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Commentary

Daily Brief For June 21, 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, the equity index and commodity futures were bid, all the while bonds and the dollar edged lower. This is after a week-long or so de-rate on tougher monetary policies.

Big headlines include the White House’s mulling of a U.S. gas tax suspension, Russia’s status as a top exporter of crude to China, Goldman Sachs Group Inc’s (NYSE: GS) recession warning, Elon Musk’s intent to cut Tesla Inc’s (NASDAQ: TSLA) workforce, and falling Iron ore prices on China’s building downturn.

Interesting reads from over the weekend include Dr. Pippa Malmgren’s letter on the market’s “nosedive” which is likely to be “followed by a newfound understanding of what is possible,” and how that plays into economic strength and military superiority. 

Adding, timely was a Sohn 2022 conversation with Stanley Druckenmiller on his experiences and the current market environment. 

Ahead is data on the Chicago Fed National Activity Index (8:30 AM ET), existing-home sales (10:00 AM ET), as well as Fed-speak by Loretta Mester (12:00 PM ET) and Tom Barkin (3:30 PM ET).

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

What To Expect

Fundamental: Keeping this letter brief, today.

The sale of both bonds and equities worsened in part due to the implications of inflation and the Federal Reserve’s (Fed) response to that inflation.

Graphic: Via Nordea Bank’s (OTC: NRDBY) research. “We suspect that the real economy will be less sensitive to a rise in interest rates this time, which means that the Fed could have to move rates more-than-expected before policy gets restrictive. The strongest argument is that the household balance sheets are in a much better shape to sustain their level of spending as the massive injections of money and credit through both monetary and fiscal stimulus have changed household balance sheets dramatically.”

We talked about this in the weeks prior. 

Essentially, as Joseph Wang, who was a trader at the Fed, puts it, “[b]onds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol.”

“Investors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.” 

Graphic: Via Bloomberg.

Ultimately, an increase in the RRP (reverse repo) and QT (which is a direct flow of capital to capital markets) “would drain the pool of bank deposits by ~$1t by year-end,” and this may prompt investors to “continue to lower their selling prices to compete for the cash they want.” 

Graphic: Via CrossBorder Capital.

Positioning: Detailed was Friday, June 17’s commentary that honed in on some of the implications of pre- and post-Federal Reserve meeting positioning. 

Essentially, with the June monthly options expiration (OPEX), there was a roll-off of a large amount of customer negative delta exposure (via put options they owned). 

Graphic: Via SpotGamma’s S&P 500 Index (INDEX: SPX) Gamma Model. Updated June 17, 2022.

With expiration, liquidity providers (who were short these put options, as well as underlying to hedge) re-hedged (bought back some of their static short-delta), and this removes pressure.

“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, who we quoted last week.

“Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”

Accordingly, markets are off their lows. However, in the above text, we made little mention of participants’ rolling forward of their options bets to lower strikes, further out in time, as well as the impact of customers still maintaining a “sizable short put position,” a dynamic we’ve talked about before.

Graphic: Via SpotGamma. “Options flow, last week, was unsurprisingly dominated by index puts (red lines). Most interesting was index puts bought to cover (third chart) indicating there was a fairly sizable short put position heading into last week.”

Taken together, coupled with what SpotGamma observes is “anemic” call buying (viewed as the blue line in the top chart above), participants are hedged and volatility remains well-supplied. 

Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from The Market Ear. “The ‘muted’ VIX narrative goes on. The VIX vs SPX gap remains rather wide here. The second chart shows just how ‘depressed’ VIX remains vs the underlying px action. Most people have been stopped out/de-grossed risk, so there isn’t much demand to hedge exposure.”

Despite being stretched from a technical perspective, positioning-wise, lower prices are sticky and the context for a far-reaching bounce, all else equal, is not there.

We shall provide updates to this, later in the week. Read the Daily Brief for June 17, 2022, for more on how to position in light of the above information.

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, 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 $3,735.75 HVNode puts in play the $3,749.00 ONH. Initiative trade beyond the ONH could reach as high as the $3,773.25 HVNode and $3,821.50 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,735.75 HVNode puts in play the $3,722.50 LVNode. Initiative trade beyond the $3,722.50 LVNode could reach as low as the $3,690.25 HVNode and $3,639.00 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

Volume Areas: 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.

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

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 5, 2022

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

What Happened

Overnight, equity index futures took back a small chunk of Wednesday’s post-Federal Open Market Committee (FOMC) advance. Both bonds and equity indexes were lower while most commodities and the dollar were bid.

The Federal Reserve hiked interest rates by 50 basis points while knocking the odds of a larger hike (~0.75 or above) later this year, all else equal. The Fed’s holdings of U.S. Treasuries (UST) and mortgage-backed securities (MBS) are set to fall starting June 1.

As expected, the Fed will cut $95 billion a month from its holdings, split between $60 billion of USTs and $35 billion of MBS, per Reuters, in the span of three months.

Heading into the FOMC event, markets were sold and protection, particularly that which is shorter-dated, was demanded. This was evidenced via metrics like the VIX’s term structure which had short- and mid-term VIX futures prices higher than those that are longer-term.

The compression of implied volatility after the event affecting existing concentrations of options positioning, particularly at the short-end, coupled with lackluster options buying and selling at the index level, has us questioning the rally’s sustainability.

Ahead is data on jobless claims, productivity, and unit labor costs (8:30 AM ET).

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

What To Expect

Fundamental: The Fed is raising rates and reducing the size of its balance sheet in light of the economy’s “strong underlying momentum,” as Nordea Bank (OTC: NRDBY) research puts it, a hot labor market and elevated inflation.

During a press conference after the release of meeting statements, the Fed’s Jerome Powell assuaged participants of their fears regarding a 75 basis point hike in later meetings.

Instead, it’s likely the fed tightens twice more by 50 basis points before scaling back to 25 basis point hikes, helping bring inflation down to the 2% target.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, “roughly double the maximum pace of $50 billion a month targeted in the 2017-2019 cycle.”

With QT, central banks remove assets from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities,” as JH Investment Management explains

Since March, the Fed’s balance sheet was at $9 trillion, steadied by the reinvestment of proceeds from maturing securities. After a small run-up, starting in September, the Fed will allow for a maximum of $95 billion to roll off without reinvestment.

Per MarketWatch, “In this cycle, one key to markets is when the Fed might actually sell some of its holdings of mortgages $2.7 trillion. This will ripple out through U.S. debt markets.”

This, however, “would be announced well in advance,” enabling “suitable progress toward a longer-run … portfolio composed primarily of Treasury securities.”

When bonds fall in value, their yields rise. This may have the effect of driving yield-hungry investors into relatively less risky asset categories.

Graphic: Via Reuters.

Positioning: There was a large squeeze, post-FOMC. 

The prevailing narrative is that participants’ fears, with respect to how aggressive the Fed would tighten, were assuaged.

Per Standard Chartered’s (OTC: SCBFY) Steve Englander, at its core, “it is fair to say that positioning and excess pessimism reflect a big part of the market reaction.” ​​

“Overall, the tone was much more balanced than at the January and March FOMC meetings.”

As discussed in the past few letters, markets were stretched and participants were demanding protection in size. To quote the May 2 letter:

“Barring a worst-case scenario, if markets do not perform to the downside (i.e., do not trade lower), those highly-priced (often very short-dated) bets on direction will quickly decay, and hedging flows with respect to time and volatility may bolster sharp rallies.” 

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.”

That’s precisely what happened. The question now is whether there’s a sustained reversal. 

Based on SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO), participants’ reaction to the FOMC was lackluster and capital was not committed to bets further out in price and time at higher or lower prices. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. Capital was not committed to bets further out in price and time at higher or lower prices. 

If participants start to concentrate their bets at higher prices, further out in time, that confirms the odds of sustained follow-through. If not, it’s likely that indexes, after a short-term relief, will succumb to fundamental weaknesses.

According to Kai Volatility’s Cem Karsan, the rally was purely a function of “structural buyback” and the baseline is that the bear trend holds.

This is because Fed is expected to continue withdrawing liquidity, and this will prompt risk assets to converge with fundamentals as “QT is a direct flow of capital to capital markets.”

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 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 $4,260.25 overnight low (ONL) puts in play the $4,303.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,260.25 ONL puts in play the $4,177.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,142.75 RTH Low and $4,123.00 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. Please note that some levels have been adjusted since this graphic was made.

Considerations: Strong advance, yesterday, characterized by very supportive breadth.

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).

The weaker of the indexes we monitor – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – just retook a major VWAP anchored from the lows of March 2020. 

That indicator denotes the level at which the average buyer/seller is in. In other words, that’s the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called supply zone, the level ought to, again, be looked at as a demand area. 

What’s next? Looks like there are some key areas where supply is likely to show. Mainly the $340.00 and $360.00 areas in the QQQ are of significance. In the SPY, those areas include $435.00 and $445.00.

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

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 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.