Bloomberg reports that if the US defaults on its debt, which could happen as soon as June 1 if President Biden and House Speaker McCarthy fail to reach a deal on raising the ceiling, homebuyer borrowing costs may surge to 8.40%. As a consequence, the typical home’s monthly payment would increase by 22.00% and cool property sales; the monthly payment on a $500,000.00 mortgage may rise to $3,800.00, compared to about $3,095.00 at the current rate of 6.30%.
In prior letters, we concluded that past monetary action made stocks less sensitive to interest rates, quoting JPMorgan Chase & Co (NYSE: JPM) strategists that the market would likely continue to “artificially suppress perceptions of fundamental macro risks,” barring surprises like a debt limit breach.
With a debt limit breach a potential reality, Moody’s Corporation (NYSE: MCO) says a breach may compound recessionary pressures; expect a drop in equities, a volatility spike, and a disruption of funding markets.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ).
“Data show that short-term bonds have the most predictable reaction – with interest rates and default insurance costs rising significantly – before quickly returning to normal after the uncertainty has passed,” Nasdaq’s Phil Mackintosh writes. “In reality, a crisis was averted in all [prior] cases, with the government able to increase or suspend the debt limit before the X Date.”
Notwithstanding the short-term uncertainty regarding the debt limit, Bank of America Corporation (NYSE: BAC) is adamant there will be a recession that manifests cracks in “credit and tech,” similar to the situation in 2008. BAC sees the bubble in technology, media, and telecommunication stocks soon deflating as they face higher-for-longer interest rates and a tempered earnings outlook.
Graphic: Retrieved from Societe Generale SA (OTC: SCGLY) via The Market Ear.While investors poured $3.8 billion into technology stocks in the week through May 10, $2.1 billion was pulled from financial equities, the most significant redemption since May 2022.
Compounding the recessionary pressures BAC sees, EPB Research adds, are banks’ funding costs, which have increased too much relative to prevailing asset yields. If the spread drops too low, bank lending tightens, and a recession occurs. Also, other data suggests tightening is finally starting to have an impact. Bloomberg reports that initial claims for unemployment insurance are on the rise. There has been a drop in overall wage growth to 5.1% last month, too, the biggest fall in the rate of increase since the series began.
Separately, breadth divergences are becoming more frequent, with the Daily Advance-Decline (A-D) Line for the NYSE showing lower highs while DJIA and S&P 500 show slightly higher highs, McClellan Financial Publications writes. The bond CEF A-D Line is also showing a bearish divergence, indicating a shift in liquidity that could weigh on other stocks, including the big-cap stocks holding up the SP500 and the Nasdaq 100.
Graphic: Retrieved from McClellan Financial Publications.
McClellan adds that the A-D Line originated from data collected by Leonard Ayres and James Hughes in the 1920s. It was made famous in 1962.
Graphic: Retrieved from McClellan Financial Publications.
That’s when Joe Granville and Richard Russell commented on it in their newsletters, noting how it had shown a big bearish divergence ahead of the 1962 bear market.
Graphic: Retrieved from McClellan Financial Publications.
To end, the economic calendar next week is focused on manufacturing and housing. The housing market is showing some downside risk for existing-home sales for April due to a weak reading on pending sales, MCO says, adding that housing permits and starts are expected to move sideways as builders remain cautious amid high-interest rates and economic uncertainty. Regional Fed surveys in New York and Philadelphia will provide the first read on factory activity for May, with little hope for a significant rebound in manufacturing. Jobless claims will be critical, as continuing the recent trend would likely signal a rapid deceleration in monthly job gains. Other critical data to be released include retail sales, industrial production, and business inventories.
Should readers wish to hedge the debt ceiling debacle, June call options on the Cboe Volatility Index appear attractive, some suggest. But, with RVOL as low as it is, owning optionality is not generally warranted. The risk is lower lows in volatility.
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
The S&P 500 (INDEX: SPX) recovered after a violent sell-off led by products like the SPDR S&P Regional Banking ETF (NYSE: KRE). This is before updates on the Federal Reserve’s (Fed) monetary policy today.
Graphic: Retrieved from Danny Kirsch of Piper Sandler Companies (NYSE: PIPR).
The consensus is the Fed ratchets up the target rate to 5.00-5.25%. Following this, it is likely to keep rates at this higher level for longer than markets expect, letting the effects of the tightening work through the economy and tame the still-sticky inflation (e.g., lenders eating the cost of interest to sell more goods, job vacancies dropping, and payrolls surprising higher).
Graphic: Retrieved from Citigroup Inc (NYSE: C) via Bloomberg. “The Fed’s own projections from March suggest rates will be only just above 5% by year’s end — implying a protracted pause with no cuts, after the most aggressive hiking campaign in decades. It’s marked in red in the chart [above].”
Strategists at JPMorgan Chase & Co (NYSE: JPM) think a “hike and pause” scenario prompts a push higher in stocks.
“Here, the Fed would be relying on a tightening of lending standards stemming from the banking crisis to act as de facto rate hikes. Any language that the market interprets as the Fed being on pause should benefit stocks,” JPM wrote. “This outcome is not fully priced into equities.”
This idea was alluded to in yesterday’s letter; stocks likely do “ok” in a higher rates for longer environment. Beyond economic surprises and the debt ceiling issue, the Fed’s balance sheet (not likely to be addressed in this next announcement) strategists like Andy Constan of Damped Spring Advisors are most concerned about, since the size of quantitative easing or QE made stocks less sensitive to interest rates. Ratcheting quantitative tightening or QT, the flow of capital out of markets, would prompt some increased bearishness among those strategists.
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via Macro Ops.
JPM strategists add the market may continue “artificially suppress[ing] perceptions of fundamental macro risks,” prompting upside momentum.
“We expect these inflows to persist over the next two weeks, with several more large returns expected to drop from the trailing sample window,” Tier1Alpha explains. “Even if market volatility increases during this time, it would take exceptionally significant moves to trigger substantial selling. While these inflows are advantageous during market upswings, it’s essential to remember that they can be particularly brutal on the way back down once volatility inevitably returns.”
Eventually, “as recessionary conditions proliferate,” EPB’s Eric Basmajian says, asset prices will turn. Downside accelerants include the debt limit breach, which Nasdaq Inc (NASDAQ: NDAQ) and Moody’s Corporation (NYCE: MCO) think portends recession and volatility spike.
Trade ideas and more in our recently published report.
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Although banks’ earnings were better than anticipated, sone figures indicate that the broader economy is declining, as retail sales and manufacturing output fell more than projected. Despite the challenges, most believe the Federal Reserve will raise interest rates next month.
Loretta Mester of the Federal Reserve, explained there should be another rate hike as the monetary policy will need to be more restrictive this year, with the fed funds rate rising above 5% and the real fed funds rate remaining positive for an extended period.
Thus far, monetary policymakers’ efforts to work liquidity out of the system have been complicated, particularly with rates at the back end falling, said Kai Volatility’s Cem Karsan in a conversation with TD Ameritrade Network. CrossBorder Capital confirms. Liquidity has been on an upward trend since October, partly due to China’s efforts to recover from Covid-19 restrictions and the collapse of the UK gilts markets.
Graphic: Retrieved from CrossBorder Capital via Bloomberg.
“Our original conjecture that Central Banks have effectively split their policy tools to use quantitative or balance sheet policies (QE) to ensure financial stability, whilst targeting inflation with interest rate policy is becoming more widely discussed in the media,” CrossBorder Capital’s Mike Howell said. “This splitting of roles can explain why interest rates have risen at the same time that Global Liquidity is turning higher.”
Accordingly, with the recent response to the bank issues cutting down tail risks for the S&P 500 (INDEX: SPX), markets are positioned to stay contained with falling implied volatility (IVOL) and correlations, as well as the passage of time, positioning-wise, key market boosters, Karsan added.
It’s appears the SPX may strengthen before it weakens with risk indicators, including IVOL measures, rising with the SPX. Physik Invest agrees: buy call structures on any weakness and monetize them into strength to finance long dated put structures.
It is better for traders to limit their expectations and stay the course, despite the big gap between IVOL measures like the Cboe Volatility Index and Merrill Lynch Option Volatility Estimate or MOVE, and big bets on market movement in the VIX complex, potentially to hedge against the breach of the US debt limit as soon as June.
As an aside, recent VIX hedging makes sense given that a breach of the debt limit likely results in recession, a ~20% drop in equities, and a volatility spike, Moody’s said.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ).
Quoting The Ambrus Group’s Kris Sidial, “When volatility starts to move, it moves at a higher rate than S&P volatility which is something that’s really important for the call option buyers,” which are stepping in aggressively as we’ve shown in the past letters.
Graphic: Retrieved from Piper Sandler Companies’ (NYSE: PIPR) Danny Kirsch. “With $VIX sitting at lowest level since early 2022, VIX call open interest approaching all-time highs reached in 2017/2018.”
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 9:25 AM ET. Sentiment Risk-Off if expected /MES open is below the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
Pardon, the delay. Also, the levels in this letter are a little messy to the downside. Too many confluences. Will clear them up over the coming days. Have a great day!
Fundamental
In the face of contrarian economic indications, based on CME Group Inc’s (NASDAQ: CME) FedWatch Tool, traders’ activity in the Fed Fund Futures shows the terminal rate peaking at 5.25-5.50%. Expectations for easing are pushed out to 2024, though at a less steep rate. This context, coupled with the prospects of slower economic growth, presents uninspiring realities for investors.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
Consequently, the equity-bond correlation break is set to persist.
Graphic: Retrieved from Credit Suisse Group AG (NYSE: CS).
Quoting a Bloomberg analysis of Credit Suisse’s Global Investment Returns Yearbook, “[b]onds, equities and real estate tend to be negatively correlated with inflation,” while “only commodities had a positive correlation, making them the only true hedge.”
However, commodities are “often susceptible to deep and lengthy drawdowns … in periods of disinflation” and falling growth expectations. Though commodities are a hedge against inflation, they aren’t a hedge against (rising odds of) recession.
Graphic: Retrieved from Credit Suisse Group AG (NYSE: CS).
So, interest rates are likely to rise and stay higher for longer.
Graphic: Retrieved from Bridgewater Associates LP. “Nominal spending on services has continued to grow at a rapid clip of about 6% annualized. Real and nominal demand for goods has been gradually weakening. This shift in the mix of demand has implications. Services spending is an upward pressure on employment and wages, while weak goods demand has a more pronounced impact on listed company sales.”
Equities, which are particularly sensitive to interest rates, are likely to weaken despite economic and earnings growth which is set to fall (i.e., close to zero earnings growth).
Graphic: Retrieved January 5, 2023, from Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh.
Quantitative tightening or QT (i.e., the flow of capital out of capital markets and an asset headwind), which has been offset by the running off of the Treasury General Account and injecting liquidity into markets (i.e., TGA runoff increases the room banks have to lend and finance trading activities) in the face of the debt ceiling issue, is set to accelerate and compound the rising rate impact.
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
In light of rates and QT risk asset headwind, as well as slowing growth and inflation headwind to bonds and commodities, how does one protect their portfolio? As The Ambrus Group’s Kris Sidial explains, “[e]ven if inflation continues, the rate at which it rises won’t be the same. Due to this, CTA exposures likely will not perform as well as they did in 2022, and that’s why you may see more opportunities in the volatility space … [where] we can get cheap exposure to convexity.”
Graphic: Retrieved from Bloomberg via Tier1Alpha. “[T]he correlation between bond yields and equities, has begun to turn higher from a negative level. Remember that a negative correlation between bond yields and equity prices means equities go lower as bond prices go lower, defeating the historical diversification benefits of a 60/40-type portfolio. Historically, this rotation has been associated with a period of LOWER returns, but it’s important to emphasize that this is because these periods are associated with Fed-induced slowdowns. Whether 2023 follows the same pattern remains to be seen.”
Please refer to past letters for trade examples. Though such trades may not be as attractive to enter now, they are attractive to keep on for longer.
Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR). Downside trades are rather attractive now in the absence of hedging demands in longer-dated protection convex in price and volatility. Naive measures like the Cboe VIX Volatility (INDEX: VVIX), as well as the graphic above, allude to the little demands for convexity and a declining sensitivity of the VIX with respect to changes in share prices.
If, as Bridgewater Associates put it, there is another stage to tightening “marked either by an economic downturn or failure to meet the inflation target, prompting more tightening,” risk assets will perform poorly and this letter’s trade examples are likely to protect portfolios well until assets appear attractive enough to buy again.
SpotGamma explains that more of the same (i.e., back-and-forth consolidation and a grind higher or lower) can be expected until some macroeconomic catalysts solicit demand for upside or downside protection and, accordingly, counterparty hedging pressures catalyze a far-reaching movement.
As an aside, “With IV at already low levels, the bullish impact of it falling further is weak, hence the SPX trending lower all the while IV measures (e.g., VIX term structure) have shifted markedly lower since last week. If IV was at a higher starting point, its falling would work to keep the market in a far more positive/bullish stance.”
Graphic: VIX Term Structure retrieved from VIX Central via The Market Ear.
Consequently, “if traders enter the market and demand protection, particularly that which is farther-dated, the bearish effect of rising IV will far outweigh the bullish effect of it falling. This will add to the underlying/fundamental pressure we see building via weak price action.”
Technical
As of 9:20 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a positively skewed overnight inventory, outside of the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,965.25.
Key levels to the upside include $3,979.75, $3,992.75, and $4,003.25.
Key levels to the downside include $3,949.00, $3,927.50, and $3,908.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: Areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
The author, Renato Leonard Capelj, works in finance and journalism.
Capelj spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market. Separately, Capelj is an options analyst at SpotGamma and an accredited journalist.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Administrative
Monday’s letter had some holes. Let’s try to fill them in, today, and get a fuller picture.
Summary of today’s letter: though the real economy may be strong, sticky inflation likely results in higher rates for longer, as well as quantitative tightening. This is not good for the financial economy. Some suggest the equity market rally persists into mid-February before further weaknesses appear. Read on for more.
Fundamental
Many sentiment and positioning indicators are bearish.
For instance, surveys by Bank of America Corporation (NYSE: BAC) point to allocators being very underweight US stocks. Also, investors are reporting some of their biggest one-month exits from stocks since BAC started surveying.
Graphic: Retrieved from BAC via Bloomberg’s John Authers.
The consensus is turning more bearish, we see, and some of this letter’s most quoted voices maintain that markets (not necessarily the economy) are in for more weakness.
That is in the face of a severely depressed S&P 500 (INDEX: SPX) crossing above key areas denoting technical resistance, a signal for trend-followers to get involved on the long side (i.e., buy stocks) Kai Volatility’s Cem Karsan explained in a video last week.
Equity market strength drivers, Karsan said, include China reopening and increasing stimulus, Europe’s not-so-bad winter, and little worsening of conflicts (e.g., Ukraine and Russia situation).
Adding, as The Macro Compass’ Alfonso Peccatiello said, the bond market thinks the Fed will not hike into a recession. Inflation likely “slows down to 2.5% quickly, [with] the Fed cutting rates to neutral (and never below). [That’s] not recessionary pricing. It’s immaculate disinflation pricing.”
The base case is a landing that’s soft.
To elaborate, the data shows the Fed cut by about 350 basis points or so within 18 months of the start of a recession, Peccatiello said. Now, the markets are pricing a mid-2023 pivot with about 200 basis points of cuts between 2023 and 2024.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ).
“That must mean the bond market’s base case (60%) is a recession,” Peccatiello said, noting that the Fed Funds is not pricing “below reasonable estimates of neutral rate (2.25-2.75% in nominal terms)” in the next 2-5 years. That means this would be the first time ever the US is in a recession and the Fed doesn’t cut rates below neutral.”
And, though downside earnings revisions are happening, the “2023 EPS consensus at $225 implies a +4% earnings growth this year [while] in [past] recessionary episodes the average EPS decline is instead -30%.”
“[C]yclical sectors and countries are outperforming defensive,” and there is little fear and desire to protect against far-reaching weakness. “Protection in the S&P 500 is at the cheapest levels in 2 years” as evidenced by “the implied volatility in 20% out-of-the-money SPX puts … trading in the lowest” percentiles.
But, as Karsan implied in his recent appearance, there’s a disconnect. The economy is not the stock market, and the liquidity context is poor, which many may not recognize.
The economy performing well due to China reopening and strong demand among businesses surveyed, consumers’ savings excesses, persistent credit boom, and a strong labor market suggest inflation lasts longer.
Consequently, interest rates remain higher for longer and quantitative tightening is likely to persist. This is not so good for the financial economy.
Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM) via Fabian Wintersberger.
“[B]lindly trusting the bond market could end badly,” Fabian Wintersberger added, noting that “recent bear market rallies in stocks and bonds will reverse” eventually.
Karsan appears to agree: though green shoots are likely to push better than expected economic performance, the Fed “is in a box” and this rally likely ends in early spring.
Graphic: Retrieved from Nasdaq Inc (NASDAQ: NDAQ). Note that “[h]igher rates act as a headwind for valuations – prices should fall if earnings don’t change [and] increased earnings make PEs (valuations) fall and make stocks look more attractive.” Currently, “the market is currently pricing in a year where rates and earnings don’t change much … inflation could stay elevated [with China reopening and supply chain re-shoring] which means rates should too.”
For now, the break of the 200-day moving average is a significant impetus since it’s a level many watch (i.e., technicals matter if enough people look at them). The chase is manifesting an SPX up, Cboe Volatility Index (INDEX: VIX) up dynamic (i.e., those who fear they may miss a rally bid volatility while the underlying market trades higher).
The Daily Brief for January 13 said “the more depressed technology names to the upside for debits [looked] attractive.”
Accordingly, Tesla Call Ratio Spreads have performed really well.
The 1/2 BACKRATIO TSLA 100 17 FEB 23 160/180 CALL is pricing in excess of a $1.00 credit to close, up about 400% in the span of 14 days or so.
A push likely lasts until mid-February, after which a window for weakness may open, particularly with the liquidity context (see the below video) no longer as supportive. However, if the market consolidates for a period after, this would be bullish.
To end, the median projection puts the S&P 500 at a level above $4,000.00 by year-end with the worst estimate putting the index at $3,000.00.
Joseph Wang explained, also, that there is an “increasing probability of a second bout of inflation, an issue in the 1970s that the Fed is keen to avoid … [by] retighten[ing] financial conditions … through its balance sheet” with an extended quantitative tightening or QT maintained “even if policy rates are cut.”
Given that QT is the flow of capital out of capital markets, this context presents more pressure on the financial economy (not necessarily the real economy).
Technical
As of 6:55 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the bottom part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
Our S&P 500 pivot for today is $4,028.75.
Key levels to the upside include $4,045.75, $4,061.75, and $4,077.00.
Key levels to the downside include $4,011.75, $3,998.25, and $3,988.25.
Click here to load updated key levels into the web-based TradingView platform. All levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
Vanna: The rate at which the delta of an option changes with respect to implied volatility.
Charm: The rate at which the delta of an option changes with respect to time.
POCs: Denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Options: Options offer an efficient way to gain directional exposure.
If an option buyer was short (long) stock, he or she could buy a call (put) to hedge upside (downside) exposure. Additionally, one can spread, or buy (+) and sell (-) options together, strategically.
Commonly discussed spreads include credit, debit, ratio, back, and calendar.
Credit: Sell -1 option closer to the money. Buy +1 option farther out of the money.
Debit: Buy +1 option closer to the money. Sell -1 option farther out of the money.
Ratio: Buy +1 option closer to the money. Sell -2 options farther out of the money.
Back: Sell -1 option closer to the money. Buy +2 options farther out of the money.
Calendar: Sell -1 option. Buy +1 option farther out in time, at the same strike.
In the most basic way, if bullish (bearish), sell at-the-money put (call) credit spread and/or buy a call (put) debit/ratio spread structured around target price. Alternatively, if the expected directional move is great (small), opt for a back spread (calendar spread). Also, if credit spread, seek to capture 50-75% of the premium collected. If debit spread, seek to capture 2-300% of the premium paid.
Be cognizant of risk exposure.
Negative (positive) Delta = synthetic short (long).
Negative (positive) Gamma = movement hurts (helps)
Negative (positive) Theta = time decay hurts (helps).
In short, Renato Leonard Capelj is an economics graduate working in finance and journalism.
Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.
Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.
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.
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.
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!
Overnight, equity index futures were divergent and weighed by the tech- and growth-heavy Nasdaq 100. Most commodity and bond products were much weaker, also.
This stocks down, bonds down dynamic points to a continued deleveraging.
Notwithstanding, sideways after a fast move lower, is not a bad thing. It’s one of the better cases to have given certain mechanics with respect to the options market, for instance.
Ahead is data on international trade (8:30 AM ET) and real household debt (11:00 AM ET).
Graphic updated 6:20 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: Ranges, at the index level, have tightened markedly since the January sell-off culminating in a cross-market deleveraging cascade.
The situation is different at the single-stock level. There are a couple of factors behind this.
For one, ARK Invest’s Catherine Wood recently made an interesting point suggesting events of today are the exact opposite of the events leading into the tech-and-telecom bust.
“During the tech-and-telecom bubble, … investors were falling all over each other, trying to one-up each other, to get a bigger tech position, because tech in the indexes had moved to 35%. We saw many portfolios with 40%, 50% tech.”
Basically, Wood thinks that investors are dumping single-stocks for index exposure. The below data supports this.
“We think that decision is going to prove to be just as incorrect as the decision to move en masse in the late 90s.”
Graphic: Per Nasdaq, “we’ve seen patches of retail selling of stocks that have mostly lasted for less than a week (blue bars in Chart 2). Interestingly, ETFs (yellow bars) remained net buy every single day, albeit at lower levels than usual in the last week of January.”
There is also the increasing demand for positive delta (long) exposure in the indexes as participants hedge their negative delta (short) exposure in the single stocks.
Graphic: Via Bloomberg.
Then, there is also the supply and demand for options protection, at the index level.
Mainly, the indexes are where the world will hedge and so the effects of dealers re-hedging their risks to decaying options protection provide markets a sort of passive buying support.
The S&P 500, which carries a more liquid derivatives complex and less exposure to tech- and growth-heavy constituents (when compared to the Nasdaq 100 and Russell 2000), appears stronger, but not as strong as the Dow Jones Industrial Average, a clear beneficiary of the rotation out of growth- and innovation-names to value- and cyclical-type stocks.
Graphic: Anchored Volume Weighted Average Price (VWAP) analysis via Physik Invest. Notice Dow Jones Industrial Average (bottom right) and S&P 500 (top left) strength, as well as Nasdaq 100 (top right) and Russell 2000 (bottom left) weakness. Key pivots marked off.
All the last-mentioned point is trying to make is the following: try hard enough and you’ll find an explanation for anything.
Sometimes, though, a focus on the simplest of explanations (e.g., demand for assets that perform better in higher rate environments) may suffice in navigating volatility.
Going forward, despite many index heavy-weights reporting, the earnings season is set to accelerate over the coming weeks, and equity index futures traders have positioned themselves (as evidenced by tight, sideways trade) to react to new information accordingly.
Graphic: Via @MikeZaccardi. Retrieved from Callum Thomas.
Per JPMorgan Chase & Co (NYSE: JPM) strategists, the bull thesis remains intact.
The pace of economic growth is to stabilize in 2022 and the Federal Reserve is unlikely to move further into the hawkish territory.
We’re “Continuously seeing gains for earnings. Consensus projections for 2022 will most likely prove too low again,” JPM explains. “P/E multiples are elevated, but not equity yields vs credit & bond yields. We expect further, mild and benign, P/E compression in 2022. Overall, the picture is favorable, post the recent de-risking.”
Graphic: Via The Market Ear. As money supply (which played a part in increased CPI figures) is slated to fall, there have been large outflows from Treasury Inflation-Protected Securities. @MacroAlf notes that these are some of the largest outflows “since the pandemic crash in March 2020. CPI might be 7% today, but markets are forward-looking.”
Positioning: Though markets will tend toward instability so long as volatility is heightened and products (especially the index constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).
Graphic: VIX term structure compresses markedly at the front end affecting most shorter-dated options more sensitive to the effects of direction and volatility.
“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma adds.
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.”
Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics point to “[m]odest bullishness on the 1-month timeframe.”
Technical: As of 6:20 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.
Balance-Break Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) may soon occur.
Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.
In the best case, the S&P 500 trades higher; activity above the $4,497.00 untested point of control (VPOC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,555.00 VPOC and $4,586.00 RTH High (regular trade high), or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,497.00 VPOC puts in play the $4,438.25 HVNode. Initiative trade beyond the $4,438.25 HVNode could reach as low as the $4,393.75 HVNode and $4,365.00 VPOC, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
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 is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.
Disclaimer
Physik Invest does not carry the right to provide advice.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
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!
Overnight, markets were calm as most equity index, commodity, and bond futures traded in tandem.
Ahead is data on consumer credit (3:00 PM ET).
Graphic updated 7:50 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: On the back of divergent breadth, geopolitical tensions, the prospect of reduced stimulus to combat inflation, wild responses to earnings, and disappointments in real demand and growth, 2022 has panned out as an incredibly bearish year for the stock and bond market.
Amidst this deleveraging of sorts, the S&P 500, in particular, traded well into correction territory, albeit in line with the average non-recessionary pullback of about 15%, and seasonality patterns of mid-term election years.
Graphic: Via Seth Golden, “Not sure investors realize just how BEARISH this year has been to date.”
According to an article from Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh, retail investors have become even more active, setting “a new record for gross trading (buying and selling).”
To note, despite the recent “3.9 standard deviation share disposal,” when “retail investors offloaded a net $1.36 billion worth of stock by noon,” January 24, as discussed in prior Daily Briefs, retail investors “were still net buyers of stocks in January, adding $5 billion to their holdings for the month.”
What’s interesting though is retail’s reduced interest in ETF products tracking growth (those which have the most to lose in a higher rate environment).
Graphic: “Suddenly retail have less interest in growth ETFs,” via Nasdaq.
That’s amidst the fear of contractionary monetary policy, so to speak.
To explain, with additions in money supply, there were increases in consumer prices and monetary policymakers are now looking to temper those (supposed non-transitory) increases.
According to ARK Invest’s Catherine Wood, “we’ve seen money growth go from 27% at its peak during the coronavirus, to 13%, recently.”
In tempering this inflation, Wood, too, thinks that rate hikes are on the table heading into the mid-term election cycle.
Contrary to commentary that alludes to the Federal Reserve (Fed) hiking between 4 and 7 times, Wood thinks that “50 basis points is the number that the Fed will basically [use to] telegraph that it means business and that it’s going to head inflation off.”
Graphic: Per Bloomberg, “Wall Street expects front-loaded hikes: Goldman Sachs Group Inc. and JPMorgan Chase & Co. are aligned on five hikes in 2022, while Bank of America Corp. is out front with a seven-hike forecast.”
“They might want to do the 50 basis points just to say: ‘Okay, we’re done for a while, now,’ … [because] I think the Fed could overdo it quite quickly.”
“If the fast increase in the rate of change of money supply (M2) led to a sharp increase in the rate of change of prices (CPI),” what happens to inflation if M2 is falling?
Pursuant to Wood and @MacroAlf’s comments are large outflows from Treasury Inflation-Protected Securities (TIPS) that “protect against inflation because they mirror the movements of the consumer price index (CPI),” according to Nerd Wallet.
Graphic: @MacroAlf notes: “Largest weekly outflow from TIPS since the pandemic crash in March 2020. CPI might be 7% today, but markets are forward-looking.”
Positioning: Over the past weeks, measures of implied volatility (IV) expanded amidst heightened demand for negative-delta (short call and long put) exposure on the part of customers.
Counterparties, in hedging their positive-delta (long call, short put) risk, sold stock and futures (added negative delta hedges), and this pressured markets.
However, as SqueezeMetrics puts it well, “When investors buy puts, but the underlying doesn’t violently go down, those puts decay.”
Graphic: Ratio of puts bought to sold, via SqueezeMetrics.
Basically, demand for protection can result in options decay briefly taking a back seat, if you will.
As markets settle, though, “decay returns with vengeance,” according to SpotGamma.
“As time and volatility trend to zero (as all options expire), given the current market environment, dealers’ exposure to the risk of out-of-the-money protection will decline. All that means is that the market ought to be supported by positive vanna and charm flows as dealers unwind short-delta hedges to decaying positive-delta protection (they are short).”
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.”
Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics point to “[m]odest bullishness on the 1-month timeframe.”
Technical: As of 6:20 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, 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 $4,474.75 point of control (POC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,555.00 untested point of control (VPOC) and $4,586.00 regular trade high (RTH High), or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,474.75 POC puts in play the $4,438.25 HVNode. Initiative trade beyond the $4,438.25 HVNode could reach as low as the $4,393.75 HVNode and $4,365.00 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.
What People Are Saying
Are you tired from constantly living in the dark, fully unaware of the current Gamma Exposure?
Are you frustrated from having to guess the Zero Gamma level ALL THE TIME?
Are you annoyed from not knowing what the f*ck all of this even means!?!
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.
Vanna: The rate at which the delta of an option changes with respect to volatility.
Charm: The rate at which the delta of an option changes with respect to time.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.
Disclaimer
Physik Invest does not carry the right to provide advice.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
Editor’s Note: Thanks for subscribing to The Daily Brief, a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products.
In the coming week, commentaries are set to pause as I go on vacation. Look forward to providing valuable market color when I return, on February 7, 2022.
Despite certain index heavy-weights trading higher in light of earnings announcements, equity index futures remain weak, trading sideways to lower overnight with bonds.
Measures of implied volatility (IV) remain bid while certain metrics continue to show buying support. Given the way counterparties to customer options trades hedge, a compression in volatility may bolster a move higher.
Though the odds point to a counter-trend rally, continued selling is not out of the question. A break of multi-session support levels, combined with rising IV, would pressure indices further.
Ahead is data on PCE Inflation, incomes, spending, and the Employment Cost Index (8:30 AM ET). After is University of Michigan data on sentiment and inflation expectations (10:00 AM ET).
Graphic updated 6:55 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: Equity indices are struggling to catch a bid amidst a more hawkish Fed, persistent geopolitical tensions, and data showing slowing growth at home and abroad.
Graphic: @MacroAlf plots credit impulse as a percent of GDP and SPX year-over-year earnings.
This is in the face of heavyweights, like Apple Inc (NASDAQ: AAPL) which posted its highest-ever quarterly earnings after sales climbed 11% to a record $124 billion, trading higher.
Coming back to comments from yesterday, the Federal Open Market Committee (FOMC) revealed asset purchases would stop in March. Then, in the face of an economy that’s much stronger than at the start of the last hiking cycle, the window for higher rates would be opened.
What spooked markets was Fed Chair Jerome Powell “saying that the Fed has plenty of room to raise interest rates without harming the labor market,” according to an analysis by Moody’s Corporation (NYSE: MCO).
“Powell didn’t push back against market expectations for three to four rate hikes this year, but he signaled the central bank will have zero tolerance for any upside surprises in inflation.”
According to a write-up by Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh, “some economists are already worrying whether the Fed can engineer a ‘soft landing’ for the economy, which is where rate hikes slow the economy and inflation but don’t cause a recession.”
Based on the data, though, “selloffs in rate hike cycles, especially since 1975, are mostly much smaller corrections,” Mackintosh adds.
“So, it seems we should worry much more about a recession than hikes.”
Graphic: Per Nasdaq, “[S]tock market corrections are much more dependent on the business cycle than the rates cycle. That makes sense—during rate-hike cycles, companies have strong demand and revenue growth recessions. Whereas, during recessions, unemployment and spending usually contract.”
Complicating the Fed’s job, per Nasdaq, are outside influences such as waning fiscal stimulus and further supply shocks (the good and bad ones).
However, “annualized returns for the S&P 500 during rate hike cycles are mostly positive, … [as] rising rates usually equals a strong economy, which is usually good for companies, leading to earnings growth.”
“That earnings growth more than offsets the valuation impact of higher rates.”
Graphic: Per Nasdaq, annualized S&P 500 returns during rate-hike cycles.
To assuage some fears, Goldman Sachs Group Inc (NYSE: GS) thinks that the “interplay of Fed policy, financial conditions, and the growth outlook could make it hard for the Fed to actually deliver consecutive hikes, even if they feel like a natural forecast along the way.”
Graphic: Goldman Sachs sees a (small) tightening in financial conditions. Graphic retrieved from The Market Ear. According to Bloomberg, “there is quite a long way to go before the Fed would feel any great need to come to their rescue.”
Positioning: A short-gamma environment (wherein an options delta falls with stock price rises and rises when stock prices fall) portends increased two-way volatility.
This is as the counterparties to customer options trades hedge in a manner that exacerbates movement (i.e., buying strength and selling weakness).
Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. For instance, in selling a put, customers add liquidity and stabilize the market. How? The market maker long the put will buy (sell) the underlying to neutralize directional risk as price falls (rises).
As noted in past commentaries, the removal of put-heavy exposure, after the January monthly options expiration (OPEX), as well as the reduction in event premiums tied to FOMC, opened a window of strength, wherein dealers would have less positive delta to sell against.
In other words, as measures of implied volatility were to compress, as is the case when there is less demand (or more supply) of downside put protection (a positive-delta trade for the dealers), the dealer’s exposure to positive delta declines.
However, the failure to expand range is punishing toward highly demanded protection with a shorter time to maturity. These options, which are more “convex” and sensitive to changes in direction and volatility, have the most to lose as markets settle and “decay returns with vengeance,” according to SpotGamma, an options modeling and data service.
“As time and volatility trend to zero (as all options expire), given the current market environment, dealers’ exposure to the risk of out-of-the-money protection will decline.”
That solicits the dealers’ unwind of “short-delta hedges to decaying positive-delta protection.”
Those delta hedging flows with respect to time (charm) and volatility (vanna) are to reinforce the strong buying support (as measured by liquidity provision on the market-making side).
Graphic: From 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.
At present, in putting it simply, markets would really have to (1) fall out of bed or (2) demand for protection to explode for options counterparties, at least, to pressure markets much further.
“In other words, the frantic hedging that destabilizes markets as customers reach for protection en masse has already happened. There would have to be an addition of macro flows for sale and/or new put buying for dealers to sell.”
Updated $SPY IV for 30 delta options expiring <30 days.
For these put holders, a market that goes nowhere is painful, a rally is painful, and a just little selling doesn't really help. pic.twitter.com/nDfM6XOsQj
Technical: As of 6:55 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
Gap Scenarios: Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.
Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.
In the best case, the S&P 500 trades higher; activity above the $4,332.25 high volume area (HVNode) puts in play the $4,370.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,393.75 HVNode and $4,421.50 regular trade high (RTH High), or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,332.25 HVNode puts in play the $4,299.25 RTH Low. Initiative trade beyond the RTH Low could reach as low as the $4,263.25 overnight low (ONL) and $4,212.50 RTH Low, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.
Vanna: The rate at which the delta of an option changes with respect to volatility.
Charm: The rate at which the delta of an option changes with respect to time.
Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.
Disclaimer
Physik Invest does not carry the right to provide advice.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
