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 7:30 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 this letter. 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. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Positioning
The Federal Reserve (Fed) upped its benchmark interest rate by 25 basis points. This puts the target rate range between 4.5% and 4.75%.
The Fed’s Jerome Powell signaled that toughness on inflation will last; though the “disinflation process has started,” and markets are pricing about 50 basis points of cuts by year-end, Powell said rates will continue to increase at least a couple more times. He said rates may reach as high as 5.25% to cut “inflation to 2% over time.”
Markets rallied sharply when Powell began talking. Some suggest his not “overly combative” responses were a reason. Looking back to the Daily Brief for February 1, 2023, we said that in spite of “toughness from the Fed,” markets would likely trend sideways to higher as traders would “not be able to justify the pricing of the ultra-short-dated options they demanded heading into Wednesday.”
Consequently, the supply and expiry of short-dated options coincided with dealers, who were short-stock against the puts they supplied, buying back their hedges. Kai Volatility’s Cem Karsan put this well in a media appearance pre-Fed.
He said that “vol structurally affects how markets move” and that put options, which traders own and dealers are short (and hedging with short stock, as well), would likely go down in value as the “event vol” falls; “those vanna and charm effects will naturally lead to a buyback.”
Graphic: Retrieved from SqueezeMetrics. Click to learn the implications of volatility, direction, and moneyness.
For context, vanna is the change in an options delta with respect to changes in IVOL. Charm is the change in an options delta with respect to changes in time. These are second-order derivatives of an option’s value, once to time or IVOL, and once to delta.
The positive market response, however, should not overly excite. Rather, the market is in a precarious position, and the compression of volatility, given its low starting point, probably does little to encourage a long-lasting rally.
Graphic: Small spread between realized (RVOL) and implied (IVOL) volatility. Retrieved from Bloomberg via CME Group Inc (NASDAQ: CME) analysis.
Trades this letter put forth (e.g., call butterflies and ratio spreads) that would benefit from a sharp move higher while limiting the downside, in products like the Nasdaq 100 (INDEX: NDX), are working spectacularly. In fact, while your letter writer was traveling, his trading partner initiated some +1 x -2 (17 FEB 23 13500/14000) call ratio spreads for free (i.e., $0.00 debit or better to enter), and those spreads are now pricing over $6.00 credit to close. That’s $600.00. Nice job, Justin!
Anyways, though markets could continue trending higher, the risks for a move lower, particularly after mid-February, are increasing some say. Additionally, though we keep our technical analysis usually limited to volume and market profiles, there are a few anchored volume-weighted average price levels sticking out just above current prices.
For context, VWAPs are metrics 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.
Knowing that longer-dated S&P 500 (INDEX: SPX) implied volatility (IVOL) is cheap, now attractive trades include selling rich call verticals to finance put verticals.
As an aside, there are a number of reasons for calls pricing the way they do. Some of them include the opportunity cost of forgone interest (i.e., buy a call and invest the outlay difference in an interest-bearing account), as well as a fear of missing out in the context of a lower liquidity environment and less supply to absorb demand for hedging (hence higher lows in the VIX).
Graphic: Retrieved from Morgan Stanley (NYSE: MS).
Technical
As of 7:30 AM ET, Thursday’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 the prior range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,153.25.
Key levels to the upside include $4,165.75, $4,189.25, and $4,202.75.
Key levels to the downside include $4,136.75, $4,122.50, and $4,100.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels hold weight barring an exogenous development.
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 a period of time, this will be identified by a low-volume area (LVNodes). The 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 the nearest HVNodes for more favorable entry or exit.
About
In short, Renato Leonard Capelj is 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.
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 8:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. 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. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Positioning
Markets think the Federal Reserve (Fed) raises its benchmark rate by 25 basis points. Notwithstanding the less aggressive hike, strategists believe the Fed will stay tougher on inflation for far longer and, accordingly, crush traders’ optimism.
“I suspect the Fed messaging tomorrow will push back against the pivot narrative and thereby current bond market pricing,” DoubleLine Capital CIO Jeffrey Gundlach said. Former investment banker and trader, as well as the president of the Minneapolis Fed, Neel Kashkari warned the Fed is set on finishing the job and cutting inflation, even if it costs millions of Americans their jobs. “I’ve spent enough time around Wall Street to know that they are culturally, institutionally, optimistic,” he said.
Further, relief in markets (e.g., stocks, housing) is a boon for asset owners and may enable companies to raise cash, bid up equipment prices, and demand new hires.
Graphic: Retrieved from Mortgage News Daily. “A trend of [increasing] purchase applications implies home buyer demand is [increasing].” The prevailing narrative is that the Fed wants less inflation and less demand. This narrative’s been disrupted, in part. Recall our Monday letter talking about investors’ desire to put their cash to work and the demand for treasuries (i.e., bond bid and yield pressured) which forced investors into previously depressed assets.
With inflation still a problem, regardless of whether there are better solutions as we put forth in the January 31 letter, the Fed is looking to keep rates above 5% for the rest of 2023, though markets are pricing a pivot far earlier and at a lower rate.
Despite the expectation of toughness from the Fed, markets have not broken down. Rather, if we zoom out, they are trending sideways to higher and may continue to do so. That’s according to Kai Volatility’s Cem Karsan who says that implied volatility (IVOL) is heightened across options with very little time to expiry (1- to 3-days).
“Event vol, which is the pricing of one-, two-, and three-day options, is significantly higher than everything else behind it right now,” he said, noting that customers’ or traders’ demands for downside put protection is the culprit. That said, despite the committee’s recent hawkishness, “the market responded relatively well at those levels, and you’re seeing vol come back down.”
Graphic: Retrieved from TradingView. First included in SpotGamma’s PM Note for 1/31/2023. During Tuesday’s strength, measures of IVOL, such as the Cboe Volatility Index (INDEX: VIX) fell, though the VIX did not move lower in as sharp of a fashion that the S&P 500 (INDEX: SPX) traded higher. In fact, the VIX trended up into the close, after a mid-day bottom, suggesting some left-over hedging demands ahead of some important macroeconomic drivers this week.
“I think that’s kind of likely what you’re going to see, regardless of what the Fed does,” Karsan added. That’s because, barring some unexpected development, traders will not be able to justify the pricing of ultra-short-dated options post-Fed; the supply and expiry of short-dated options will coincide with the dealers or market makers who are short-stock against the puts they supplied buying back their hedges.
“Vol structurally affects how markets move. Puts are the way people hedge in the market and dealers are short the puts. If you have an event vol that comes down, those vanna and charm effects will naturally lead to a buyback,” post-Fed.
For context, vanna is the change in an options delta with respect to changes in IVOL. Charm is the change in an options delta with respect to changes in time. These are second-order derivatives of an option’s value, once to time or IVOL, and once to delta.
You might have heard the old #trading adage "never short a dull market", Cem Karsan @jam_croissant explains how some second order Greeks, vanna & charm, play a role in proving out that phrase. #Vol411pic.twitter.com/AMnd7kQQdA
As your letter writer explained in a SpotGamma analysis yesterday, we saw an interest to hedge heading into this week’s Fed announcement. This coincided with a slight rebound in measures like the Cboe VIX Volatility (INDEX: VVIX) (which, in general, reads low and suggests convexity is a good place to be), and put a damper on the rally, hence its climax on Friday.
Moreover, if “macroeconomic events do not disappoint, IVOL compression may provide markets a boost,” SpotGamma explained. “Notwithstanding, the marginal compression of heightened IVOL, because of its lower starting point, probably does less to encourage a longer-lasting rally,” hence the thought that, if there was to be relief post-Fed, it would likely last up until the mid-February monthly options expiration (OpEx). OpEx’s removal of traders’ options protection (as well as dealers’ supportive buyback to those options that were demanded), may leave the market at risk of bearish macro-type flows.
Compounding the risk is traders’ expected reaction in case of weakness. The desire to hedge during a drop would coincide with a re-pricing in IVOL dangerous to anyone who is short volatility, hence this letter’s recent focus on owning the S&P 500 (INDEX: SPX) via call butterflies and call ratio spreads, the sorts of trades that would benefit from an SPX and VIX up environment (the result of traders bidding up call options due to their fear of missing out, in the context of less liquidity to absorb those demands).
To summarize everything, we have the Fed rate decision coming up. After, markets will be volatile but more likely to trend higher into mid-February, bolstered by traders’ fears of missing out in the context of a lower liquidity environment, as well as stimulus (e.g., falling Treasury General Account played into an easing of financial conditions by making it easier for banks to lend and finance trading activities). After mid-February, the window for markets to weaken and accelerate to the downside may open, based on the information we have today.
As an aside, the last time the Nasdaq 100 (INDEX: NDX) was up more than 10% in January was in 2001, The Market Ear informed subscribers yesterday.
Graphic: Retrieved from BNP Paribas ADR (OTC: BNPQY) via The Market Ear.
Should you wish to hedge, longer-dated SPX IVOL is cheap, relative to recent history.
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via The Market Ear.
Finally, if you’re interested in following further along the fundamental conversation in Tuesday’s letter, check out Dr. Pippa Malmgren’s post on “ancient empires springing back to life.”
Technical
As of 8:00 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 negatively skewed overnight inventory, inside of the prior range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,087.00.
Key levels to the upside include $4,100.25, $4,122.50, and $4,136.75.
Key levels to the downside include $4,071.50, $4,055.00, and $4,028.75.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels hold weight barring an exogenous development.
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 a period of time, this will be identified by a low-volume area (LVNodes). The 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 the nearest HVNodes for more favorable entry or exit.
POCs: 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.
About
In short, Renato Leonard Capelj is 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.
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 8:00 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 this letter. 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. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Positioning
After a rocky end to 2022, the result of rebalances and repositioning, stocks rallied in the face of incredibly bearish sentiment and off-sides positioning. The detailed Daily Brief for January 24 discussed this context.
Presently, the S&P 500 (INDEX: SPX) is riding above an important inflection (i.e., the 200-day simple moving average) which is a trigger for many traders to flip to owning stocks. At the same time, implied volatility (IVOL), as measured by measures such as the Cboe Volatility Index (INDEX: VIX), is trending higher, and that’s, in part, a result of options hedging in a lower liquidity environment.
Anyways, little is expected to change until the middle of February, this letter quoted Kai Volatility’s Cem Karsan stating, yesterday. Following mid-February, a window for weakness opens. This could be a problem for some traders who are short volatility.
The reason being is as follows. Traders’ disinterest in hedging downside leaves them offside should the market drop quickly. Consequently, the demand for hedges (puts) will coincide with a re-pricing in IVOL dangerous to anyone who is short volatility.
Given the unstable SPX and VIX up environment, attractive trades provide exposure to the upside while limiting the downside. Structures such as call butterflies or ratio spreads, as included in yesterday’s letter, may work well.
In yesterday’s example, owning the 20-point FEB 1×2 Tesla Call Ratio Spread resulted in about 400% profit in the span of 14 days or so (i.e., $0.20 db → $1.00 cr). The loss was limited* to about $20.00 at entry while the exit was marked in excess of $100.00.
*Note that losses can exceed the entry debit should the underlying stock trade very far beyond the ratio spread’s short strikes.
Similar trades can be structured in the indexes such as the Nasdaq 100 (INDEX: NDX) where there is a steeper skew that may enable us to collect more credit in the options we are short, helping us lower the cost of the entire spread we own.
If you’re leaning toward the indexes, then you may avoid some of the volatility we saw yesterday when large swaths of stocks on the Intercontinental Exchange Inc-owned (NYSE: ICE) New York Stock Exchange commenced trading with an open book some reports have suggested.
As SpotGamma explained yesterday, “movement-reducing hedging activities” in the indexes “can mask realized volatility (RV) under the hood in single stocks.” Therefore, your index positions may be better isolated from what’s going on under the hood.
As of 8:00 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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
Our S&P 500 pivot for today is $3,998.25.
Key levels to the upside include $4,011.75, $4,028.75, and $4,045.75.
Key levels to the downside include $3,988.25, $3,979.75, and $3,965.25.
Click here to load updated 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.
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.
About
In short, Renato Leonard Capelj is 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.
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 7:00 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 this letter. 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. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Administrative
Monday’s letter had some holes. Let’s try to fill them in, today, and get a fuller picture.
Summary of today’s letter: though the real economy may be strong, sticky inflation likely results in higher rates for longer, as well as quantitative tightening. This is not good for the financial economy. Some suggest the equity market rally persists into mid-February before further weaknesses appear. Read on for more.
Fundamental
Many sentiment and positioning indicators are bearish.
For instance, surveys by Bank of America Corporation (NYSE: BAC) point to allocators being very underweight US stocks. Also, investors are reporting some of their biggest one-month exits from stocks since BAC started surveying.
Graphic: Retrieved from BAC via Bloomberg’s John Authers.
The consensus is turning more bearish, we see, and some of this letter’s most quoted voices maintain that markets (not necessarily the economy) are in for more weakness.
That is in the face of a severely depressed S&P 500 (INDEX: SPX) crossing above key areas denoting technical resistance, a signal for trend-followers to get involved on the long side (i.e., buy stocks) Kai Volatility’s Cem Karsan explained in a video last week.
Equity market strength drivers, Karsan said, include China reopening and increasing stimulus, Europe’s not-so-bad winter, and little worsening of conflicts (e.g., Ukraine and Russia situation).
Adding, as The Macro Compass’ Alfonso Peccatiello said, the bond market thinks the Fed will not hike into a recession. Inflation likely “slows down to 2.5% quickly, [with] the Fed cutting rates to neutral (and never below). [That’s] not recessionary pricing. It’s immaculate disinflation pricing.”
The base case is a landing that’s soft.
To elaborate, the data shows the Fed cut by about 350 basis points or so within 18 months of the start of a recession, Peccatiello said. Now, the markets are pricing a mid-2023 pivot with about 200 basis points of cuts between 2023 and 2024.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ).
“That must mean the bond market’s base case (60%) is a recession,” Peccatiello said, noting that the Fed Funds is not pricing “below reasonable estimates of neutral rate (2.25-2.75% in nominal terms)” in the next 2-5 years. That means this would be the first time ever the US is in a recession and the Fed doesn’t cut rates below neutral.”
And, though downside earnings revisions are happening, the “2023 EPS consensus at $225 implies a +4% earnings growth this year [while] in [past] recessionary episodes the average EPS decline is instead -30%.”
“[C]yclical sectors and countries are outperforming defensive,” and there is little fear and desire to protect against far-reaching weakness. “Protection in the S&P 500 is at the cheapest levels in 2 years” as evidenced by “the implied volatility in 20% out-of-the-money SPX puts … trading in the lowest” percentiles.
But, as Karsan implied in his recent appearance, there’s a disconnect. The economy is not the stock market, and the liquidity context is poor, which many may not recognize.
The economy performing well due to China reopening and strong demand among businesses surveyed, consumers’ savings excesses, persistent credit boom, and a strong labor market suggest inflation lasts longer.
Consequently, interest rates remain higher for longer and quantitative tightening is likely to persist. This is not so good for the financial economy.
Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM) via Fabian Wintersberger.
“[B]lindly trusting the bond market could end badly,” Fabian Wintersberger added, noting that “recent bear market rallies in stocks and bonds will reverse” eventually.
Karsan appears to agree: though green shoots are likely to push better than expected economic performance, the Fed “is in a box” and this rally likely ends in early spring.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ). Note that “[h]igher rates act as a headwind for valuations – prices should fall if earnings don’t change [and] increased earnings make PEs (valuations) fall and make stocks look more attractive.” Currently, “the market is currently pricing in a year where rates and earnings don’t change much … inflation could stay elevated [with China reopening and supply chain re-shoring] which means rates should too.”
For now, the break of the 200-day moving average is a significant impetus since it’s a level many watch (i.e., technicals matter if enough people look at them). The chase is manifesting an SPX up, Cboe Volatility Index (INDEX: VIX) up dynamic (i.e., those who fear they may miss a rally bid volatility while the underlying market trades higher).
The Daily Brief for January 13 said “the more depressed technology names to the upside for debits [looked] attractive.”
Accordingly, Tesla Call Ratio Spreads have performed really well.
The 1/2 BACKRATIO TSLA 100 17 FEB 23 160/180 CALL is pricing in excess of a $1.00 credit to close, up about 400% in the span of 14 days or so.
A push likely lasts until mid-February, after which a window for weakness may open, particularly with the liquidity context (see the below video) no longer as supportive. However, if the market consolidates for a period after, this would be bullish.
To end, the median projection puts the S&P 500 at a level above $4,000.00 by year-end with the worst estimate putting the index at $3,000.00.
Joseph Wang explained, also, that there is an “increasing probability of a second bout of inflation, an issue in the 1970s that the Fed is keen to avoid … [by] retighten[ing] financial conditions … through its balance sheet” with an extended quantitative tightening or QT maintained “even if policy rates are cut.”
Given that QT is the flow of capital out of capital markets, this context presents more pressure on the financial economy (not necessarily the real economy).
Technical
As of 6:55 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to 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.
Our S&P 500 pivot for today is $4,028.75.
Key levels to the upside include $4,045.75, $4,061.75, and $4,077.00.
Key levels to the downside include $4,011.75, $3,998.25, and $3,988.25.
Click here to load updated 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.
Vanna: The rate at which the delta of an option changes with respect to implied volatility.
Charm: The rate at which the delta of an option changes with respect to time.
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.
Options: Options offer an efficient way to gain directional exposure.
If an option buyer was short (long) stock, he or she could buy a call (put) to hedge upside (downside) exposure. Additionally, one can spread, or buy (+) and sell (-) options together, strategically.
Commonly discussed spreads include credit, debit, ratio, back, and calendar.
Credit: Sell -1 option closer to the money. Buy +1 option farther out of the money.
Debit: Buy +1 option closer to the money. Sell -1 option farther out of the money.
Ratio: Buy +1 option closer to the money. Sell -2 options farther out of the money.
Back: Sell -1 option closer to the money. Buy +2 options farther out of the money.
Calendar: Sell -1 option. Buy +1 option farther out in time, at the same strike.
In the most basic way, if bullish (bearish), sell at-the-money put (call) credit spread and/or buy a call (put) debit/ratio spread structured around target price. Alternatively, if the expected directional move is great (small), opt for a back spread (calendar spread). Also, if credit spread, seek to capture 50-75% of the premium collected. If debit spread, seek to capture 2-300% of the premium paid.
Be cognizant of risk exposure.
Negative (positive) Delta = synthetic short (long).
Negative (positive) Gamma = movement hurts (helps)
Negative (positive) Theta = time decay hurts (helps).
In short, Renato Leonard Capelj is 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.
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 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 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. The CBOE VIX Volatility Index (INDEX: VVIX) measure reflects the total attractiveness of owning volatility.
Administrative
A quick letter today, apologies.
Given the large, post-CPI movement, the above dashboard may be out of date!
Separately, your letter writer will be heading to Davos, Switzerland during next week’s World Economic Forum. Let me know if you’ll be in town. Take care!
Fundamental
Today, market participants received data that appears in line with estimates.
Expected was a 6.5% rise year-over-year (YoY) and a 0.1% fall month-over-month (MoM). These numbers were +7.1% and +0.1% the release prior.
Mattering most is core inflation, which the Fed has more control over. The expectation was that core CPI rose 5.7% YoY and 0.3% MoM. In the release prior, these numbers were 6.0% and 0.2%, respectively.
Overall, the view that inflation is trending in the right direction is supported.
We often unpack the implications, but we will save that for a coming analysis.
Positioning
We saw meaningful outperformance in realized volatility (RVOL). This was, in part, a result of increased demand for short-dated exposures to movements (i.e., gamma), as well as a supply of farther-dated volatility (i.e., +gamma worked, +vega did not).
The trends, as your letter writer explained in recent write-ups, and in a Benzinga article, may eventually exhaust; measures like the VVIX, which is the volatility of the VIX or the volatility of the S&P 500’s volatility, are printing at levels seen in 2017.
According to Kai Volatility’s Cem Karsan, markets are in a transition period and what’s worked in 2022 may not work as well in 2023; trades are becoming crowded and S&P 500 volatility skews have hit a lower bound of sorts. That was echoed by The Ambrus Group’s Kris Sidial who said that “we can get cheap exposure to convexity while a lot of people are worried.”
Since the start of the year, the skew shifted meaningfully higher while the S&P 500 and VIX have moved higher in sync, as well. Some, like SpotGamma, have their own explanation (e.g., the fear of missing out on a move higher results in call buying that bids volatility), expressing that this may be a trend that persists through events like Thursday’s consumer price update.
This letter’s takeaway is as follows. Markets can experience more of the same. As history has shown, the right trade may turn out to be short volatility across longer time horizons, and long/own volatility across shorter time horizons, for longer (i.e., current trends promoting realized volatility outperformance may persist longer).
However, should current trends persist, the market is likely to become far less well-hedged, as Karsan said in the video. If a catalyst arises, there may be a repricing in volatility which traders would not want to be on the wrong side of. Notwithstanding, as Sidial says, “[if] you’re trading volatility, let there be an underlying catalyst for doing so.” Don’t just buy it because it is cheap, or sell it because it is expensive.
We’ll go through the charts and implications in far more detail over the coming sessions. Your letter writer is stretched for time this morning. Take care!
Technical
As of 7:30 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a 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 $3,988.25 HVNode.
Key levels to the upside include $4,000.25, $4,011.75, and $4,028.75.
Key levels to the downside include $3,979.75, $3,959.00, and $3,943.25.
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.
As a disclaimer, the S&P 500 could trade beyond the levels quoted in the letter. Therefore, you should load the above link on your browser for more relevant levels.
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.
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.
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 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 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
In Physik Invest’s Market Intelligence letter for December 21, we discussed the potential for “pressure on options prices [to] remain through December.” In short, on the odds that “nothing happens through the holidays,” it made sense to sell implied volatility (IVOL) after CPI and FOMC targeting an end-of-month expiration.
The downward trajectory in IVOL remains intact in spite of some pockets of weakness under the hood in index heavyweights like Tesla Inc (NASDAQ: TSLA); expectations of future movement remain mute at both the index and single stock levels. As a result, short volatility trades (e.g., short straddle) in the indexes and near current market prices, expiring later this month, are doing really well.
Graphic: Retrieved from Kris Sidial. Tesla Inc (NASDAQ: TSLA) 1-month IVOL “relatively muted throughout the pain.”
Part of the equation resulting in this sideways market and tame IVOL environment was discussed in the December 21 letter. Today we add color.
In short, traders’ anticipation of a market drop, as evidenced by them reducing equity exposures into and through the 2022 market decline, coupled with the exploitation of loopholes manifesting increased demand for short-dated exposure to movements (i.e., gamma), and a supply of IVOL that is farther-dated, has put a lid on broad equity IVOL measures like the Cboe Volatility Index (INDEX: VIX) and pushed skew lower.
Consequently, hedges performing well have a lot of +gamma intraday and exposure to realized volatility (RVOL), and less exposure to longer-dated IVOL. The other side of this trade (and those who may be warehousing this risk) has exposure to -gamma and, to hedge that, they must act in a manner that exacerbates realized movement, hence RVOL’s meaningful outperformance.
In fact, RVOL in 2022 is nearly two times the level of RVOL in 2021, all the while the IVOL term structure is basically at the “same place it was a year ago,” according to Danny Kirsch of Piper Sandler Companies (NYSE: PIPR).
Graphic: Retrieved from Danny Kirsch, the head of options at Piper Sandler Companies (NYSE: PIPR). “Rolling 1 year realized volatility [for] … 2022 nearly 2x the level of 2021, speaks to long gamma and not vega for 2022.”
In a two-and-a-half-hour Twitter Spaces discussion, Kai Volatility’s Cem Karsan discussed what is the potential cause of this. Some of the blame rests on the way margin calculations (i.e., the loophole mentioned earlier); less cash must be posted if trades are closed the same day, basically.
Anyways, at the macro level, yes, the trends continue. Generally speaking, IVOL is mute and not accounting for the activity in short-dated options, as discussed by The Ambrus Group’s recent paper, while RVOL is about two times the level it was in 2021, making +gamma profitable.
However, at the micro level, so to speak, as we started out this discussion, traders’ anticipation that “nothing happens through the holidays,” has resulted in the supply of short-dated volatility, boosting the stickiness of open interest at current market prices.
Let’s unpack this further and explain why this activity won’t continue forever.
Near current market prices sit large concentrations of options positions. For instance, we have the $3,835.00 SPX strike (the call part of a massively popular collar trade that is rolled every quarter). At $3,835.00 is the short strike of a big collar trade.
This means the trader (or fund owner) is short the call, hence -delta and -gamma. The other side (or counterpart) is long the call, hence +delta and +gamma.
In theory, the other side, in response to this exposure, will buy weakness and sell strength. In other words, to hedge a long call, the other side sells futures. If the market falls, the call’s delta will fall and become less positive. Therefore, the other side will buy back some of their initial futures hedges (reduce -delta from short futures) to neutralize delta risk. If the market rises, the other side will have more exposure to +delta. To neutralize the delta, the other side will sell more futures.
As a consequence, the market pins.
Graphic: Retrieved from Banco Santander SA (NYSE: SAN).
This is a trend, as we discussed on December 21, that likely continues through year-end. After year-end, the market is likely to “move more freely,” per SpotGamma, “because this options activity that is promoting mean reversion will no longer be there,” and, therefore, the indexes likely trade more “in sync with its wild constituents of the likes of Tesla and beyond.”
More on what’s next:
As Karsan dissected, yesterday, there’s a “liquidity premium” that’s getting crowded short; in this less well-hedged market environment, traders’ realization with respect to liquidity and collateral needs for supporting trading activities may provide the context for some sharp drops. But first, it’s likely (though not certain) the market experiences some relief. Knowing that the long-end is cheap (hence near-zero percentile skew) on a supply and demand basis, it does not make sense to sell options blindly out in time.
Technical
As of 6:30 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 $3,857.00.
Key levels to the upside include $3,879.25, $3,893.75, and $3,908.25.
Key levels to the downside include $3,838.25, $3,813.25, and $3,793.25.
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.
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.
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.
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 9:35 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.
Positioning
Traders may have observed a unique market dynamic occurring in the past sessions.
In spite of a down S&P 500 (INDEX: SPX), fixed-strike and top-line implied volatility (IVOL) measures such as the Cboe Volatility Index (INDEX: VIX), are on a downward trajectory. Let’s unpack.
Heading into the December monthly options expiration (OPEX), traders were seeking to bet on and guard against large market movement. Traders’ demand for options, particularly those that are shorter-dated, bid IVOL markedly over the period running up to December OPEX.
Graphic: Retrieved from Bloomberg via Michael Kramer. “No reason for the Cboe Volatility Index (INDEX: VIX) to rise when OPEX every day allows precision hedging.”
In fact, based on the pricing of options, the “consensus was a large right tail move in stocks,” SpotGamma explained in a recent note. Just look at the prices of options expiring December 15. There was a big premium in ultra-short-dated S&P 500 call options (left) versus puts (right).
Graphic: Retrieved by Physik Invest via the thinkorswim platform.
The same can be viewed via low volatility skew, in part the result of traders’ decreased interest in owning downside protection (as there is less reason to hold downside protection if you have sold your long stock and/or you have monetized existing protection during the 2022 decline).
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).
Anyways, as a result, counterparties (i.e., those who supplied traders their positive exposure to movement) were left “short a massive amount of Gamma,” or negative exposure to movement, which often results in hedging that reduces market liquidity and fattens the tails of the potential distribution of returns (i.e., buying strength and selling weakness), Kai Volatility said in a letter; positioning boosted “crash risk” and the potential for “more melt-ups.”
A clear display of this was after the “CPI release on Tuesday … In a matter of hours, [the] market gapped up 4% [and] then gave it all back,” Kai Volatility said.
Graphic: Retrieved from Danny Kirsch of Piper Sandler Companies (NYSE: PIPR). S&P 500 (INDEX: SPX) January $4,100.00 call volatility down, while the market is up big, offsets rally.
To further explain, that is because short-dated options gain and lose value quickly given their increased sensitivity to changes in market movement (Gamma), as time passes. When the S&P 500 moved higher after CPI, call options gained a lot of value (Delta) very quickly. Those on the other side of that trade (i.e., counterparts), who had exposure to -Gamma or negative exposure to movement, went from having, for sake of brevity, very little -Delta to a lot of -Delta. Therefore, counterparts bought stock and futures (added +Delta) to hedge against an imbalance bolstering rapid up-market movement. When the short-dated exposure rolled off, these options risks were no longer there. Counterparts removed the +Delta they added (sold stock and futures back to the market) resulting in a move back down to where markets had started.
Moving on.
Following the events of last week, the absence of the unexpected (i.e., what traders sought to hedge and/or bet on), resulted in options selling (supply of protection), a pressure on options prices that remained through December’s large monthly OPEX.
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg. OPEX removed open interest that was demanded at higher levels of IVOL and skew over the past three years, per Kai Volatility’s Cem Karsan. The associated compression of IVOL (Vanna flow) and the passage of time (Charm flow) you would expect to see this December period (i.e., bullish seasonality), coupled with a dash-for-cash and tax-loss selling seen following the calendar flip, was front-run creating the context for this market down, IVOL down environment.
These pressures are expected to last through January 10, as it’s easy to sell high IVOL likely to expire worthless (knowing there are good odds that nothing happens through the holidays), and own IVOL on the back of that period which is cheap.
Graphic: Retrieved from Danny Kirsch of Piper Sandler Companies (NYSE: PIPR). S&P 500 (INDEX: SPX) January $3,800.00 put volatility down while the market is down.
As Karsan puts it, “you’ll have some moments of minor excitement but no crazy tails,” until the week of January 10 when we are more likely to “see a countertrend rally.”
Following this period, as far out as May, there is a seasonal effect in the volatility space that could set the stage for a sharp leg lower. More on this later.
Technical
As of 9:30 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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
Our S&P 500 pivot for today is $3,867.75.
Key levels to the upside include $3,893.75, $3,909.25, and $3,926.50.
Key levels to the downside include $3,851.00, $3,838.25, and $3,813.25.
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.
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.
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 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 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
Hope you had a great holiday with your closest!
Fundamental
Minutes from a Federal Open Market Committee (FOMC) meeting dropped last week.
As strategist Rishi Mishra summarized well, “the focus shift[ed] to the terminal rate from the pace of tightening; although the terminal rate would be higher than previously expected, the pace at which we get there will be slower because they want to take lags into account.”
At its core, the economy has not slowed as much as the Fed was expecting, said Ellen Meade, a former Fed Board economist; “[t]hey can’t stop the rate increases until they see some measured evidence that the economy is slowing.”
So, with inflation “still at its highest since the 1980s,” according to Fabian Wintersberger, all the while financial conditions have loosened on easing inflation pressures, markets have yet to face their “most significant problems, [and] … keeping interest rates around 5% will not be a Fed pivot” (which is likely to happen near the middle of 2023, per the consensus analysis).
To bring the “balance sheet back to [2020 levels], [the Fed] needs to reduce it by 41%.” The balance sheet has only been reduced by 1.5%. Should liquidity keep shrinking, that pulls investors out of risk.
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.
Positioning
From a volatility perspective, it’s not a terrible time to hedge.
An example demonstrates the point, well. As lightly discussed in last week’s letters, 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 (INDEX: SPX).
The cost of certain spread structures (e.g., long/short one option near- or at-the-money and short/long two or more further out-of-the-money options) changed by hundreds of percent for only a few basis points of change in the underlying’s price.
Here’s more detail:
The market rose (boosted by a “vol crunch” and “systemic exposure reallocation,” per Nomura Holdings Inc’s [NYSE: NMR] Charlie McElligott) and, though top-line measures of IVOL have declined (e.g., INDEX: VIX), volatility skew is performing well.
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.”
As Kai Volatility’s Cem Karsan once explained, this suggests “a potentially critical change in dealer positioning [and] the distribution of underlying outcomes”.
IVOL is at a lower bound and the bullish impacts yielded by its compressing have, largely, played out.
There is more to be gained by movement higher in IVOL. By owning protection, particularly that which is farther from current prices, you are positioned to monetize on non-linear repricings of volatility (as we saw earlier this year and may still see).
Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR).
Technical
As of 6:45 AM ET, Monday’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, 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 $4,024.00, $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
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.
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.
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.
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 …
… 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.”
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.
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Graphic updated 9:00 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
S&P Global Inc (NYSE: SPGI) put it really well in a recent update comparing today to the events of the mid-to-late 1630s. Dutch tulip bulbs traded as high as $750,000 per bulb (today’s money) before collapsing to near-zero.
That’s akin to what happened with the non-fungible token (NFT) craze of the late 2010s and early 2020s. Pictures of rocks sold for millions as recently as last year. Those pictures are worthless, now, and this has done a bit to dent the ecosystem’s apparent value, as well.
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via @LanceRoberts.
What’s going on to cause this:
It’s basically the case that easy money policies enabled market participants to borrow and fund longer-duration bets on ideas with (potential) promise in the future.
Financial asset investments, too, were far more attractive, and that’s why we saw the asset inflation accelerate, followed by goods and services inflation that was bolstered by chokepoints and trends (e.g., deglobalization via supply chain security and geopolitics) and, ultimately, prompted policymakers to pivot.
i always used to assume the large sophisticated crypto firms were mostly focused on the high risk-adjusted-return relative value arb opportunities in the space: cross exchange arb, cash-futures basis; etc
FTX (CRYPTO: FTT) is among the victims of this pivot. It’s apparent that the events surrounding the collapse of crypto ecosystems months back prompted a so-called “credit crunch,” an insider close to FTX’s leadership explained.
“Many loaners suddenly recalled all of their loans just to see who was still liquid. Alameda lost a lot from giving out loans to firms [that] defaulted. Alameda was now, also, on the hook for money they didn’t have since they had given a lot of the loan money to FTX or had lost it loaning to now bankrupt counterparties. [Founder and CEO Sam Bankman-Fried] had two choices at this point, let Alameda get liquidated or send user money from FTX to ensure Alameda’s survival.”
Apart from “strong governance and transparency [to] grow in importance as the cryptocurrency industry attempts to reassure investors and customers, … regulation of cryptocurrency markets, which was already a matter of serious debate, could accelerate,” SPGI explained, noting that some “other areas of the decentralized finance [or DeFi] market may be affected. And lastly, these contagion effects are unlikely to ripple into traditional finance [or TradFi].”
Check out Reuters (FTX bankruptcy filings in, French central bank wants quick regulation) and The Information (Startups should prepare for ‘second order fallout’ from FTX collapse).
Simplify Asset Management’s Michael W. Green (who we quoted in the past for his perspective and belief that we are in “a dot-com type collapse” that’s happened “underneath the surface of the indices which is [a result of] … passive flows supporting the largest stocks within the index, whereas the smaller stocks can be influenced to a greater extent by [] discretionary managers”) said a likely result is a Central Bank Digital Currency (CBDC) and an “almost certain … change in the monetary system,” echoing what Kai Volatility’s Cem Karsan said a long-time ago: “I don’t see … a clear window where cryptocurrency is not subject to constraints and I think it’s highly likely that we move towards a digital dollar.”
CBDCs are highly controversial per my chats with the likes of Edge & Node’s Tegan Kline. She said they could “be used as a mass surveillance tool. Leaders have done little to invalidate her beliefs given their recent discussions on, for example, using CBDCs to derive “carbon footprint.”
That means having a read on where people are “traveling, how are they traveling, what are they eating, what are they consuming … This is something we’re working on,” leaders have put forth.
The point of this all is as follows:
As many may know, “there’s no ultimate buyer” in spaces like crypto and DeFi, as ex-Goldman Sachs Group Inc (NYSE: GS) emerging market FX and yield trader Seraphim Czecker, who is now heading risk and product management at Euler Labs, said.
It’s that and the persistent interest in illiquid products that leave the door open to manipulation. Barring illiquidity, “if there’s a 10 or 15 standard deviation move, the liquidity will allow for … you [to] offload those assets quickly.”
However, that’s not the widespread case.
“For example, look at what happened in the UK with the pension funds and margin calls. That is a classic DeFi strategy. You take your bonds and borrow cash against them. Then, you put it back into bonds and loop it a couple of times. That way, you have a leveraged interest rate exposure. That’s the same principle of lending staked Ethereum (CRYPTO: ETH), borrowing ETH, and doing it a couple of times.”
So, there may be “second order fallout” amid all this tightening. Markets, everywhere, are to de-rate. Ultimately, there’s probably a pivot to happen, in the future, with many leaders and strategists in finance unable to agree whether that (pivot) is the result of a recession.
Ukraine central bank says it is preparing banking system for blackouts. It is also suddenly clear that Ukraine might have had $ in FTX. They had partnered w FTX on donations. https://t.co/oZSOchz8bI + https://t.co/sDpXGNGuNn
“To take the foot off the brake right now and not finish the job, I think it’s the absolute worst mistake that the Fed could possibly make,” Citadel’s Ken Griffin said at the Bloomberg New Economy Forum in Singapore. In spite of Citadel seeing a recession averted, Griffin said: “I am finding it a bit hard to believe we are not going to have a recessionat that point of time, sometime in the middle to back half of 2023,” adding this year finishes with “modest growth.”
Those in agreement include Stanley Druckenmiller, who once managed George Soros’ funds. “You don’t even need to talk about Black Swans to be worried here. To me, the risk-reward of owning assets doesn’t make a lot of sense,” Druckenmiller said.
“When you make a mistake, you got to admit you’re wrong and move on that nine or 10 months, that [policymakers] just sat there and bought $120 billion in bonds,” he added. The “repercussions of that are going to be with us for a long, long time.”
Positioning
From a positioning perspective, much of what we’ve discussed in past notes is still true. Among others, Goldman Sachs Group Inc calculates up to $40 billion in buying over the next weeks with more than $80 billion of buying in an up market.
Graphic: Retrieved from @LanceRoberts. “Goldman calculates a whopping $38 billion to buy over the next week and substantially more (green line) if the market is up big. The chart below shows that the bank expects more than +$79 billion of net buying over the month.”
This is pursuant to our statements on the compression of implied volatility (evidenced by a shift lower in the term structure, particularly at the front end where options are most sensitive) compounding macro-type repositioning, with follow-on support coming from the reach for “Deltas and leverage” to the upside (call options).
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).
As Alfonso Peccatiello of The Macro Compass puts it well: “incentive schemes drive people to be much more willing to pay and chase upside.”
Preferred are “convex structures” that would benefit from rallies.
However, in traders’ monetization of put protection they owned, as well as reach for upside calls (to not miss out on a potential reversal), skew is at its lows.
Graphic: Retrieved from The Ambrus Group’s Kris Sidial. “2017 is a year that is notorious for extremely low implied and realized vol. It is fascinating to see how insanely low the call-side volatility has been this year. There is low vol and then there is, in the gutter low vol.”
If the assumption is that “further tightening monetary policy and draining liquidity off the market might cause some problems down the road,” per Fabian Wintersberger, downside convexity (bets that trade non-linearly to changes in underlying price and volatility) are attractive.
Graphic: Retrieved from Banco Santander SA (NYSE: SAN).
Trades that may be attractive include collars, as well explained in a recent thread by IPS Strategic Capital’s Pat Hennessy.
“[T]he combination of historically flat skew [and] the highest rates we’ve seen in 15 years makes longer dated collars an attractive trade for those who are worried about the performance of stocks over the next year but do not want to sell or try timing the market.”
Technical
As of 9:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
Our S&P 500 pivot for today is $4,000.25.
Key levels to the upside include $4,069.25, $4,136.75, and $4,231.00.
Key levels to the downside include $3,965.25, $3,913.00, and $3,871.25.
Click here to load today’s key levels into the web-based TradingView platform. All levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga journalist.
