Categories
Commentary

Daily Brief For January 20, 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 upward, into the prior day’s range, after some overnight exploration, lower. 

As explained better below, some positioning metrics suggest a bottom (at least near-term) may be in the making.

Ahead is data on jobless claims and manufacturing (8:30 AM ET), as well as home sales (10:00 AM ET).

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

Fundamental: The prevailing narrative facing market participants in recent trade is centered around the prospects of contractionary monetary policy in the face of strong economic and earnings growth, as well as cooling inflation while “excess supply” of goods/services builds.

This, as Bloomberg puts it well, “threatens to inject more volatility across a range of assets.” 

As a result, the benefits afforded to holders of diversified portfolios are less.

“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,” which would, according to Damped Spring Advisors, “generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Participants are pricing in these expectations, selling heavy the rate-sensitive products, and pushing the Nasdaq into correction territory, yesterday.

Graphic: Per Bloomberg, “The rout pushed the Nasdaq Composite over the threshold into correction territory.”

“Right now you have people waiting before they go and buy back in,” said Jamie Cox, managing partner at Harris Financial Group.

“You have a Fed meeting coming up, so there’s not going to be a lot of movement anywhere until the Fed meeting is over with. You look around, there’s not a lot of problems in the economy, what you have is just the question of, ‘does all this add up to a faster rate hiking cycle that we anticipate?’ And I don’t think so. I think it’s not likely.”

Moreover, unlike the U.S., counterparts elsewhere, in China and Europe, for example, are not looking to tighten as quickly.

“If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers,” said Chinese President Xi Jinping. 

“They would present challenges to global economic and financial stability, and developing countries would bear the brunt of it.”

For context, China cut its benchmark interest rate to 3.70% (10 basis points), “cement[ing] the pivot to easing.”

Graphic: Per Topdown Charts, “China cuts benchmark interest rate -10bps to 3.70%. i.e. the 1-year LPR [Loan Prime Rate].  n.b. the PBOC also cut the 5-year loan prime rate by -5bps to 4.6%.”

Though this move away from tightening in China is good for assets in that country, emerging markets, and commodities, according to Callum Thomas, an economic slowdown there may foreshadow what is to come in other parts of the world.

Obviously, in saying that plainly, we’re discounting China’s clampdown on its housing and financial sector, but the data seems to suggest the “reopening [and] stimulus-driven global economic rebound may be losing steam headed into 2022.”

Graphic: Per Topdown Charts, OECD leading indicator down sharply from highs.

Stifel Financial Corporation’s (NYSE: SF) Barry Bannister provides us with the implications of tighter U.S. financial conditions: a correction down to $4,200.00 in the S&P 500, near-term.

And, with that, post-correction, equities risk the 3rd bubble in 100 years if the “Fed loses its nerve and cancels much of the tightening plan.”

Graphic: From The Market Ear.

As an aside, to temper some of the bearishness in the above section of the newsletter, here is a chart of S&P 500 returns during Federal Reserve hiking cycles.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS), from The Market Ear.

Positioning: Despite elevated measures of implied volatility like the Cboe Volatility Index (INDEX: VIX), the VIX term structure remains upward sloping, albeit less so than before.

Graphic: VIX term structure shifts higher. The flows associated with hedging protection in the S&P complex ought to pressure the market, should this term structure continue higher.

This is as the unwind of large long-delta positions in heavily weighted index constituents, pre-monthly options expiry (OPEX), alongside demand for downside (put) protection, is finally feeding into the large index products.

Graphic: SpotGamma’s (beta) Hedging Impact Of Real-Time Options (HIRO) indicator suggests Negative options delta trades likely had dealers selling the S&P 500 and Nasdaq 100 ETFs, yesterday.

Moreover, further flattening or inversion of the VIX term structure would clearly coincide with destabilizing demand for protection (as a result of the counterparty supplying protection selling underlying to hedge).

Thus, any expansion in volatility (which could be construed as demand for protection), likely coincides with further weakness.

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

Some sort of bottom (at least near-term) may be in the making.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Technical: 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 upper part of a positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Spike Scenario 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).

The spike base is at $4,549.00. Above bullish. Below bearish.

In the best case, the S&P 500 trades higher; activity above the $4,565.00 untested point of control (VPOC) puts in play the $4,603.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,619.00 HVNode and $4,650.75 extended trade low (ETH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,565.00 VPOC puts in play the $4,514.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,492.25 regular trade low (RTH Low) and $4,471.00 VPOC, or lower.

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

Definitions

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.

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 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 13, 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 diverged from commodity and bond products. Measures of implied volatility showed signs of bottoming. The dollar continued a plunge. 

Overall, the stance is neutral as the “hottest U.S. inflation in 39 years sets up March rate liftoff.”

Ahead is data on jobless claims and producer prices (8:30 AM ET). The Federal Reserve’s Lael Brainard will have a confirmation hearing (10:00 AM ET), Tom Barkin will speak later (12:00 PM ET), with Charles Evans speaking last (1:00 PM ET).

Graphic updated 5:55 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: The consumer price index printed 7%, rising 0.5% from November. 

Much of the increases were attributed to shelter, used vehicles, and food.

With unemployment falling and inflation proving stubborn, monetary policymakers have been emboldened to tighten, raising rates in March and (later) shrinking the balance sheet. 

“In terms of where the Fed is on their dual mandate — inflation and the labor market — they’re basically there,” Michael Gapen, chief U.S. economist at Barclays Plc (NYSE: BCS), said on Bloomberg Television. “I don’t really think anything stops them going in March except one of these kind of outlier events. I think they’re ready.”

Market reaction was muted, mostly, with commodities bearing the brunt of the bullishness.

The calm reaction in equities, ahead of the earnings season, and bonds “showed that there was nothing particularly surprising in the [CPI] report, and that traders were confident that prices already covered the risks,” Bloomberg’s John Authers explained

“Fed funds futures barely budged, leaving a first rate hike in March almost fully priced. As they did before these numbers came out, dealers feel certain that the Fed will hike at least three times this year, while a fourth in December is seen as a 50-50 call.”

Graphic: Via Callum Thomas of Topdown Charts, “With the composite measure of inflation expectations at 40-year highs it’s fair to suggest that the Fed may have some catching up to do as it kicks off the transition away from easing.”

As an aside, there was a big drop in the dollar. In raising rates, currencies ought to attract money. Right? 

“[T]he combination of another really bad inflation number and an insouciant bond market response has been enough to knock the dollar off course. Many factors drive currencies, but this is consistent with a view that the rate hikes already priced in, and supporting the dollar until now, won’t be enough to head off inflation.”

Graphic: Via Bloomberg, “a weaker dollar makes imports more expensive and increases inflation.”

Positioning: On January 7, this commentary suggested metrics of options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side) were positively skewed, even more so than before.

What followed was upside resolve, exacerbated in part by the compression in volatility and unwind of hedges to destabilizing customer options activity (i.e., put buying and call selling).

What now?

Scott Rubner of Goldman Sachs Group Inc (NYSE: GS) had the following to say.

“I am in the process of writing flow-of-funds note for February. My gut tells me to be bearish in February for when the ‘January Inflows’ run out. However, I just re-ran the CURRENT SET-UP for January and the conditions are not in place for a larger correction (>5%). Said another way, I want to be bearish, but this is the consensus. Investors are short, hedges are too big, everyone has on the puts, sentiment is negative (lowest in 86 weeks), I think everyone is already looking for the correction, and this may shift into buying dip alpha.”

So, what does all that mean? 

Demand for downside protection, as already touched on, coincided with customers indirectly taking liquidity and destabilizing the market as the participant short the put sold underlying to neutralize risk.

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).

Expansion in implied volatility increases the directional exposure of that protection. 

This is good for put buyers and bad for put sellers, simply put. As a result, in weakness, hedging of these contracts pressures markets further, making for violent up and down trade.

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

As volatility contracts, however, and underlying prices rise, the directional exposure of protection declines. This is bad for put buyers and good for put sellers. In offsetting this decline in directional risk, counterparties will unwind earlier hedges to bearish customer options activity. 

The unwind of these hedges, as SpotGamma explains, “likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’).”

Couple this flow with strong passive buying support, as evidenced by metrics quoted elsewhere in this newsletter (e.g., DIX), the odds that markets continue to rally (or trade sideways, at least, short-term), in the face of “above-trend growth” and a record year of buybacks, as well as other things, seem good.

Graphic: Taken from The Market Ear. Goldman Sachs’ Scott Rubner: “The GS corporate buyback desk expects a record year for executions of $975B or >$4B per day.”

Technical: As of 5:55 AM ET, Thursday’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.

In the best case, the S&P 500 trades 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 $4,756.00 LVNode and $4,779.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,717.25 LVNode puts in play the $4,691.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,674.25 HVNode and $4,643.00 VPOC, or lower.

Considerations: As evidenced by the volume-weighted average price anchored from the release of FOMC minutes (blue color, below), the average buyer, since that, is winning.

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.

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.

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

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

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

Options Expiration (OPEX): 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.

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.

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, 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 12, 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, as well as most commodity, and bond futures were higher ahead of data releases on the Consumer Price Index (8:30 AM ET), Federal Budget, and Beige Book (2:00 PM ET), as well as Fed-speak by Neel Kashkari (1:00 PM ET).

Graphic updated 6:30 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: The focus, today, is whether or not the headline inflation rate tops 7%. 

Graphic: Inflation forecasts via Bloomberg.

This is as improvements in the U.S. labor market and increased hawkishness from the Federal Reserve (Fed) are playing into a recent rotation (into value) and broad market slump.

As stocks recover from their multi-day slump; Jerome Powell reassured investors, Tuesday, that the Fed would stem increasing inflation and shrink its balance sheet. 

“Hawkish Fed repricing is likely largely done for now,” and “resilient earnings should help equities rebound,” Barclays Plc (NYSE: BCS) strategists explained in a recent note. 

Graphic: Via @biancoresearch, “we are in a rare period when what the market has priced in is the outlier call.”

JPMorgan Chase & Co (NYSE: JPM) agrees. Equities should be able to withstand hikes and balance sheet runoff amidst above-trend growth and a rebound in some international markets.

“As long as yields are rising for the right reasons, including better growth, we believe that equities should be able to tolerate the move,” a JPMorgan note said. 

“The rise in real rates should not be hurting equity markets, or economic activity, at least until they move into positive territory, or even as long as real rates are below the real potential growth.”

In support of JPMorgan’s comments on real rates and growth, Sanford Bernstein outlines a bull case stating: “[H]istorically, when real yields normalized back to zero from negative levels, equities have had positive returns.”

As a bonus, per Ryan Detrick of LPL Financial, “Yes, the Fed will probably hike rates for the first time in a new cycle some time during the first half of 2022. Remember though, looking at the past 8 first hikes, stocks were higher a year later every single time.”

Graphic: S&P 500 performance post-hiking, via LPL Financial.

In opposition to the bull-narrative, Jim Bianco of Bianco Research puts it well: “So, if the bond market is having epic convulsions in the wake Fed printer getting turned off, do not take solace that the stock market ‘doesn’t get it.’ 

“This is how financial markets turn, the stock market often stays too long and turns last.”

Positioning: To keep things fresh, recall that in buying a put, for instance, customers indirectly take liquidity as the counterparties hedge short put exposure by selling underlying.

Higher implied volatility marks up options delta (exposure to direction) and this leads to more selling, as hedging pressures exacerbate weakness. Higher volatility, higher delta, more selling.

As implied volatility compresses, options delta (exposure to direction) is marked down. This leads to buying by the counterparty.

Per SpotGamma’s (unreleased) Hedging Impact of Real-Time Options indicator, over the past sessions, positive delta trade on the part of counterparties, as a result of customer put selling and call buying, has supported the near-vertical price rise from Monday’s lows.

Graphic: SpotGamma’s (beta) Hedging Impact of Real-Time Options (HIRO) indicator.

As visualized, above, positive delta trade tapered off into the close, Tuesday, while S&P 500 prices continued higher. Interesting, right? Part of that rally has to do with volatility compression.

The VIX term structure remains upward sloping and volatility (via the INDEX: VIX) has fallen. As stated, above, compression marks options delta down and leads to buying by the counterparty.

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 middle part of a positively skewed overnight inventory, just 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 $4,717.25 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 $4,756.00 LVNode and $4,779.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,717.25 LVNode puts in play the $4,691.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $4,674.25 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.

What People Are Saying

Definitions

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

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

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

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

About

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

Capelj 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 11, 2022

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

What Happened

Overnight, equity index, commodity, and bond futures were sideways to higher. This is ahead of important Fed-speak; Federal Reserve Chair Jerome Powell speaks at 10:00 AM ET.

Graphic updated 6:40 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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: JPMorgan Chase & Co (NYSE: JPM) strategists led by Marko Kolanovic noted, yesterday, that the selloff is overdone, arguing higher rates would not derail the bull market. 

Graphic: Interest rates relative to Russell 1000 Value/Growth. Via The Market Ear, “Higher bond yields and growth-to-value rotation within equities.”

“The pullback in risk assets in reaction to the Fed minutes is arguably overdone,” Kolanovic said. “Policy tightening is likely to be gradual and at a pace, that risk assets should be able to handle, and is occurring in an environment of strong cyclical recovery.”

An analysis of equity market performance in the face of past rate spikes, suggests Kolanovic’s comments aren’t out of line. 

“We found that while SPX tends to see returns slow in the short term, the NDX and RTY actually tend to outperform on a 1M basis,” Jefferies Group says on S&P 500 (SPX), Nasdaq 100 (NDX), and Russell 2000 (RTY) performance post major rate spikes.

“Looking further out, the NDX (naturally) is the only of the three that flags. The SPX trends back toward its historical return profile and the RTY actually tends to beat the SPX in the intermediate to longer-term”.

Graphic: Taken The Market Ear. Original source Jefferies Group.

Beyond asset price support from a recovering economy, strong growth in business profits, rents, and other income, Moody’s Corporation (NYSE: MCO) believes another reason “financial markets are brushing off QT is that there will still be a lot of excess liquidity—a little less than $1 trillion— when the central bank’s balance sheet does begin to decline.”

This excess liquidity is to shrink, naturally, as the economy grows quicker than the M2 money supply; the Marshallian K – the difference between year-over-year growth in M2 money supply and GDP – which had turned negative late last year (and prompted concerns around liquidity and its impact on the equity market) is now positive.

Graphic: Marshallian K had turned negative late last year. According to Bloomberg, “While stocks kept rising during frequent negative Marshallian K readings in the 1990s, the pattern since the 2008 global financial crisis — a period when the central bank was in what Ramsey calls a “perpetual crisis mode” — begs for caution.”

Notwithstanding, according to Callum Thomas, “[t]he election cycle + decennial cycle (i.e. that ‘years ending in 2’ line) suggest some challenging months ahead… (as opposed to the usual unconditional seasonal pattern).”

Graphic: Taken from Callum Thomas. Source: @mrblonde_macro.

Positioning: Heading into Monday’s session, the broader market was set to experience increased two-way volatility.

That happened. The S&P 500 and Nasdaq 100 explored lower but ended higher yesterday.

What’s next? There’s been a noticeable shift in relative strength. The Nasdaq 100 has firmed, relative to its counterparts, and overnight activity built on yesterday’s end-of-day advance.

At the same time, the VIX term structure, a good gauge of fear, remained upward sloping and volatility (via the Cboe Volatility Index) compressed suggesting a reduction in the demand for protection. 

Graphic: Visualizing the compression in volatility.

All that means is that the opposite of what was expected heading into yesterday happened.

Recall, in demanding downside protection (buying a put), customers indirectly take liquidity as the counterparties hedge their short put exposure by selling underlying. 

Higher implied volatility marks up options delta (exposure to direction) and this leads to more selling, as hedging pressures exacerbate weakness.

Alongside yesterday’s end-of-day rally, lower implied volatility marked down options delta (exposure to direction). This lead to buying by the counterparty.

We can maintain the notion that despite markets tending toward instability so long as volatility is heightened and products (especially some constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).

“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma.

Technical: As of 6:40 AM ET, Tuesday’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, 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 $4,674.25 high volume area (HVNode) puts in play the $4,691.25 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as high as the $4,717.25 low volume area (LVNode) and $4,732.50 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,674.25 HVNode puts in play the $4,647.25 HVNode. Initiative trade beyond the latter could reach as low as the $4,629.25 HVNode and $4,593.00 untested point of control (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.

What People Are Saying

Definitions

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

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

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

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

About

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

Capelj 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 10, 2022

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

What Happened

Overnight, equity index futures auctioned lower alongside bonds and most commodities.

Ahead is data on wholesale inventories (10:00 AM ET) and Fed-speak (12:00 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: Improvements in the U.S. labor market and increased hawkishness from the Federal Reserve are some of the factors playing into a recent rotation.

With yields climbing and the 10-year benchmark breaking out toward 2.00%, there’s been a clear move out of growth- and innovation-names to value- and cyclical-type stocks.

Graphic: Via Bloomberg, “Markets face increasing volatility as investors grapple with how to reprice assets as the pandemic liquidity that helped drive equities to record highs is withdrawn.”

This is just as Goldman Sachs Group Inc (NYSE: GS) announced that it expects four interest rate hikes this year (in MAR, JUN, SEP, and DEC) and a balance sheet runoff to begin in July.

“Valuations are at historical highs, companies are raising billions based on fairy dust, and the Fed is signaling a tightening cycle,” said Jason Goepfert of Sundial Capital Research. “All of these are scaring investors that we’re on the cusp of a repeat of 1999-2000.”

Why are higher rates scary? 

Though higher rates are to fend off inflation, they have the potential to decrease the present value of future earnings making stocks (especially high growth) less attractive.

For context, at no other point since the dot-com bubble has so many constituents have fallen while the index was so close to its peak.

Graphic: From Sundial Capital Research. Posted by Bloomberg.

Despite participation continuing to narrow, equities should be able to withstand rate hikes and balance sheet runoff amidst above-trend growth and a looming rebound in some international markets, JPMorgan Chase & Co (NYSE: JPM) adds.

“As long as yields are rising for the right reasons, including better growth, we believe that equities should be able to tolerate the move,” a JPMorgan note said. 

“The rise in real rates should not be hurting equity markets, or economic activity, at least until they move into positive territory, or even as long as real rates are below the real potential growth.”

Positioning: As discussed in Friday’s detailed write-up, bonds and equities are down.

That’s due in part to the bond-stock relationship being upended as a result of monetary tightening to combat inflation.

“At stake are trillions of dollars that are managed at risk parity funds, balanced mutual funds, and pension funds that follow the framework of 60/40 asset allocation.”

As explained Friday, we mention this (broken) relationship as it forces us (participants, in general) to look elsewhere for protection. 

The growing asset class of volatility, so to speak, is that protection. Investors are aware of both the protective and speculative efficiency afforded to them by options and that is the primary reason option volumes are so comparable to stock volumes, now.

If interested, read this primer on “Trading Volatility, Correlation, Term Structure, and Skew.”

With option volumes higher, related hedging flows can represent an increased share of volume in underlying stocks; the correlation of stock moves, versus options activity, is pronounced.

All that means is that we can look to the options market for context on where to next.

According to options modeling and data service SpotGamma (learn more here), the S&P 500, in particular, based on an earlier demand for protection is set up for higher volatility.

“End-of-week compression in volatility, in spite of a high-volatility, negative-gamma regime characterized by dealer hedging that exacerbates movement, sets markets up for instability in case of even lower prices and demand for protection.”

Why? 

Knowing that demand for downside protection coincides with customers indirectly taking liquidity and destabilizing the market as the participant short the put will sell underlying to neutralize risk, participants ought to keep their eye out on whether implied volatility expands or contracts.

All else equal, higher implied volatility marks up options delta (exposure to direction) and this leads to more selling as hedging pressures exacerbate weakness.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book.
Graphic: Per Interactive Brokers Group Inc (NASDAQ: IBKR), VIX futures show little concern; “An inverted curve, or even a flattish one, indicates a shortage of available volatility protection.  We saw that as recently as a month ago, but not now.”

Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

In ending this section, Friday’s put-heavy expiration removed some negative gamma that was adding to instability, at least at the index level. 

Though markets will tend toward instability so long as volatility is heightened and products (especially some constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).

“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma adds.

At present, there’s a push-and-pull; “no-touch” garbage stocks in the S&P and Nasdaq 100 are gaining strength. If this dynamic persists, in light of what was discussed above, what happens?

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

Spike Scenario Still 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).

Spike base is at $4,761.25. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,647.25 high volume area (HVNode) puts in play the $4,674.25 HVNode. Initiative trade beyond the latter could reach as high as the $4,691.25 micro composite point of control (MCPOC) and $4,717.25 low volume area (LVNode).

In the worst case, the S&P 500 trades lower; activity below the $4,647.25 HVNode puts in play the $4,629.25 HVNode. Initiative trade beyond the latter could reach as low as the $4,585.00 and $4,549.00 untested point of control (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.

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.

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

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

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

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 7, 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

Equity index futures auctioned sideways, mostly, ahead of important economic releases such as data on Nonfarm payrolls, the unemployment rate, and average hourly earnings (8:30 AM ET), as well as Fed-speak (10:00 AM and 12:15 PM ET), and consumer credit data (3:00 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: Participants will receive further clarity around payrolls data.

According to Bloomberg, the expectation is that Friday’s jobs report ought to show the addition of about 450,000 workers, last month. 

“[T]he so-called whisper number has already jumped to 500,000,” in light of this “Wednesday’s consensus-busting ADP Research Institute data that showed U.S. companies added the most jobs in seven months.”

This is all the while major equity indices are down on the week, “fueled by one of the most intense bouts of selling by professional speculators since the financial crisis.”

Per Goldman Sachs Group Inc (NYSE: GS) prime broker data, the sale of highly valued growth stocks reached levels not seen in more than 10 years. Selling worsened after minutes to the Federal Reserve’s last policy meeting pointed to faster hikes and balance sheet normalization.

As higher rates are to fend off inflation, they, too, have the potential to decrease the present value of future earnings making stocks (especially high growth) less attractive. 

“A strong [payrolls] print will see the market factor in hikes/quantitative tightening even earlier,” strategists at Mizuho International Plc said. “We’d therefore prefer to be positioned for more equity downside, and for higher yields.”

Positioning: Bonds down, equities down. Interesting, right?

Fresh in my mind is a conversation I had with Karan Sood, CEO and Managing Director, Head of Product Development at Cboe Vest Financial LLC, regarding his firm’s packaged options and volatility targeting strategies that help investors manage their portfolio volatility.

Moreover, 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.

“Bonds have been giving you really good returns because interest rates have been going down since the 1970s when they peaked at about 11%,” Sood explained to me. 

“That’s changing now; we’re at the zero bound, and it’s unlikely that will be as a strong of a tailwind. Worse, it could be a headwind if interest rates start to rise.”

As a result of this dynamic, coupled with participants’ increased exposure to rate and equity market risk which can play into cross-market hedging and de-leveraging cascades, 60/40 can be somewhat of a poor hedge.

“Now, with the Fed poised to hike interest rates to combat raging inflation, the bond-stock relationship could be upended,” Bloomberg explains

“At stake are trillions of dollars that are managed at risk parity funds, balanced mutual funds, and pension funds that follow the framework of 60/40 asset allocation.”

Graphic: Via Bloomberg.

Why mention any of this? Well, it forces us to look elsewhere for protection. 

In this case, the growing asset class of volatility, so to speak, is that protection. Investors are aware of both the protective and speculative efficiency afforded to them by options and that is the primary reason option volumes are so comparable to stock volumes, now.

Notwithstanding, with option volumes higher, related hedging flows can represent an increased share of volume in underlying stocks. Therefore, the correlation of stock moves, versus options activity, is more pronounced.

To put it simply, we can look to the options market for clues on where to next, for lack of better phrasing. So, let’s do that!

Wednesday’s session unwound some of the single-stock bullishness (in stocks like Tesla) that fed into the S&P 500, itself; an expansion in volatility coincided with the demand for downside (put) protection and supply of upside (call) protection.

Conditions settled, Thursday. Though positioning metrics had little to offer in terms of predicting movement, implied volatility remained heightened and many products did not expand range.

All else equal, higher implied volatility marks up options delta (exposure to direction). 

Knowing that demand for downside protection coincides with customers indirectly taking liquidity and destabilizing the market as the participant short the put will sell underlying to neutralize risk, participants ought to keep their eye out on whether implied volatility expands or contracts.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book.

Higher implied volatility, higher delta, more selling. Hedging pressures will exacerbate weakness, as a result of real selling (as talked about above), at the index and single-stock level.

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

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

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

As stated yesterday, though the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher), markets will tend toward instability so long as volatility is heightened and the market remains in short-gamma territory.

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

Spike Scenario 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).

Spike base is at $4,761.25. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,691.25 micro composite point of control (MCPOC) puts in play the $4,717.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,732.50 high volume area (HVNode) and $4,756.00 LVNode, 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 latter could reach as low as the $4,647.25 and $4,629.25 HVNode, or lower.

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

What People Are Saying

Definitions

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

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

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.

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

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

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

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 6, 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

Equity index futures were lower on some hawkish commentary from the Federal Reserve.

Ahead is data on jobless claims and trade deficit (8:30 AM ET), the ISM services index, factory orders, and core capital goods orders (10:00 AM ET), as well as Fed-speak (1:15 PM 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: Yesterday, participants were provided further clarity around the Federal Reserve’s intent to hike interest rates and taper the pace of asset buying. 

“At first blush, the December FOMC minutes read hawkish, and the market reaction supports this,” said Cliff Hodge, chief investment officer for Cornerstone Wealth. 

“The fact that FOMC participants are discussing faster and more aggressive rate hikes, alongside a faster pace of balance sheet normalization than the last hiking, indicate that the Fed put for the stock market has been repriced lower.”

The news coincided with a fast move higher in Treasury yields and weakness in the growth- and innovation-heavy Nasdaq-100. 

Graphic: Via The Market Ear, JPMorgan Chase & Co analyzes sector and yield correlations.

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.

Recall yesterday’s commentary touching on the implications of tight monetary frameworks and less liquidity, so to speak. 

In short, easy monetary frameworks pushed participants out the risk curve. 

As a result, removal of liquidity, in the face of increased exposure to risk across different assets, can result in “hedging and de-leveraging cascades that affect the stability of all markets,” as well put in one article I recently wrote.

“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,” is one way to put it, additionally.

Positioning: Wednesday’s session unwound some of the single-stock bullishness that fed into S&P 500, itself. 

Recall that 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.

Heading into Wednesday, volatility continued compressing. This is all the while the counterparty to the aforementioned trade was 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).

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

The tone changed, however. According to SpotGamma data (click here to learn more about access), customers sold upside (call) and bought downside (put) protection. The demand for puts accelerated after the release of FOMC minutes as can be seen via the chart, below.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator suggested negative options delta trades in SPY likely had dealers selling into the close.

That demand for protection coincided with an expansion in volatility; all else equal, higher implied volatility marks up options delta (exposure to direction).

Graphic: SHIFT Search confirms SpotGamma data.

With put buying, for instance, customers are indirectly taking liquidity and destabilizing the market as the market maker short the put will sell underlying to neutralize directional risk.

Higher implied volatility, higher delta, more selling. Hedging exacerbated weakness at the index and single-stock level, yesterday.

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book.

Taking into account the aforementioned positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed, better than before.

Graphic: Data SqueezeMetrics. Graph via Physik Invest.

Though the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher), markets will tend toward instability so long as volatility is heightened and the market remains in short-gamma territory.

Technical: As of 6:30 AM ET, Thursday’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, just outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Spike Scenario 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).

Spike base is at $4,761.25. Above, bullish. Below, bearish.

In the best case, the S&P 500 trades higher; activity above the $4,691.25 micro composite point of control (MCPOC) puts in play the $4,717.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,732.50 high volume area (HVNode) and $4,756.00 LVNode, 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 latter could reach as low as the $4,647.25 HVNode and $4,623.00 point of control (POC), or lower.

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

What People Are Saying

Definitions

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

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

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.

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

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

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

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 January 4, 2022

What Happened

Overnight, equity index futures auctioned higher alongside most commodities and volatility fell.

This is as investors await data on manufacturing and job openings/quits (10:00 AM ET).

Graphic updated 6:30 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: The aforementioned trade is happening in the context of a resurgence in the coronavirus, as well as the Federal Reserve’s intent to moderate stimulus, among other things. 

“We expect 2022 to be far more challenging from an investment perspective,” Heather Wald, vice president at Bel Air Investment Advisors, said

“Rarely has a market delivered three consecutive years of double-digit returns, as we have seen from 2019-2021. With the Federal Reserve set to accelerate tightening and a fairly valued stock market, we anticipate more muted returns for the S&P next year but still expect equities to remain attractive versus other liquid asset classes.” 

Wald’s comments align with some metrics posted by LPL Financial’s Ryan Detrick. 

“The bad news is when the S&P 500 gains more than 25% in a year, it has never gained more the following year,” Detrick said. “The good news? That next year can still be pretty darn good. Higher 85% of the time and up a solid 11% on average.”

Graphic: S&P 500 returns via Ryan Detrick. 

This is as the S&P 500 sticks to its seasonal script; in the face of light positioning metrics, expected are massive inflows in the first few months of this year. 

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.”

This year is likely to be “dominated by continued knife-edge judgments by the Fed,” and inflation proving better than the most pessimistic forecasts, potentially. 

The prospects of a rally into the first rate hike are emboldened. Thereafter, the market may decline through the rest of 2022.

Positioning: Interesting Twitter thread by Kris Sidial on the transfer of risk in different areas of the volatility term structure. 

“You are seeing institutions aim to harvest the VRP in single stock land by hammering away at the front of the term structure. Especially the exotics desks that are notorious for carrying this inherent short calendar profile.”

What Sidial is talking about is most easily visualized by the compression and expansion of the VIX term structure in the graphic below. Notice the front move, relative to the back, below.

Graphic: VIX term shifts inward; as mostly short-dated protection is monetized or expired, volatility collapses and dealers’ exposure to the positive delta (via short puts) declines which meant they would cover their short futures hedges. This “vanna” flow bolsters SPX rallies.

The implications of this are staggering.

Participants, having been pushed out the risk curve, are using leverage to juice returns; option volumes are comparable to stock volumes.

As a result, related hedging flows represent an increased share of volume. 

As I once wrote in a Benzinga article: “The reflexive response by the opposing side of options trades — a result of regulatory frameworks, the low-interest-rate environment, as well as growth of the derivatives complex — causes a cascading reaction that exacerbates underlying price movements.”

Sidial adds: “[T]his short gamma profile with more and more people using derivatives will make way for the rapid moves in shorter time frames.”

That explains a lot!

Moreover, if we zoom in more narrow, today, though implied volatility “is well above its pre-COVID level across the term structure,” it is being sold at the front end.

SpotGamma data confirms this. Via the graphic below, the compression of volatility coincides with call and put selling at the index level; note, though, the increased put selling (more bullish).

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator.

Participants’ activity in shorter-dated tenors (as evidenced by the compression of VIX term structure mainly at the front-end) where options are more so sensitive to changes in the underlying price, time, and volatility, is promoting choppy (but bullish) price action, for now.

With bullish activity in single stocks like Tesla Inc (which was primed for an options-driven squeeze heading into Monday) feeding into S&P positioning, alongside the removal of hedges to positioning that was pressuring stocks and indices heading into Friday OPEX, and passive buying support, there’s potentially more room for higher, to put it simply.

Graphic: SpotGamma posts on TSLA’s options positioning, Monday.

In the end, the concern is whether this bullishness leaves participants reaching for downside (put) protection, later. This would have destabilizing implications, as Sidial alluded to earlier.

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

Expectations: 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 upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. 

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. 

Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

In the best case, the S&P 500 trades higher; activity above the $4,798.50 low volume area (LVNode) puts in play the $4,805.50 extension. Initiative trade beyond the $4,805.50 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 $4,798.50 LVNode puts in play the $4,790.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,777.00 untested point of control (VPOC) and $4,756.00 LVNode, or lower.

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

Definitions

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

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

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

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

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

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

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.

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.

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, 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

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.