been assuaged.

In such a case, the odds of a seasonally-aligned rally, into Christmas, are supported.

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

Developing Balance Scenario: Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

In the best case, the S&P 500 trades sideways or higher; activity above the $4,618.75 high volume area (HVNode) puts in play the $4,647.25 HVNode. Initiative trade beyond the latter HVNode could reach as high as the $4,674.25 micro composite point of control (MCPOC) and $4,691.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,618.75 HVNode puts in play the $4,590.00 balance boundary (BAH). Initiative trade beyond the BAH could reach as low as the $4,574.25 HVNode and $4,551.75 LVNode, or lower.

Click here to load today’s updated 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. Learn about the profile.

Charts To Watch

Graphic: (NYSE: SPY). (S~$454, R~$463). S is for support. R is for resistance.

What People Are Saying

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.

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.

Definitions

About

After years of self-education, strategy development, 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.

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

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.