Categories
Commentary

Daily Brief For June 27, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!

What Happened

Overnight, equity index and commodity futures were higher while bonds were lower. Volatility measures were bid, too.

In the news is Russia’s default on foreign debts. Quarterly repositioning may bolster attempts higher, per JPMorgan Chase & Co (NYSE: JPM), while Morgan Stanley (NYSE: MS) strategists see the potential for lower with base cases calling for a soft economic landing.

Ahead is data on goods orders (8:30 AM ET) and pending home sales (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: Very short, today.

Later this week, I’m excited to share some insights I gleaned from a veteran trader and macro strategist. As a preview, this person thinks that we are in a recession. However, a recovery in equity markets is not off the table with 2022 likely being a 1% total GPD year with 4% inflation.

Stay tuned for that.

Positioning: We’ve been speaking on the demand for protection and the still-strong supply of it lending to tameness in Wall Street’s preferred “fear gauge,” relative to those gauges tracking markets like rates and commodities.

Graphic: Via Bloomberg.

“The current behavior is playing out similar to the 2000-2002 dot-com bear market, with no big sudden shocks but sustained high realized volatility,” explained Talal Dehbi of PrismFP.

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

Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

Anyways, noteworthy is the sale of short-dated volatility, and this has played into generally poor performance in skew. In light of that, it makes sense to lean toward owning volatility, rather than selling it.

Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), was very depressed, too, in comparison to the VIX, itself.

The note to point out, here, is – and this is in accordance with some very recent notes – that a “higher starting point” in IVOL, and a still-present right-tail, makes it so we may position, for less cost, in shorter-dated spread structures with attractive and asymmetric payouts.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). Multi-expiry skew in the Invesco QQQ Trust Series 1 (NASDAQ: QQQ). Notice the v-shape in the shorter maturity and smirk in the longer maturity. Here’s what that means.

Heading into the end of the quarter is the expected rollover of large options positions. These are hedges to customer long-equity exposure, which the liquidity providers are short. A front-running of this repositioning flow is (and is expected), in part, to add to the equity market upside.

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

Per SpotGamma, after expiration, “it is more likely the [bearish] tone [all else equal] remains unchanged at least from a positioning perspective,” albeit many metrics appear a tad stretched.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from Callum Thomas’ Weekly S&P 500 ChartStorm.

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

In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,982.75 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,016.25 HVNode and $4,055.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,909.25 MCPOC. Initiative trade beyond the $3,909.25 MCPOC could reach as low as the  $3,889.00 VPOC and $3,821.50 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.

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

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

Definitions

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.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 14, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!

What Happened

Overnight, equity index futures auctioned sideways-to-higher, along with bonds, snapping the pricing in of tighter monetary policies and economic slowing.

Creeping up are expectations regarding the amount of tightening policymakers are to add. Treasury yields had their biggest jump in decades. U.S. 3-year Treasury yields, in particular, were up 25 basis points, to 3.49%, the highest since 2007, per Bloomberg.

Now, traders see nearly 200 basis points of tightening by the Federal Reserve’s (Fed) by September, as well as the possibility of a one-off 75 basis point hike. The overnight rate is expected to peak near 4% by mid-2023.

Accordingly, the U.S. and European real estate values have taken a hit amid rising rates and inflated prices, falling 5-10%. Rental demand has thinned, also. 

In other news, the U.S. sought to boost supplies of Russian fertilizer as “sanctions fears have led to a sharp drop in supplies, fueling spiraling global food costs.”

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: In what seems to be “a coordinated attempt to guide the market through trusted journalists,” recent updates on the path of inflation may push policymakers to surprise markets.

Graphic: Via Tier1Alpha. “A disappointing CPI suggested that calls for inflation peaks were premature and now markets are trying to interpret Powell’s (and Lagarde’s) true intentions.”

Markets reacted, accordingly, pricing in a near-certainty of a 75 basis point hike, later this week.

Graphic: Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. In one session, participants priced in a near-certainty of a 75 basis point hike.

Looking into the future, Fed Funds target rates, based on the Fed Fund futures contract prices, are projected to peak into the mid-next year (Spring/Summer 2023).

Graphic: Via CME Group Inc’s FedWatch Tool

Accordingly, Treasury market turmoil continued with liquidity “worse than it was leading up to Lehman,” says Christian Hoffman, a portfolio manager for Thornburg Investment Management.

“That creates even more risk because if the market doesn’t have liquidity, it can gap down very quickly.”

Graphic: Via Bloomberg. Taken from @DonutShorts. This could “be a sign of another shortage of collateral and that another systemic risk event might come up in the future,” as Fabian Wintersberger well explained in his newsletter.

As talked about in past newsletters, pressures in the financial system, all the while the economy is slowing, are rising. This is amidst a dash for cash as fixed income and equity markets are not perceived to be as safe.

Graphic: Via Bloomberg. “Two-year US Treasury yields surged 29 basis points as bond prices tanked, … the biggest two-day increase since 2008, a sign of just how rapidly traders are adjusting where they think the Federal Reserve will take interest rates.”

“People are trying to process what’s behind these large moves,” Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA (OTC: SCGLY), said. She attributes some of the volatility to poor liquidity, panic selling, and margin calls.

Ultimately, according to Bloomberg’s John Authers, this is a tantrum the Fed is likely to let “rip for a while” before, potentially, suffocating “with more easy money.”

“The relationship between central banks and bond markets is, as I’ve said before, a lot like that between a parent and an angry toddler. Indulging the bond market early last year might prove a critical mistake in losing parental authority for the Fed.”

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. MS’s Mike Wilson says: “From our vantage point, both rates and ERP appeared to be mis-priced [and] we think the S&P 500 is headed toward 3,400 before a more tradable low is in.”

Positioning: Last night, as I wrote a report for SpotGamma’s subscribers, noteworthy is how “subdued” volatility was with, recently, “realized outpacing that which is implied by participants’ options activity.”

That dynamic resolved, Monday, as implied (IVOL) finally retook that which is realized (RVOL).

Read, also, the Daily Brief for Monday, June 13, 2022.

Graphic: Via Robson Chow.

Moreover, for much of the session, the equity markets were range-bound as most of the movement in both equity and volatility markets happened overnight. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for ES (SPX + SPY). Via SpotGamma, “Into weakness, participants mainly sold puts (a bullish trade). Into strength, they bought puts (a bearish trade). Throughout the session, too, there was light call buying (a bullish trade). This helps with understanding why the VIX moved much less during the day session.”

Noteworthy, was the absence of demand for protection that performs non-linearly with respect to changes in direction (delta) and volatility (vega).

“Fixed strike vols actually caught a bid, VIX futures are in backwardation,” The Ambrus Group’s Kris Sidial explains.

“However, that spot-vol relationship in the S&P still underperformed and skew was also lackluster.”

Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), remains depressed, too, in comparison to the VIX, itself.

As said before, it is supply and demand dynamics that played into divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL). Participants are hedged and volatility remains well-supplied.

Was there to be forced selling and demand for protection en masse, we’d likely see that repricing in volatility we have been looking for.

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

Graphic: Via Banco Santander SA (NYSE: SAN) research.

And so, to position for that, (although it is not as opportune as it was a week ago), it continues to make sense to own volatility structures (that, one, either sold very short-dated pre-FOMC and OPEX volatility to fund that which is farther-dated or, two, buy into implied skew convexity, non-linear with respect to delta [gamma] and vega [volga] changes).

Notwithstanding, per SpotGamma, a lower bound in the market is near $3,700.00. It is at this level options flows may shift from “inducing” to “reducing” volatility as, “beneath this level, all else equal, liquidity providers would have less and less pressure to add on further weakness.”

Ultimately, it is at higher levels of volatility that the marginal impact of further volatility compression is likely to do more to bolster equity market upside as liquidity providers buy back their negative delta hedges to positive delta (short put) exposures. 

SpotGamma’s founder, Brent Kochuba, adds: “Ultimately this expiration is clearing out a lot of equity put protection, which clears the way for lower lows in the weeks and months ahead.”

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

In the best case, the S&P 500 trades higher; activity above the $3,768.25 HVNode puts in play the $3,808.50 HVNode. Initiative trade beyond the $3,808.50 HVNode could reach as high as the $3,836.25 LVNode and $3,863.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,768.25 HVnode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as low as the $3,688.75 and $3,664.25 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.

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.

Point Of Control: 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.

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 27, 2022

The Daily Brief will be on pause till June 7, 2022, due to the author’s travel commitments. Apologies for this inconvenience.

What Happened

Overnight, U.S. equity index futures came off of their Thursday peaks before, late in the morning, trading to a new rally high, at which is a confluence of technical nuances.

Thursday’s cash session was characterized by a near-vertical advance into mid-day. Then, trade became two-sided, a feature of short-covering and not new buying. More on this, later.

In the news was Citigroup Inc’s (NYSE: C) downgrading of U.S. stocks on recession risks and the “elements of a deflating bubble,” while leaning optimistic on China assets due to marginal policy support, there. This is on the heels of similar conclusions put forward by BlackRock Inc (NYSE: BLK) and Morgan Stanley (NYSE: MS).

Mortgage rates staged their biggest drop since April of 2020 as “the housing market has clearly slowed, and the deceleration is spreading to other segments of the economy,” the Federal Home Loan Mortgage Corporation’s (OTC: FMCC) Sam Khater explained.

In other news, Secretary of State Antony Blinken took aim at China, commenting on the U.S.’s intention to “shape the strategic environment around Beijing to advance [its] vision for an open, inclusive international system.” This is as the U.S. also plans economic talks with Taiwan.

Pippa Malmgren, who is a former White House adviser and economist we wrote on earlier this week, discussed more of this decoupling and coordination among Eastern and Western powers.

In a two-part series, she explains the challenging of U.S. island bases by China and Russia, as well as their maritime strategies, “island hopping [and] shopping.” Check them out.

Today we received data on PCE inflation, real disposable and personal income, along with consumer spending and trade in goods (8:30 AM ET). University of Michigan Sentiment and five-year inflation expectations come later (10:00 AM ET).

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

What To Expect

Fundamental: At its core, there’s a commitment to cutting liquidity and credit after the spending of COVID-era “benefits and lockdown savings … created a lot of demand,” and inflation.

Graphic: Via the Federal Reserve. Taken from Nasdaq Inc (NASDAQ: NDAQ). “Rates have risen dramatically this year, impacting valuations of stocks and bonds.”

This has consequences on the real economy and asset prices, accordingly, which rose and kept the deflationary pressures of prevailing monetary policies at bay.

Graphic: Taken from Nasdaq Inc. “At a very simple level, rising rates increase interest expenses, reducing profits. But they also cause investors, who can earn more interest on safe cash deposits, to demand stronger returns from all other investments too.”

As unpacked, in detail, on May 18, 2022, there is an argument that stock market drops are both a recession and a reflection of the unwind of carry (or investment in long-duration bets with cheap debt) – a deflationary shock.

Graphic: Via Bloomberg. “Tighter financial conditions themselves are a clear success story for the Fed — it is the only way they can reduce inflationary pressures,” said Seema Shah, chief strategist at Principal Global Investors.

“The Fed has a mandate … to control price stability,” Kai Volatility’s Cem Karsan had explained.

“With supply-side economics, the only way that they can control this ultimately is to pull back. And slow capital markets decrease via the wealth effect. Ultimately, there’s a significant lag, so they are not in a position to ultimately control inflation without bringing down markets.”

Graphic: Via Bloomberg. “Of course, economic growth is a good thing. But too much of that good thing will just continue to stoke inflation. With that perspective in mind, the slowdown in surprises is positive.”

Accordingly, in our May 25, 2022 commentary, in which we discussed what to search for in the minutes of the last Federal Open Market Committee (FOMC) meeting. Knowing that there’s a lag in policy impact, we accurately floated the potential for the Federal Reserve (Fed) to “shift gears” late this summer if further cooling of inflation and “evidence of a growth slowdown.”

Graphic: Via Bloomberg. “After hitting a record above 3% last month, 10-year breakevens are on track for their biggest monthly drop since March 2020. The so-called five-year, five-year forward — the Fed’s favored measure — is set to post its biggest drop in May since August 2019.”

“Policy works with a lag,” as Diane Swonk of Grant Thorton explained. The Fed may pause as it seeks to “catch up but not outrun the market in its effort to tighten credit market conditions.” 

“There is still more progress to be made in bringing inflation expectations down to resonate with the Committee’s target, but current valuations are at least in the realm of acceptable,” Ian Lyngen, who is head of U.S. rates strategy at the Bank of Montreal (NYSE: BMO), said

“The market is showing some faith in Powell’s inflation-fighting creditability.”

Graphic: Taken from Nasdaq Inc. “Although inflation is high right now, it’s because of Covid and the Ukraine war. Both, hopefully, will pass, and 3%-4% inflation a year from now seems possible if the economy slows to a more normal level. In turn, that means the interest rate that keeps the U.S. economy growing slowly is likely much lower than we might currently be thinking. It might, in fact, be right around where bond rates are now.”

Concluding the fundamental section with remarks from a March 2022 Substack newsletter published by Andreas Steno Larsen of the Stenos Signals Substack.

“I simply don’t find >3.5% territory for the Fed Funds feasible as the hiking cycle peaked at 2.25-2.50% in 2018/2019 and fundamentals have worsened since. Debt loads are much higher, demographics have weakened, and the labour force is smaller, which suggests that the neutral rate is lower, not higher, than in 2018/2019.”

Graphic: Via Bloomberg. “​​The swaps market and consensus forecasts to Bloomberg Economics both imply considerably faster rate hikes, while Bloomberg’s own forecast is more hawkish still.”

Positioning: Per Bank of America Corporation (NYSE: BAC) notes, investors poured nearly $20 billion into global stocks (in the week to May 25, 2022).

As I wrote in a SpotGamma note, notable was the reversal in beaten-down areas of the market, as well as the implosion at the front-end of the volatility term structure, affecting protection most sensitive to changes in direction and volatility.

The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX or the volatility of volatility (a naive but useful measure of skew), dropped off markedly, too, in comparison to the VIX, itself.

Graphic: Via Physik Invest. Taken from TradingView. VVIX, top. VIX, bottom.

Further, as stated in SpotGamma’s note, a “falling VVIX (and VIX term structure drop off) may be the product of a collapse in the value of customers’ long put exposures concentrated in very short-dated timeframes (potentially exposures hedging tail risks with respect to the release of FOMC minutes, among other things).”

“It is then as the skew, here, decays, and term structure compresses, that liquidity providers buy back their hedges to the puts they are short (i.e., the vanna dynamic pointed to, earlier).”

This market-generated information helps us give context to this most recent equity market rally that is characterized by a little change in demand for bets on upside further in price and time 

All else equal, this is not a feature of sustainable market rallies.

Why you ask?

Those names that have been most depressed, and are now reversing, were recipients of heavy demand for protection in the months prior.

For this reason – participants being well hedged – selling was orderly, rather than violent as in past episodes of market shock when the reach for protection solicited a cascading reaction that exacerbated underlying price movements due to liquidity providers’ hedging.

Graphic: Via Banco Santander SA (NYSE: SAN) research.

The large drop off in term structure, as well as the VVIX versus the VIX, is affecting protection most sensitive to changes in direction and volatility and the unwind of liquidity providers’ short futures and stock hedges to this protection is, in part, playing into this internally weak rally.

So, what? How do you play this? Good question.

It still may make sense to have exposure to underlying markets, synthetically (i.e., own options), as detailed, well, May 25, 2022. Read that letter for detail on how to think about trade structure.

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

In the best case, the S&P 500 trades higher; activity above the $4,069.25 HVNode puts in play the $4,095.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,119.00 VPOC and $4,148.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,069.25 HVNode puts in play the $3,997.75 RTH High. Initiative trade beyond the RTH High could reach as low as the $3,982.75 LVNode and $3,951.00 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 Highs And Lows (ONH and ONL): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 25, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!

What Happened

Overnight, equity index futures were steady alongside commodities and bonds. This is ahead of the release of minutes from a Federal Reserve (Fed) policy meeting. 

In the news were advertising and social media firms. Snap Inc (NYSE: SNAP) warned of slower growth and deterioration in the macro-environment. Its peers Meta Platforms Inc (NASDAQ: FB), Alphabet Inc (NASDAQ: GOOGL), and Twitter Inc (NYSE: TWTR) also saw weakness.

China’s COVID Zero commitment likely nudges it off a path to achieve economic targets “by a large margin for the first time ever,” as Bloomberg explains

This is as China and Russia have conducted one of their largest joint air drills “to send their own political, economic and military message to the international community,” much of which is at Davos, Switzerland doing thought exercises.

In a recent podcast, Pippa Malmgren, who is a former White House adviser and economist, well said, particularly in reference to some of the tension abroad, that “autocracy is not working well,” and “[y]ou go to war because … you have a domestic objective.”

Thought it was interesting. Give it a listen, here.

And, finally, Michael Burry of the “Big Short” sent a cryptic tweet alluding to what is likely the risk of another financial collapse. 

Moreover, ahead is data on durable goods and core capital equipment orders (8:30 AM ET). Later, the Fed publishes the minutes of its last policy meeting (2:00 PM ET).

Graphic updated 6:10 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 Fed will issue policy meeting minutes that may provide clarity with respect to its intent to hike and reduce the size of its balance sheet.

In focus, per ex-Fed insider Ellen Meade, is “the rate path, the expected economic conditions, and what policymakers want to see from the data before they slow the pace of tightening.”

“The minutes may tell us they see the tightening in conditions this time around as greater than in earlier cycles. If that’s the case, then they may judge that they don’t need to raise the funds rate by as much this time around.”

Graphic: Via Morgan Stanley (NYSE: MS) research.

John Authers notes, however, that “inflation tends to move in waves” and it doesn’t, usually, “plateau and stay there.”

Graphic: Via Bloomberg.

“That suggests that even though the focus is already shifting to whether there is evidence of a growth slowdown,” he added, in a statement echoed by Meade who is betting on slower “GDP growth, below its longer-run rate, and a rise in the unemployment rate, perhaps to its longer-run median rate or slightly above.”

Graphic: Via Bloomberg.

Pursuant to those last remarks, the Fed’s Raphael Bostic is already floating a pause to rate hikes near September if inflation falls more than expected over the summer.

As Diane Swonk of Grant Thorton explains, “Policy works with a lag. The Fed wants to catch up but not outrun the market in its effort to tighten credit market conditions.”

Graphic: Via Bloomberg.

Futures First analyst Rishi Mishra, who is also the author of the “On Another Note” newsletter, suggests the Federal Open Market Committee may, rather, hone in on monthly changes with annual inflation still elevated.

“This brings down inflation expectations into a range where the Fed feels comfortable about de-anchoring risks,” Mishra said.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from Bloomberg. Though, potentially, “premature,” JPM’s model tracking the S&P 500, credit spreads and yield curve implies a 40% chance of a recession.

JPM’s Marko Kolanovic adds: “We have gone from a situation where both stocks and bonds were sold on the back of de-leveraging, to a situation where bonds rallied as stocks fell, nudging stock/bond correlations toward a more normal (negative) level.”

“We do indeed think this is where things could be gradually heading, but we acknowledge this is not likely to play out in a linear way.”

Graphic: Via @MrBlonde_macro. “Stock/bond correlation negative over the last 10 days. Some ‘normalization’ in cross-market relationships can be a source of relief.” The flip happened with 10-year yields at or above 3%.

Positioning: In yesterday’s in-depth write-up, we talked about the underperformance of implied volatility (IVOL), relative to that which is realized (RVOL).

Dennis Davitt of Millbank Dartmoor Portsmouth had explained that the “RVOL of the underlying S&P 500 is above 27% … with IVOL of options trading between 24%-27%,” which translates to a VIX at 30%.

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

So, essentially, it makes more sense to have exposure to underlying markets, synthetically (i.e., own options). 

This, though, merits a bit more clarification (as I do not want it to be construed as if I was buying, systemically, bets on the downside). The opposite, actually.

Moreover, this was stated in the context of a market that is “(1) stretched and (2) near a critical inflection which we see at $3,700.00 SPX,” per SpotGamma. Separately, investors are bidding “skew on the call side” amid their “fear of missing on the upside.”

That’s when it makes sense to buy closer to at-the-money (ATM) and sell farther from ATM, or out-of-the-money (OTM). For instance, a margin intensive but low cost call +1 [ATM] x -2 [OTM] ratio spread

Note, however, that width and timing are everything. Too much time or too narrow may result in asymmetric losses when the demand for upside bets further out in price and time bids the skew that you’re short, relative to the at-the-money volatility you own. 

I’m willing to talk through this via email, if interested. Ping me at renato@physikinvest.com. I’m mindful that if I do post actual trade ideas, people may take them without knowing how to size and manage them, accordingly. Big yikes!

Goldman validates this thesis: “Even though the VIX’s reaction to recent spot downside has been mild, its high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

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

Further, though SpotGamma assigns an edge to lower prices until the June FOMC and OPEX, “markets (which are already ‘fully loaded’ with puts) [are likely] pressured by liquidity providers’ hedging [at most] down to $3,700.00,” the area where that added pressure from hedging cools.

Graphic: Via SpotGamma.

Technical: As of 6:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a balanced overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,969.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,917.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,863.25 LVNode and $3,831.00 VPOC, or lower.

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

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

Such traders often lack the wherewithal to defend retests.

Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.

Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.

Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.

Definitions

Overnight Highs And Lows (ONH and ONL): 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 value tests as they offer favorable entry and exit.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 4, 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 were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

A check on some naive measures suggests we’re in for an expansion of range (i.e., heightened realized volatility) in the coming session(s). Key, today, are Federal Open Market Committee (FOMC) updates (2:00 PM ET) and a news conference (2:30 PM ET). 

The expectation is a 50 basis point hike and balance sheet contraction with run-off caps of $95 billion. If the action is in line with expectations (priced in), the reaction is likely to be positive.

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (10:00 AM ET). 

Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: Expected is front-loaded tightening, by the Federal Reserve (Fed), today.

The consensus is anchored around a 50 basis-point hike in May and no adjustments to the Reverse Repo Rate (RRP) or Interest on Reserve Balances (IORB), says Nordea Bank (OTC: NRDBY) research. The Fed may opt, also, to initiate a 75 basis-point hike in June.

“We believe that after the FOMC hikes by a half-point in May and presents a detailed plan to reduce the Fed balance sheet,” imminently, says Anna Wong, Yelena Shulyatyeva, Andrew Husby, and Eliza Winger of Bloomberg. 

“Powell will avoid definitive guidance about the size of future hikes, as policymakers assess how the runoff is affecting the economy in coming months.”

Graphic: Via Nordea research. Heightened inflation, exacerbated by sticky supply pressures and the conflict in Ukraine, and trends in demand have played into a tough talk on monetary policies.

As noted before, the key (risk) is the statements on the Fed’s balance sheet and the (imminent) process to shrink it through quantitative tightening (QT).

Graphic: Via Mish Talk. “The Fed expanded QE aggressively for years. But nearly all of that expansion was longer-dated securities as the [] chart shows. If the Fed had short-term securities it could reduce its balance sheet simply by runoff. Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

Per Nordea, QT is likely to consist of a 3-month phase-in period and run-off caps of $95 billion (i.e., $60 billion on U.S. Treasuries [USTs] and $35 billion in mortgage-backed securities [MBSs]), effectively lowering the Fed’s balance sheet by $670 billion by year-end.

Graphic: Via Bloomberg and Mitsubishi UFJ Financial Group Inc (NYSE: MUFG) U.S. Macro Strategy.

This is alongside the realization that “1Q may be the last good quarter of earnings as higher costs and increased recession risks weigh on future growth,” Morgan Stanley’s (NYSE: MS) Mike Wilson explains.

Graphic: Via Royal Bank of Canada (NYSE: RY) U.S. Equity Strategy and Bloomberg.

Market weakness in the past weeks was the result of “growing evidence that growth is slowing faster than most investors believe,” Wilson adds, and “the market is currently so oversold, any good news [such as Fed action being as expected] could lead to a vicious bear market rally.”

“We can’t rule anything out in the short term but we want to make it clear this bear market is far from complete.”

Positioning: Borrowing from yesterday’s letter, as little has changed, bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and highly sensitive to changes in implied volatility and direction.

Graphic: SqueezeMetrics on “how IV, direction, and moneyness cause option dealers to buy or sell the underlying.”

This exposure’s roll-off and compression in volatility ought to coincide with liquidity provider support to markets (i.e., relief of pressure from hedges to concentrated options positioning).

Per Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Validation of the latter (move) ought to be confirmed by participants’ new concentration of bets. In other words, if participants start to concentrate their bets at higher prices, further out in time, that confirms (changing sentiment) and (improves) the odds of sustained follow-through.

If not, it’s likely that prices, after a short-term relief, will succumb to fundamental weaknesses.

Technical: As of 7:00 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced overnight inventory, just 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 $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,157.00 VPOC puts in play the $4,123.00 VPOC. Initiative trade beyond the $4,123.00 VPOC could reach as low as the $4,055.75 and $3,978.50 low volume areas (LVNodes), or lower.

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

What People Are Saying

Definitions

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.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 26, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-lower ahead of an earnings season that’s set to accelerate.

Concerns that remain include the implications of China’s response to COVID-19, the resolution of the tension between Russia and Ukraine (and the rest of the world for that matter), as well as the intent, by policymakers, to accelerate a pivot to normalization (i.e., rate hikes and beyond).

Graphic: Via Sanford Bernstein. Taken from The Market Ear.

With a larger part of the market moving in sync (as talked about more in the “Technical” section), many strategists suggest the outlook for equities is continuing to worsen and positioning is likely to compound further volatility.

Ahead is data on durable goods and core capital equipment orders (8:30 AM ET), the S&P Case-Shiller U.S. home price index and FHFA U.S. home price index (9:00 AM ET), as well as consumer confidence index and new home sales (10:00 AM ET).

Graphic updated 7:00 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: “With defensive stocks now expensive and offering little absolute upside, the S&P 500 appears ready to join the ongoing bear market,” Morgan Stanley (NYSE: MS) says.

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. “[T]he accelerative price action on Thursday and Friday may also support the view we are now moving to this much broader sell-off phase.”

“The market has been so picked over at this point, it’s not clear where the next rotation lies. In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison.”

Graphic: Via Bloomberg. “Everyone bearish, but redemptions just starting,” explain Bank of America Corporation (NYSE: BAC) strategists led by Michael Hartnett, adding that the environment of “extreme inflation” and rates shock is just setting in, as the Federal Reserve tightens monetary policy. “75 basis points is the new 25 basis points,” Hartnett said, referring to the scope of future interest-rate hikes.

Adding, Bank of America’s global EPS model predicts negative growth by year-end.

Graphic: Via Bank of America Corporation. Taken from The Market Ear.

Positioning: Monday’s bottoming at $4,200.00, near intraday lows, came as participants sold puts, and the hedging of the consequent volatility compression, thereafter, bolstered a price rise.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options Indicator.

At this juncture, though positioning appears (a tad) stretched and prices are nearing a lower bound, there may be room for volatility to expand, further.

Per SpotGamma’s Delta Tilt indicator, which “reflects the market approaching a maximum put threshold, [there’s] potential for further hedging that may result in sharp rallies and declines with volatility climaxing around early May (FOMC and potential for Russian Default).”

Graphic: SpotGamma’s Delta Tilt.

This is as options counterparts themselves have hedges (i.e., protective puts) that reduce hedging requirements, so to speak, when underlyings trade down to certain levels. 

SpotGamma explains

“Using this logic, when the downside puts gain value, they may reduce the need to delta hedge. In turn, dealers may be able to advantageously reduce delta hedging (sell less), and supply markets with more liquidity (buy more stock). This could serve to reduce volatility.”

So, in summary, participants are pretty well-hedged. Should they begin to monetize protection, that may lower counterparty exposure to positive delta, thus fueling a price rise.

Whether that price has legs is dependent on improvement in the fundamental situation.

Graphic: Via Bloomberg.

Technical: As of 7:00 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, 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 $4,272.00 high volume area (HVNode) puts in play the $4,303.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,272.00 HVNode puts in play the $4,233.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,195.25 regular trade low (RTH Low) and $4,129.50 overnight low (ONL), or lower.

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

Considerations: The market is weak and all major indexes covered by this newsletter are trading below their 20-, 50-, and 200-day simple moving averages.

Additionally, all indexes are below their volume-weighted average prices anchored from the start of this year (or their respective peaks). Further, AVWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

Graphic: Invesco QQQ Trust Series 1 (NASDAQ: QQQ) with anchored VWAPs.

The modus operandi is to sell into a flat-to-declining AVWAP. So long as prices are below the below AVWAPs, sellers remain in control and rally attempts are to likely fail, all else equal.

Another important note to make is the market’s poor breadth (via VOLD and ADD). Previously, there were divergences; rate-sensitive areas of the market were sold while more value was bid. Last week, there was a change in tone. All areas of the market were sold, heavily. 

This suggests the potential for a broader sell-off (and this is supported by the U.S. Equity ETF flows graphic included, above).

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).

What People Are Saying

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.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 1, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to higher after their late-day liquidation and break from a multi-day consolidation area on technical factors (e.g., options expirations) among other things, potentially, like the increase in personal consumption expenditures.

Broadly speaking, the narrative that investors are showing some concern over the economic outlook, with respect to geopolitical tension and monetary policy, continues to emanate. 

U.S. high-grade bonds shed over 5%, booking the worst quarterly performance since the ‘80s. This is as recession risks have risen more than two-fold. 

Notwithstanding, the Federal Reserve’s (Fed) favorite yield curve metric remains steep; per a Bloomberg commentary, “the gap between the three-month bill rates and 10-year yields is the ‘most useful term spread for forecasting recessions,’ … [and] it currently stands at 186 basis points, versus negative 2 basis points on 2s10s.”

In terms of news, the U.K. will join the U.S. in releasing oil from its reserves to lower prices and reduce its reliance on external partners. This helped ease futures calendar spreads on oil, Reuters’ John Kemp said in a newsletter to followers; the “six-month spread [narrowing] to a backwardation of $9 per barrel, the lowest since before Russia’s invasion of Ukraine.”

Ahead is data on nonfarm payrolls, the unemployment rate and average hourly earnings, as well as labor-force participation (8:30 AM ET). Thereafter, the Chicago Fed’s Charles Evans is scheduled to speak (9:05 AM ET). 

Later is Markit manufacturing PMI (9:45 AM ET), as well as ISM manufacturing index and consumer spending data (10:00 AM ET).

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

What To Expect

Fundamental: The S&P 500 bagged its first quarterly loss in two years as recession probabilities, implied by some yield curves, have risen.

Graphic: Via Barclays. Taken from The Market Ear. “[T]he 1y ahead recession probability implied by the 3m10y curve rises to about 40% a year from now (so for an early 2024 recession), slightly higher than implied by other curves.”

This is as the stock performance, relative to bonds against the lagged spread of 10- and 2-year bond yields, is expected to be weak, according to insights by Pictet Asset Management.

Graphic; Via Pictet Asset Management Ltd. Taken from Bloomberg. “On this basis, stocks’ great outperformance this quarter may end up looking like a head-fake.”

Pictet’s narrative further validates some of the theses shared by institutions like Brevan Howard Asset Management, which is having one of its best years, Morgan Stanley (NYSE: MS), Goldman Sachs Group Inc (NYSE: GS), and Bank of America Corporation (NYSE: BAC).

Adding to the prospects for weaker earnings amid higher costs, among other things, some of these institutions see the potential for the Fed’s terminal rate to reach between 3% and 3.25%.

Graphic: Via Andreas Steno Larsen. “The Fed is now priced to hike to levels above 3% by Dec-2023, … which is the main reason why we have seen a sell-off in all assets with an intensive duration profile over the past 12-15 months … [and has] duration intensive assets … starting to look attractive again from a risk/reward perspective.”

This would hit valuations as higher yields both reduce the present value of future earnings and “hurt those carrying the highest leverage,” potentially playing into a slowdown or recession. 

Graphic: Via S&P Global Inc (NYSE: SPGI) “expects the economic damage [of geopolitics and pricing pressures] to lower U.S. GDP growth to 3.2% this year, matching its preliminary forecast in early March but a full 70 bps lower than its November forecast of 3.9%.”

“Now rates volatility can drive growth volatility and that actually becomes a vicious cycle between the two,” said Christian Mueller-Glissmann of Goldman Sachs. 

“That’s a big difference to the last cycle where growth volatility drove rates volatility.”

Graphic: Via Vanda. Taken from The Market Ear. “The bond market is pricing the 2022 cycle to be remarkably fast. Macro Alf: ‘Remember: sharp changes in borrowing conditions often cause non-linear reactions in a highly leveraged system.’”

However, this is as the dominance of rate-sensitive tech stocks is set to shrink next year amid sector reclassifications, as well as still-stimulative policy and beats of economic expectations that may feed into earnings surprises, later.

JPMorgan’s Marko Kolanoivc explains that (1) “both equity and credit markets have historically fared well at the start of monetary tightening cycles,” (2) “the real policy rate is extremely negative and thus stimulative,” and (3) “not all central banks are tightening.”

Morgan Stanley’s Michael Wilson vehemently disagrees suggesting the recent equity market turnaround “was nothing more than a vicious bear market rally,” and offers participants a clear opportunity to sell at better prices.

Taking all of the above comments and perspectives together, one thing is for certain: this period in history is like no other. It makes sense to pick a timeframe and stick with it. 

Positioning: In the past weeks, according to JPMorgan Chase & Co’s Nikolaos Panigirtzoglou, the supportive “rebalancing flows away from bonds into equities” are no more and, therefore, equities are subject to increased vulnerabilities “if bond yields continue to rise.”

This is after measures of equity implied volatility were crushed heading through the mid-March FOMC and monthly options expiry (OPEX) events, and the options hedging impact of this, at least, was very supportive, as we’ve talked about many times in this newsletter.

Graphic: Via Bloomberg. “The CBOE-VIX index, measuring stock volatility from the options market, unsurprisingly spiked immediately after Russia’s attack. It reached another high three weeks ago. Then the VIX started to fall, and in the two weeks since the Fed unveiled its first rate hike in years, the decline has been almost linear. The ‘fear gauge,’ as it is often known, is now significantly lower than it was a week before the invasion, when markets were priced on the assumption that there would be no war.”

On the contrary, measures of volatility for other assets, like the Merrill Lynch Options Volatility Estimate (INDEX: MOVE), a useful measure of bond market sentiment, are doing the opposite. 

We discussed early last month, what we saw was an increased supply of equity market volatility, as a potential reason for some of these divergences. 

As Bloomberg’s John Authers explained well, it, too, could have been “an aggressive central bank” that prompted a move out of bonds and into equities, and subdued target-date fund rebalancing flows which usually sell stocks and buy bonds.

Graphic: Via Bloomberg.

“[I]t looks as though the contradictions that had built up in the market over the last two years, and in the decade before that, are being put under extreme stress by the double whammy of a newly aggressive Federal Reserve, and the worst geopolitical shock in decades,” Authers adds.

Still, realized volatility continues to trend down which ought to force those (e.g., computer-driven traders) who position (and size equity exposure) based on underlying volatility to load up, again.

Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott explains that “volatility-targeting funds and trend-following commodity trading advisers, purchased” billions of equity futures which bolstered the price rise of the last weeks.

From a positioning versus buying support perspective, the forward returns distribution is skewed positive but not by a lot; a lot of the supportive options exposure is rolling-off and this could free up (i.e., unpin) indexes for the next leg up or down.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options Indicator shows negative delta trade in the S&P 500 SPY ETF, and this pressured the underlying index.

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

In the best case, the S&P 500 trades higher; activity above the $4,546.00 spike base puts in play the $4,573.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,583.00 untested point of control (VPOC) and $4,611.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,546.00 spike base puts in play the $4,526.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,515.25 and $4,489.75 LVNodes, or lower.

Considerations: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) occurred.

Continue to monitor for acceptance outside of the balance area. Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance. See the below graphic for more.

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.

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): Marks change in dealer gamma exposure. 

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 31, 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

A mixed bag, overnight, with U.S. equity indexes pinned at their most recent swing highs ahead of large options expirations (OPEX). 

News, too, was mixed. Notable was the United States’ potential release of oil reserves amounting to nearly a million extra barrels of oil a day. Oil sold alongside this update. 

Geopolitical tensions remain. Mainly, Russia and Ukraine tensions are ongoing and there’s a lack of clarity on what’s going on with the negotiations between the two parties.

Additionally, China is weighing the raise of billions to stabilize its economy and cut off the spread of the crisis. The money would stem risks from small, weakened banks and developers.

Ahead is data on jobless claims, personal income and consumer spending, PCE price index, as well as real disposable income and consumer spending (8:30 AM ET). Later, Chicago PMI is posted (9:45 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: Carry trades (i.e., the act of borrowing at low rates and investing where there are higher rates to make money so long as nothing [bad] happens) are receiving attention, again.

In recent days, it’s been the sale of the Japanese yen and the purchase of the Aussie dollar.

Example: Via Bloomberg.

Prior to 2008, this carry trade, according to a commentary by Bloomberg’s John Authers, which “became very correlated with speculative equity investing, … suffered an almighty crash as the yen appreciated dramatically against the Aussie dollar in 2008.”

Basically, Bank of Japan (BoJ) interventions are dovish and consistent, as Authers explains, buying bonds at a massive scale and “making the country an irresistible source of [cheap] funds.”

The risk of the trade is that the yen appreciates. In such a case, the opposite of what is going on now (similar to what happened during the Global Financial Crisis or GFC) occurs.

A great book on this – “The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decay Growth and Recurring Crisis – discusses many of the different forms of carry, their attractiveness, and the implications of their failure.

Mainly, such strategies are characterized by a sawtooth wave returns pattern (i.e., steady positive returns followed by sharp drops).

Graphic: Via Risky Finance. “Cumulative log returns from shorting the VIX future, a common carry strategy. Notice the poor returns in 2008 and other market crises.”

One such trade is that which captures the VIX futures curve roll yield.

Basically, the VIX futures curve is (usually) in contango (i.e., sloping upward) as farther-dated contracts are priced up (since portfolio insurance [should] cost more over longer periods). 

As those contracts near expiration, they converge with spot.

If volatility is flat (all else equal), the sale of farter-dated contracts allows you to capture the difference between the future and spot (or shorter-dated contracts). 

It’s a bit more complex, but that’s a general idea. Such trades attract lots of capital (and leverage) as they work (most of the time); positioning turns one-sided and complacency builds.

Eventually, markets move and this hurts those with not much wherewithal such as during 2020 when yield-seeking participants (who were forced out the risk curve given the reduction in rates and market stabilization programs) deleveraged en masse.

Since 2020, hardcore volatility selling (especially that which is short-dated), if you will, hasn’t returned and, as stated in yesterday’s commentary, this “has us a little less concerned (about some sort of armageddon situation).”

According to Banco Santander SA’s (NYSE: SAN) cross-asset research, “[t]he supply of volatility remains very subdued in a trend that has continued since the pandemic. For example, there are still virtually zero sales in short-term index variance swaps.”

“We did observe some activity in 4Q21 and 1Q this year, but almost all of that was unwinding of existing positions from earlier, and these were not new trades.”

Graphic: Via SG Cross Asset Research. Taken from Corey Hoffstein.

Notwithstanding, Santander’s research says that the demand for volatility (to hedge) remains strong “amidst the elevated uncertainty from geopolitics and central banks.”

With there being less of a supply of something, demand is not as easily absorbed and may have greater implications for the pricing of that something (such as the volatility of volatility itself).

Graphic: Cboe VIX Volatility Index (INDEX: VVIX). Per the Milken Institute, “The VIX is a measure of the expected volatility in S&P 500 index options. It trades as a futures contract, and there are also options traded on this futures contract,” and the VVIX, which is the “expected volatility of the VIX futures contract,” is referred to as “the VIX of the VIX.”

Hence, we see sharper moves in measures of volatility itself as the counterparts to this demand seek to absorb and hedge their risks (in the underlying), in accordance with prevailing regulatory frameworks, among other things.

Though we’ll, once again, explore this phenomenon in later commentaries, as well as the potential implications of its return in size, below is an interesting conversation featuring Kevin Coldiron, co-author of the “Rise of Carry” book pointed to earlier. Check it out!

Positioning: Yesterday’s commentary explained well the implications of recent positioning. If you haven’t checked it out, click here.

Conditions, today, are similar. OPEX’s clearing of existing options exposure, in the coming days, likely opens the door to underlying breadth which has improved markedly since early March. 

Though today’s market is unprecedented, so to speak, improvements in breadth support a historical case for sideways-to-higher through tightening cycles.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM).

Should there be some exogenous event or weakness on fundamentals, any new demand for protection (in size) likely adds velocity to a leg lower. Caution new buyers.

Graphic: Via Morgan Stanley (NYSE: MS).

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 balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,611.75 low volume area (LVNode) puts in play the $4,618.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,631.00 regular trade high and $4,641.75 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,611.75 LVNode puts in play the $4,573.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 spike base and $4,533.00 untested point of control (VPOC), or lower.

Considerations: The market is in balance. This is 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).

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

Spikes: Spikes 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).

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.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 23, 2022

Editor’s Note: Hey team! Thanks for all the support. I enjoy putting together these notes as it helps keep me aware of narratives that may impact my own trades.

I’ll be taking the rest of the week off (i.e., no notes till Monday most likely), focusing on other areas of the business like prep for the weeks and months to come.

Take care and trade safe,

Renato

What Happened

Overnight, equity index futures auctioned sideways to lower while commodities, bonds, and implied volatility metrics were bid.

This is in the context of a global bond market rout. Central banks intend to tighten policy in light of surging inflation; investors are selling bonds and rotating into areas that have “better upside.”

Ahead is data on new home sales (10:00 AM ET). The Federal Reserve’s (Fed) Loretta Mester speaks at 10:00 AM ET. Mary Daly follows at 11:45 AM ET.

Moreover, yesterday’s commentary carried a pessimistic tone. In hindsight, too pessimistic. The reality is that this is a market environment like no other. Certain metrics that were very reliable carry little-to-no value (predictive ability) right now. This is true for those who base much of their decision-making on “fundamental” and “technical” analyses, too.

To combat this, we zoom out and look for trades that offer asymmetric payouts. We’re careful to provide liquidity when others demand it en masse. Similarly, we are to give ourselves room for error; stops are widened and lot sizes are smaller.

Read on for today’s lighter-hearted take on what’s happening and frameworks to trade on.

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: Bloomberg’s John Authers published a discussion on the performance of stocks, relative to bonds. Essentially, there have only been four previous two-week periods when stocks beat bonds by this much.

Graphic: Via Bloomberg. The 10-trading-day return of the SPDR S&P 500 ETF (NYSE: SPY) relative to the iShares 20 Plus Year Treasury Bond ETF (NASDAQ: TLT).

“All of the big positive moves were driven by classic stock market rebounds that proved to be durable. There was no particular move in bond yields. This is the first time a turn this dramatic has been pushed almost as much by falling bond prices as by rising stock prices.”

Graphic: Via Bloomberg. “The upper bound of the fed funds rate is still only 0.5%, but the two-year bond yield implies confidence that there are seven more hikes to come in that time.”

Authers explains that “equities are enjoying a false dawn as they’re recipients of the money coming out of bonds, and that we are about to be reacquainted with the bear markets in both bonds and stocks which come when rates [i.e., cost of money] have to rise to control inflation,” which impacts longer duration stocks (i.e., a stock whose value lies further in the future) most.

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear

Adding, the impact of rising Treasury rates is magnified further when credit spreads (i.e., the difference in yield between bonds of similar maturities but different credit quality) also rise.

Graphic: Via Bloomberg. “But the speed with which corporate yields are rising again gives the impression of a market process that is coming around from an anaesthetic injected to help it survive the trauma of the credit crisis back in 2008.”

“The performance of stocks relative to bonds suggests we’re at the beginning of a big upswing; the absolute performance of bond yields in their own right suggests we need to bail out now before another crisis engulfs us,” Authers says.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “GS has lowered GDP a number of times over the past few weeks. Remember that during the fantastic bull from Q220 and 1 year onwards it was the flipside with GS way above consensus…”

Positioning: Dip buying serves investors well.

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. “Buy the dip has worked well during periods of QE but has not historically worked during QT. Better to ‘buy the rally’ during QT (2018-2019), which was also the case during the 80s/90s.”

The near-vertical price rise in markets, over the last week, comes after a long period of weakness during which participants concentrated their activity in negative delta trades (which make money when markets trade lower, all else equal).

From a static delta perspective, now, there is both the covering of shorts and so-called macro buying (pointed to in the above section). 

From a dynamic delta perspective, there are the implications of volatility compression (e.g., Cboe Volatility Index [INDEX: VIX] and term structure dropping), the removal of put-heavy exposures via last week’s options expiration (OPEX), and the market’s trade higher.

Graphic: Via Deutsche Bank AG (NYSE: DB). Taken from The Market Ear. Volatility control is the concept of managing assets “through continual rebalancing between a risky asset holding – often, but not always, equity – and cash holdings,” via The Actuary.

Taken together (short covering, macro buying, volatility compression, OPEX, and so on), the aforementioned dynamics bolster markets. It is the dynamics of positioning (demand or supply of liquidity) that magnify (add to) the velocity of moves up (or down).

Graphic: Via Refinitiv. Taken from The Market Ear. “Poor liquidity (and short gamma) magnified moves on the way down. It seems poor liquidity works both ways seeing px action during the latest squeeze.”

Earlier this week, this newsletter pointed to the potential non-sustainability of the market’s rise. This was based on metrics that have provided tremendous predictive power, in the past. 

Participants’ commitment to positive delta exposure (i.e., buying calls and selling puts), is a feature of sustained reversals. Data through Tuesday did not show this at the index level. 

As discussed by SpotGamma, yesterday, in the S&P, participants bought puts and sold calls (i.e., a negative delta trade).

This was in the context of aggressive call buying and put selling in heavily weighted index constituents like Tesla Inc (NASDAQ: TSLA).

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

As stated in yesterday’s commentary, markets remain vulnerable to sharp drops. In the case of further volatility suppression (e.g., customer call and put selling), counterparties will tend toward supporting markets and laying the foundation for later-dated rallies.

However, if markets trade down and volatility rises, accordingly, as participants seek protection, the potential exists for magnified moves on the way down.

Straight up could well precede straight down. A bottom (as some strategists are calling for) may take time to hammer out.

Graphic: Via Vix Central.

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 lower part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,489.75 low volume area (LVNode) puts in play the $4,515.25 LVNode. Initiative trade beyond the $4,515.25 LVNode could reach as high as the $4,548.75 LVNode and $4,565.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,489.75 LVNode puts in play the $4,464.75 LVNode. Initiative trade beyond the $4,464.75 LVNode could reach as low as the $4,438.25 high volume area (HVNode) and $4,409.00 VPOC, or lower.

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

Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.

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.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 22, 2022

Editor’s Note: 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 were sideways to higher, and this validates higher prices, more. 

This is as implied volatility metrics – such as the Cboe Volatility Index (INDEX: VIX) – continue to suggest less demand for protection and a potential easing of concern.

As discussed in detail, yesterday, participants are not committing themselves to increased call option (i.e., insurance for shorts or bets on the upside) exposures, a dynamic usually seen at the start of sustained reversals. 

Given this, as well as institutional selling in spite of underinvestment (watch a chat), and the Federal Reserve’s (Fed) commitment to reining in inflation via “aggressive” monetary policy (i.e., hike and taper asset purchases) action, there is concern over the sustainability of this rally.

Ahead is Fed-speak. The New York Fed’s John Williams speaks at 10:35 AM ET. San Francisco Fed’s Mary Daly talks at 2:00 PM ET. The Cleveland Fed’s Loretta Mester talks at 5:00 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: Based on remarks by the Fed’s Jerome Powell, quantitative tightening (QT) will move at a pace of $1 trillion a year. This is a faster pace than that of the prior QT.

Read yesterday’s commentary for more on QE and QT.

According to Joseph Wang’s detailed discussion on the implications of QT, the “[a]nticipation of QT is already widening the spread between Agency MBS and Treasuries but does not yet appear to affect Treasury prices.”

“The supply and demand dynamics suggest that the market may simply be slow to react. In that case, Treasury prices will also have to adjust downward, maybe by a lot.”

Pursuant to that remark, Damped Spring’s Andy Constan explains that quantitative easing (QE), “which decreased risk premiums and increased wealth was inflationary to assets but ineffective in generating inflation of goods and services.”

Essentially, QT is not a good tool to fight inflation.

“Raising rates is the strong tool to fight inflation for the Fed and decreasing the budget deficit growth is the tool for Fiscal policymakers; … the [Fed] will do both QT to reduce the balance sheet and hike rates to fight inflation.”

Moreover, higher bond yields (lower bond prices) are usually not good for stocks. The question is whether participants want to take on the added risk of investing at high valuations?

Graphic: Via S&P Global Inc (NYSE: SPGI). Markets tend not, necessarily, to perform poorly during rising interest rate environments. 

The QT narrative amplifies the impact of rate hikes

Lisa Shalett, CIO at Morgan Stanley (NYSE: MS) Wealth Management, discussed recently QT at $80 billion per month (and $500 billion in balance sheet reduction through year-end), as well as how the added risks are to be compensated through lower price-to-earnings multiples in the stock market.

“In tightening terms, that’s the equivalent of another 25-basis-point hike,” Shalett explained. “In contrast, balance sheet run-off totaled $700 billion from 2017 through 2019 before the Fed stopped because markets seized and stocks sold off.”

Graphic: Via Index Indicators. Breadth, here, is measured by the % of SPX stocks above the 50-day average.

Positioning: As discussed before, a feature of falling markets is the demand for protection. 

When this protection is monetized (or decay ensues), options counterparties add to the market liquidity (i.e., buying back short futures hedges).

Graphic: Via CME Group Inc (NYSE: CME). Book depth thickens since early March swing low.

A feature of markets entering a sustainable recovery is the demand for call options.

Based on metrics published by SpotGamma, call-buying was near its lows.

Graphic: Via SpotGamma. “Plots show the premium per trade aggregated each week, with calls in blue and puts in orange. This is only customer flow (i.e. retail, hedge funds). Starting with equities, call buying this past week was at LOWS going back to 2020 (top right).”

Looking at intraday measures, yesterday, we see that participants’ commitment to a change in direction remains low, still.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options trade. The rising blue line denotes put selling (a positive delta impact). The falling orange line denotes call selling (a negative delta impact).

It’s possible that the bottoming process has yet to conclude. Instead, a build of positive options gamma (via the supply of protection – call selling – and more active hedging of call options near the money) may give the market some support.

To explain, in accordance with the HIRO graphic above, we surmise counterparties are long calls and therefore tend toward selling into strength (buying into weakness) amid increasing (decreasing) positive delta exposure.

As short-dated activity clusters in the area just north of the most recent price rise, and this protection decays, dealer exposure to positive delta (gamma) falls (rises).”

“Taken together, dealers add to the market liquidity. When there is rising liquidity, volatility (a measure of how ample liquidity is) falls,” SpotGamma adds. 

“Was the SPX to liquidate, again, demand for protection and increases in volatility likely have us targeting options-based support.”

Graphic: Via SpotGamma. Key levels of interest.

In other words, based on the information we have at the moment, the market is prone to sharp drops lower, and the rally is questionable. Caution.

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

In the best case, the S&P 500 trades higher; activity above the $4,464.75 low volume area (LVNode) puts in play the $4,499.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,526.25 high volume area (HVNode) and $4,565.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,464.75 LVNode puts in play the $4,438.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,409.00 and $4,355.00 VPOC, or lower.

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

Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.

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

Definitions

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

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

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

Liquidation Breaks: The profile shape suggests participants were “too” long and had poor location.

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.

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

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

Disclaimer

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