Tag: Put-Call Ratio

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Commentary

Daily Brief For March 14, 2023

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Graphic updated 6:30 AM ET. Sentiment Neutral if expected /MES open is inside of 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

A long(er) letter, today. Through the end-of-this week, newsletters may be shorter due to the letter writer’s commitments. Take care!

Fundamental

Yesterday’s letter focused on the SVB Financial Group (NASDAQ: SIVB) failure, albeit with an optimistic tone. In short, the bank could not make good on fast accelerating withdrawals. Read more here.

According to one TechCrunch article, the likes of Founders Fund “reportedly advised their portfolio companies … to withdraw their money, … [and], if everybody is telling each other that SVB is in trouble, that will be a challenge,” as it was.

Graphic: Retrieved from @Citrini7. In the worst-case scenario, it was likely that uninsured depositors at SIVB would have received $0.80 on each dollar barring a bailout.

Authorities later put forth emergency measures guaranteeing all deposits. The effort shored up confidence in the banking system and markets strengthened, though some regional names such as First Republic Bank (NYSE: FRC) continued trading weak. In FRC’s case, the Federal Reserve’s (Fed) new bailout facility does not help. As former Fed trader Joseph Wang explains, “you need Treasuries and Agency MBS to tap the facility, and [FRC] barely owns any.”

Graphic: Retrieved via Joseph Wang.

Anyways, as yesterday’s letter briefly mentioned, expectations on the path of Fed Funds shifted. Traders put the terminal/peak rate at 5.00-5.25%, down from 5.50-5.75%, while pricing cuts after spring. Previously, no cuts were expected in 2023.

Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.

Some Treasury yields fell spectacularly, too, …

Graphic: Retrieved from Bloomberg.

… on par with those declines experienced amidst major crises, at least in the case of the 2-year.

Graphic: Retrieved from Bloomberg.

Measures of US Treasury yield volatility implied by options (i.e., bets or hedges on or against market movement) adjusted higher, accordingly. This is often a harbinger of equity market volatility.

Graphic: Merrill Lynch Option Volatility Estimate retrieved from TradingView

Call options on the three-month Secured Overnight Financing Rate (FUTURE: SOFR) future (i.e., bets on interest rates falling in the future) paid handsomely.

For instance, bull call spreads that expire in December 2023 (e.g., BUY +1 VERTICAL /SR3Z23:XCME 1/2500 DEC 23 /SR3Z23:XCME 96/97 CALL @.0375) increased in value by about 650.00% to $0.33 (i.e., $750.00 per contract).

Graphic: Retrieved via TradingView. Three-month SOFR Future (December 2023). When SOFR is at a lower (higher) number, the market is pricing an increase (decrease) in interest rates. Participants put the December 2023 SOFR rate at 100-96.145 = 3.855%.

In the equity space, some readers may have caught some commentary on spot-vol beta in the VIX complex strengthening like we have not seen in a while, a nod to the harbinger of equity market volatility remark a few paragraphs higher.

Recommended Readings:

  • Read: The Ambrus Group’s Kris Sidial on two major risks investors should watch out for in 2023. In short, volatility’s sensitivity to underlying prices (spot-vol beta) was low, and Sidial cast blame, in part, on commodity trading advisors and strong volatility supply.
  • Read: Simplify Asset Management’s Michael Green on using option and bond overlays to hedge big uncertainties facing markets. Following 2022, investors swapped poor-performing long-dated volatility exposures for ones with bounded risk and less time to expiry, hence the increase in 0 DTE trading.
Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch.

This spot-vol beta remark suggests that (at least some of) the volatility in rates, as well as certain small pockets of the equity and crypto market, manifested demand for crash protection in the S&P 500, “which feeds back into VIX,” one explanation put well.

Graphic: Retrieved from Piper Sandler’s (NYSE: PIPR) Danny Kirsch. “[Last] week finally got a bit of explosiveness in VIX as fixed strike volatility got bid. This is VIX generic front month future and move in SPX. Last time it really “paid” to have VIX upside was Jan of 2022 (point in upper left corner).”

Notwithstanding, for these options to keep their value and continue to perform well, realized volatility (RVOL) must pick up substantially, which is not likely.

Unlimited’s Bob Elliott comments: “the bond market is pricing a broad-based credit crunch, … [and though] it’s not crazy for the Fed to slow down here given the current uncertainty,” odds are financial problems are contained and the Fed moves forward with its mission to get (and keep) inflation down.

Graphic: Retrieved from Fabian Wintersberger. Just as the “monetary expansion supported the rise in equity and bond prices in January.”

Consequently, “the pricing of Dec23s and 5yr BEIs makes no sense,” Elliott adds. This means the example SOFR trade above is/was ripe for some monetization, and equity volatility must be dealt with carefully (i.e., price movements must be higher than they are now which would be difficult given that authorities/Fed do not want liquidations).

In support of siding with the less extreme take, we paraphrase Kai Volatility’s Cem Karsan who says that for years prior to the 2007-2008 turmoil, macro tourists were calling for a crash.

For markets to crumble, there would have to be an exogenous event far greater in implications than what just transpired with SIVB over the weekend. With odds that such turmoil doesn’t happen soon, coupled with participants easing up on their long-equity exposure (i.e., selling stock and not needing to hedge, hence the statement that owning equity volatility must be dealt with carefully), RVOL is likely to stay contained. That’s not to say that this volatility observed in the rates market can’t persist. It’s also not to say that markets can’t continue to trade lower (in fact, with interest rates rising and processes like quantitative tightening challenging bank liquidity, there is less incentive for investors to reside in lower-yielding equities). It just means that, barring some exogenous event, the market remains intact.

Graphic: Retrieved from Jack Farley. “Silicon Valley Bank owns >$80 Billion of Mortgage-Backed Securities (MBS), a market that is ‘more prone to bouts of volatility’ because ‘small investors & leveraged funds have become the main buyers’ as the Fed & banks step away from market, according to Dec 2022 BIS report.”

Positioning

Following important events like the release of the Consumer Price Index (CPI) today, the compression of implied volatility or IVOL, coupled with the nearing of big options expirations (OpEx), sets the market up for potential short bursts of strength heading into the end of the month and next month.

Graphic: Retrieved from Bloomberg. Inflation has been well within forecasts.

A quick comparison of the Russell 2000 (INDEX: RUT) and Nasdaq 100 (INDEX: NDX) suggests this options-induced strength may help keep the recent re-grossing theme intact. The compression of wound IVOL and passage of OpEx, coupled with the still-live re-grossing theme, may put a floor under equities.

Graphic: Retrieved from TradingView. Orange = RUT. Candles = NDX. Note the weakness in RUT. Note the strength of the Nasdaq relative to the Russell.

To play, one could place a portion of their cash in money market funds or T-bill ETFs or box spreads, for instance, while allocating another portion to leverage potential by way of some call options structures that use one or more short options to help bring down the cost of a long option that is closer to current market prices (e.g., a bull call spread or short ratio call spread). To note, based on options prices as of this writing, it may be too early to enter call structures (i.e., too expensive given the context).

 Technical

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

The S&P 500 pivot for today is $3,904.25. 

Key levels to the upside include $3,921.75, $3,945.00, and $3,970.75.

Key levels to the downside include $3,884.75, $3,868.25, and $3,847.25.

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.

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

The author, Renato Leonard 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 accredited journalist with past works including interviews with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, North Dakota Governor Doug Burgum, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.

Connect

Direct queries to renato@physikinvest.com. Find Physik Invest on Twitter, LinkedIn, Facebook, and Instagram. Find Capelj on Twitter, LinkedIn, and Instagram. Only follow the verified profiles.

Calendar

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.

Categories
Commentary

Daily Brief For January 9, 2023

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.

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Graphic updated 7:50 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) measure reflects the attractiveness of owning volatility. Green means that owning volatility is attractive.

Administrative

In last week’s letters, we discussed, mainly, fundamental and positioning contexts. Today’s letter will add to the discussion on the positioning.

Positioning

Last week, for an article published on Benzinga.com over the weekend, your letter writer spoke with The Ambrus Group’s co-chief investment officer Kris Sidial. Shared were the things to look out for in 2023 and tips for newer traders. The article can be viewed here, at this link.

In short, there are four big takeaways. 

First, though options prices could stay under pressure, naive measures like the VVIX, which is the volatility of the VIX, or the volatility of the S&P 500’s volatility, are printing at levels last seen in 2017. This means “we can get cheap exposure to convexity while a lot of people are worried.”

Graphic: Retrieved from TradingView. Cboe Volatility Index (INDEX: VIX) is on the top. The volatility of the VIX itself (INDEX: VVIX) is at the bottom.

Second, on the other side of the growing S&P 500 and VIX complexes is a small concentrated group of market makers taking on far more exposure to risk. 

Graphic: Retrieved from Ambrus’ publicly available research.

During moments of stress, these market makers may be “unable to keep up with the demands of frenetic investors,” Sidial said, pointing to GameStop Corporation (NYSE: GME) where “there was this reflexive dynamic” that helped push the stock higher in 2021.

“That same dynamic can happen on the way down”; market makers will mark up options prices during intense selling. As the options prices rise, options deltas (i.e., their exposure to direction) rise and this prompts so-called bearish vanna hedging flows.

Graphic: Retrieved from Ambrus’ publicly available research.

“Imagine a scenario where [some disaster happens] and everybody starts buying 0 DTE puts. That’s going to reflexively drive the S&P lower,” Sidial said. “Take, for example, the JPMorgan collar position that clearly has an effect on the market, and people are starting to understand that effect. That’s just one fund. Imagine the whole derivative ecosystem” leaning one way.

Graphic: Retrieved from Ambrus’ publicly available research.

The third is in reference to liquidity. As private market investors’ “deals are getting marked down, [t]o source liquidity, they may have to sell some of their holdings in the public equity markets.” Benn Eifert, the CIO at QVR Advisors, recently put forth that “late-stage technology is a great example where public comps are down 80-90% but privates marked down 20% or not at all. It is possible to imagine large institutions engaging in forced selling of liquid public equities to meet capital calls in private fund investments.”

And, lastly, investors often go “back and forth” and do not stick to a strict process. In trying to pick what will work at one specific time, investors can “miss what is going to work in the future.” Consequently, Sidial says investors should have an outlook and process to express that outlook. “It’s not as easy as saying: ‘Buy volatility because it’s cheap or sell it because it is expensive.’” 

As a validation, in the Benzinga article, your letter writer wrote about 2017 when volatility was at some of its lowest levels. Back then, the correct trade was to sell volatility, in some cases, due to volatility’s bimodality; if you sold volatility back then, you made money due to its clustering.

Graphic: Retrieved from TradingView. Cboe Volatility Index (INDEX: VIX) is on the top. Cboe Realized Volatility (INDEX: RVOL) is at the bottom.

So, “if you’re trading volatility, let there be an underlying catalyst for doing so.” That said, from a “risk-to-reward perspective, … it’s a better bet to be on the long volatility side,” given “that there are so many things that … keep popping up” from a macro perspective.

For Ambrus’ publicly available research, click here. Also, follow Sidial on Twitter, here. Consider reading your letter writer’s past two conversations with Sidial, as well. Here is an article on 2021 and the meme stock debacle. Here is another article talking more about Ambrus’ processes.

Technical

As of 7:50 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

Our S&P 500 pivot for today is $3,926.50. 

Key levels to the upside include $3,943.25, $3,960.25, and $3,979.75.

Key levels to the downside include $3,908.25, $3,891.00, and $3,874.25.

Click here to load today’s key levels into the web-based TradingView platform. All levels are derived using the 65-minute timeframe. New links are produced, daily. 

As a disclaimer, note the S&P 500 could trade beyond the levels quoted in the letter. Therefore, you should load the key levels on your browser.

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.

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

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

About

In short, an economics graduate working in finance and journalism.

Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.

Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.

Past works include conversations with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Calendar

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.

Categories
Commentary

Daily Brief For January 6, 2023

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.

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Graphic updated 8:30 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

Hey team, hope you had a great week! Please consider reading our letters for January 3 and 4. In those letters, we discussed the potential drivers of long-lasting inflation that may not be good for traditional portfolio constructions like 60/40. 

In today’s letter, we talk about some positioning contexts, leaning into this letter writer’s interview with The Ambrus Group’s Kris Sidial for a Benzinga article to be published either this weekend or next week.

This letter will serve as a primer. Next week, we will go into further depth. Have a great weekend!

Positioning

In a conversation with your letter writer prior to 2022, and on YouTube, Sidial and some other Ambrus members said markets were increasingly fragile and traditional portfolio constructions such as 60/40 (i.e., 60% of holdings held in stocks and 40% of the holdings held in bonds) would not perform as well as history would imply. 

Instead, options (colloquially referred to as volatility) may “potentially outperform the market” and limit losses.

Pursuant to Ambrus’ warnings, 60/40 logged one of its worst stretches as inflation and interest rates rose. On the other hand, Ambrus, which is a volatility arbitrage fund, managed to end the year unscathed.

“That does not mean all volatility funds ended the same way,” Sidial said in a nod to his team’s unique approach to leveraging options’ multi-dimensionality in reducing the cost of protection they own for investors.

Here’s more on Ambrus’ approach from a previous conversation your letter writer had with Sidial for a Benzinga article.

Graphic: Text retrieved from Benzinga.com.

This approach is limiting, though, Sidial notes. Increasing assets under management can eat into the firm’s own alpha.

Anyways, Sidial went on to discuss the performance of volatility in 2022 and its potential to outperform in 2023 and beyond. 

“It caught everybody by surprise that long volatility underperformed,” he said in reference to a high spot-vol beta (i.e., volatility’s sensitivity to underlying prices) in 2021 suggesting volatility was likely to come to life in 2022, and “there would be more follow-through.”

However, there was no follow-through, and Sidial believes this was the result of allocations to commodity trading advisors or CTAs, and the “consensus trade,” or the sales of volatility on expectations markets would grind and chop lower for the entirety of 2022. 

As this letter has put forth in the past, traders proactively hedged heading into 2022. The unwind or supply of some of these hedges, coupled with investors’ expectation markets would continue to grind far lower, prompted more volatility sales (a pressure on options prices), masked by the persistently high, albeit tame Cboe Volatility Index (INDEX: VIX) and metrics like the put-to-call ratio appearing inflated, potentially the result of stock loan desks replacing short stock with in-the-money puts given high-interest rates.

Though the price of volatility could move toward the extremes (i.e., clustering/mean-reverting), trends may be near exhaustion.

Naive measures like the VVIX, which is the volatility of the VIX (i.e., the volatility of the S&P 500 volatility), are printing at levels last seen in 2017. This suggests “we can get cheap exposure to convexity while a lot of people are worried.”

Therefore, “even if inflation continues, the rate at which inflation 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.”

Moving on, though not catalysts or reasons for Ambrus to initiate trades per se, risks Sidial said could result in volatility performing well include the concentration of market makers and private markets’ sourcing of liquidity (or raising cash) through sales of public equity markets.

“During moments of market stress, the market makers are unable to keep up with the demands of frenetic investors. If you think of GameStop Corp (NYSE: GME), which we talked about before, there was this reflexive dynamic that happened when investors rushed into the stock one way.”

“That same dynamic can happen on the way down”; market makers mark up volatility during stress which can pressure markets. As the price of volatility rises, option deltas rise and this prompts bearish vanna hedging flows, as they are called. 

Your letter writer will pause the commentary at this point while he further unpacks his discussion with Sidial, but at least you got a sneak peek ahead of next week’s article release. Take care!

Technical

As of 8:30 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Our S&P 500 pivot for today is $3,834.25. 

Key levels to the upside include $3,845.25, $3,857.00, and $3,867.75. 

Key levels to the downside include $3,813.25, $3,793.25, and $3,776.75.

Click here to load today’s key levels into the web-based TradingView platform. All levels are derived using the 65-minute timeframe. New links are produced, daily.

Note that early morning news may result in quoted levels not performing well. Please make sure to use the link to view the real-time chart for more levels that may be in play.

Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.

If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.

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

About

In short, an economics graduate working in finance and journalism.

Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.

Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.

Past works include conversations with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Calendar

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.

Categories
Commentary

Daily Brief For May 9, 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!

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What Happened

Overnight, equity index, commodity, and bond futures were all lower while yields, and implied volatility metrics we monitor were bid.

This is as new fundamental data did little to disrupt the Federal Reserve’s (Fed’s) course to hike rates and reduce the size of its balance sheet, as well as the odds of further slowing as a result of actions to curb the spread of COVID-19 abroad, and geopolitical conflict.

Goldman Sachs Group Inc (NYSE: GS), among others, cut their equity market forecasts. Presently, they see an economic contraction playing into the S&P 500’s test of $3,600.00.

Notable is the market’s retest of a very key technical area ($4,055.75 in the E-mini S&P 500). This area, last week, likely solicited responsive buying by technically-driven market participants who often lack the wherewithal to defend retests, just days before the Fed’s decision on policy.

Now, the market is set to open below those key technical areas and that is the worst outcome.

Ahead is data on wholesale inventories (10:00 AM ET), as well as inflation (11:00 AM ET).

Graphic updated 6:35 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

Positioning: Last week’s letters went in-depth on the implications of volatility divergences, the post-Fed rally, responses to key technical levels, and beyond.

On Friday, May 6, 2022, this letter essentially remarked the following:

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options.

Graphic: Via MarketWatch. “[B]ack-to-back swings in the internals on the scale seen this week are rare, with the last one occurring close to the COVID lows in stocks of March 2020. Indeed, investors had never seen a swing in internals as severe as Thursday’s before the financial crisis of 2008-09.”

How do you know whether the risk is worth the reward? 

A naive measure like the Cboe VVIX Index (INDEX: VVIX), which measures the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

Graphic: Updated May 6, 2022. The VVIX via Physik Invest.

We’re not there yet and the market remains well-hedged, as SpotGamma explains well:

“From an options perspective, participants would have to demand en masse protection (buy puts, sell calls) for liquidity providers to further take from market liquidity (sell into weakness) and that volatility skew to, essentially, blowout (e.g., Corona crisis, Meme mania, and the like).”

Pursuant to those remarks, SpotGamma sees markets reaching a lower limit near the $4,000.00 SPX area. At that juncture, the rate at which liquidity providers add pressure in their hedging activities flattens as they, too, have hedges.

Graphic: Via SpotGamma. Updated April 27, 2022.

“In turn, dealers may be able to advantageously reduce delta hedging (sell less), and supply markets with more liquidity (buy more stock). This could serve to reduce volatility.”

Noting, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma.

Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

This is amid what is a front-running of the bullish flow associated with the delta decay of options with respect to changes in volatility (vanna) and time (charm), among other factors.

In other words, it is participants’ increased awareness of the implications of options and OPEX that has resulted in a front running. According to SqueezeMetrics, “People didn’t know about the OpEx week effect (in this case, largely charm). Now everyone and their mother knows about it.’”

So what?

Charm is a measure of an options delta’s change with respect to the passage of time. As time passes, delta “bleeds” as options decay. 

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.”

As most participants, at least at the index level, own protection, the counterparties to this trade are short protection. These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

Moreover, given the growth of options volumes, participants’ heavy demand for protection matters more, to put simply. Counterparties, in light of this recent drop, pressured markets with their hedging. The decay (and eventual expiry) of this protection marks options deltas down.

Graphic: Via Bloomberg. Rising put volumes coincide with early 2022 market sell-off.

To re-hedge, counterparties buy back short stock and futures hedges. This supportive action is what has been front-run. The bullishness of the event can happen in the days and weeks prior.

Technical: As of 6:35 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a negatively skewed overnight inventory, 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 $4,055.75 low volume area (LVNode/gap boundary) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,153.25 regular trade high (RTH High) and $4,212.25 micro composite point of control (MCPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,055.75 LVNode/gap boundary puts in play the $3,978.50 LVNode/gap boundary. Initiative trade beyond the LVNode/gap boundary could reach as low as the $3,943.25 and $3,907.75 high volume areas (HVNodes), or lower.

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

Considerations: Last Tuesday, we discussed the response to a key technical level ($4,055.75).

Specifically, the E-mini S&P 500 probed $4,056.00 before staging a sharp reversal and closing higher. This was noteworthy as it told us a lot about who was gaining the upper hand.

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

Such traders often lack the wherewithal to defend retests.

Moreover, heading into last week’s Federal Open Market Committee (FOMC) event, large participants (who often move by committee) de-grossed and hedged resulting in poor reliability of our technical levels.

In the days leading up to the event, these larger had little to do with respect to repositioning. 

The market’s tests of key technical areas solicited responsive buying by these short-term traders, and this played into a rally that continued through FOMC. Post-FOMC, the market quickly succumbed to the initiative selling by longer time frame participants.

All else equal, Monday’s regular trade is expected to start somewhere below a key technical area that solicited strong responsive buying by shorter timeframes. 

Given capital constraints and tolerances, shorter timeframes may fuel an acceleration of the prevailing downtrend.

What People Are Saying

Definitions

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

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

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

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

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 February 24, 2022

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

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What Happened

Overnight, equity index futures added to losses after news that Russia invaded Ukraine. 

The MOEX Russia Index fell nearly 50% while, at home in the U.S., equity index futures were off about 3%. Bonds rose with commodities which were led by crude oil (up ~9%). 

The CBOE Volatility Index (INDEX: VIX), a measure of implied volatility or participants’ forecast of likely movement in prices, printed 37.79 a ~7.00 jump from Wednesday.

This high-level context suggests to us the need for patience. Ranges will be wide. Positioning will compound headline-driven moves. Technical analyses will fail. Caution.

Ahead is data on jobless claims, gross domestic product, gross domestic income (8:30 AM ET), as well as new home sales (10:00 AM ET).

Graphic updated 6:45 AM ET. 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: “The ‘bad news = good news’ narrative for markets doesn’t work if the Fed is tightening amidst a slowdown and a military escalation risk. In this case, bad news = bad news.”

Pursuant to this remark by Alfonso Peccatiello, Russian equities fell the most on record (nearly 50%) after President Vladimir Putin ordered the demilitarization of Ukraine. 

Graphic: Via Bloomberg.

According to Bloomberg, this crisis comes “after the U.S. and its allies crossed Russia’s ‘red lines’ by expanding the NATO alliance.”

In terms of the economic implications of Russia sanctions, it is “Cyprus and eastern European countries [that] are the most reliant on Russian imports in the EU.” 

Ukraine’s crisis also throws a wrench at monetary tightening initiatives, abroad; “the European Central Bank will put even greater emphasis on its flexibility and options as it exits stimulus measures and shifts toward raising rates,” Governing Council member Francois Villeroy de Galhau said.

Graphic: Via Bloomberg.

Positioning: Implied volatility expands as heightened demand for protection is priced in.

Graphic: VIX term structure shifts higher, especially at the front-end. This denotes the heightened potential for instability.

This comes after, according to views expressed by The Ambrus Group’s Kris Sidial, “we saw larger inflow[s] into equity funds, outflow[s] out of money markets, larger buying in the ATSs, with no real put buying.”

Graphic: Via EPFR, Barclays, and Bloomberg. Taken from The Market Ear.

In other words, measures of implied volatility were not performing; participants opportunistically buying the dip witnessed an SPX down, VIX down environment in which hedges were not being marked up accordingly.

Graphic: Per Tier1Alpha, “In the past, when the $SPX/ $VIX correlation goes back to negative, there have been some pretty memorable volatility events. Worth keeping in mind.”

The implications of this action are staggering. 

As stated yesterday, as most participants, at least at the index level, own protection, the counterparties to this trade are short protection. 

These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

With measures of implied volatility expanding, as is the case when there is heightened demand for downside put protection, protection is bid and the dealer’s exposure to positive delta rises, which solicits more selling in the underlying (addition of short-delta hedges).

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).

To monitor for capitulation, we may look for when the volatility expectations of implied volatility metrics rise to extremes. Learn more about VVIX, here.

Graphic: Charting the CBOE Volatility-Of-Volatility Index (INDEX: VVIX). In that reach for highly “convex” options, counterparties react in a manner that exacerbates underlying price movement.

We may also measure for one-sidedness in sentiment by looking to naive metrics like the put/call ratio. Learn more about PCALL, here.

Graphic: Using the put/call ratio to gauge sentiment.

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, 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 $4,122.25 high volume area (HVNode) puts in play the $4,177.25 HVNode. Initiative trade beyond the HVNodes could reach as high as the $4,212.25 regular trade low (RTH Low) and $4,249.25 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,122.25 HVNode puts in play the $4,055.75 LVNode. Initiative trade beyond the latter could reach as low as the $3,978.50 LVNode and $3,943.25 HVNode, or lower.

Considerations: If you are not well-versed in navigating trade at heightened levels of volatility, it is best to sit on your hands (SOH) or trade with a smaller size. Often, on large gaps, indexes may move sideways (and not up or down). This can be frustrating. 

Also, in high volatility, negative-gamma environments, headlines matter, and technical analyses often fail. Do not think “this time is as others” and let this event lead to your demise. Caution.

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

What People Are Saying

Definitions

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 23, 2022

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

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What Happened

Overnight, equity index futures traded sideways to higher after Monday’s post-options expiration (OPEX) probe lower. Ahead, there are no data releases scheduled.

Graphic updated 6:15 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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 what point are monetary tightening and geopolitical tensions priced in? 

According to some strategists, such as JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic, the sell-off is overdone and, if anything, Ukraine tensions “would likely prompt a dovish reassessment.” 

“Short-term rates markets have likely moved too far vs. what CBs will ultimately deliver in hikes this year,” he adds. “We expect risky asset markets to rebound as they digest these risks and sentiment improves, aided by inflows from systematic investors and corporate buybacks.” 

In the worst case, though, pursuant to notes by peers in the industry, Kolanovic nods to the fact that if selling were to continue, there would likely be a point the would Fed reassess tightening.

Basically, in the worst case, there is the potential that further selling invokes the so-called “Fed put,” which is about 15% below current prices. 

“[R]isk is being repriced to fit the world where real rates are a lot higher, and the Fed put (is) much lower thanks to the Fed’s need to fight inflation,” says rates strategist Rishi Mishra. 

Graphic: Via Bank of America Corporation (NYSE: BAC). Retrieved from Callum Thomas.

Positioning: Markets stabilize after last week’s large monthly options expiration (OPEX). 

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

Per Bloomberg, that event saw the roll-off of nearly $2.2 trillion in options. In the past, this event had bullish implications (i.e., markets rose into OPEX). That is not the case, really, any longer.

It is participants’ increased awareness of the implications of options and OPEX has resulted in a front running; according to SqueezeMetrics, “People didn’t know about the OpEx week effect (in this case, largely charm). Now everyone and their mother knows about it.”

For context, charm is a measure of an options delta’s change with respect to the passage of time. As time passes, delta “bleeds” as options decay. 

As most participants, at least at the index level, own protection, the counterparties to this trade are short protection. These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

Moreover, given the growth of options volumes, participants’ heavy demand for protection matters more, to put simply. Counterparties, in light of this recent drop, pressured markets with their hedging. The decay (and eventual expiry) of this protection marks options deltas down.

Graphic: Rising put volumes coincide with early 2022 market sell-off.

To re-hedge, counterparties buy back short stock and futures hedges. This supportive action is what has been front-run; the bullishness of the event happens days and weeks prior. 

The unwind of these hedges now, as seen Friday-Tuesday, often culminates in a post-OPEX low. That “means chase-y accelerant flows from dealer hedging into moves and creating overshoots in both directions,” Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott wrote.

Taken together, according to SpotGamma, though “post-OPEX, the removal of linear short (-delta) hedges [to put-heavy exposures] may further bolster attempts higher, … [t]he removal of downside (put) protection may also open the door for weakness in a case where some outside (fundamental) event solicits real-money selling and a new demand for protection.”

Graphic: Via EPFR, Barclays, and Bloomberg. Taken from The Market Ear.

“The market looks fairly well hedged and it’s why up until today we’ve had little follow-through on the downside despite negative headlines,” Danny Kirsch, head of options at Piper Sandler Companies (NYSE: PIPR), said in an interview.

“We’ll see if things open up after the February expiry.”

Technical: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of its 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 $4,332.75 high volume area (HVNode) puts in play the $4,415.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,438.00 key response area and $4,464.00 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,332.75 HVNode puts in play the $4,249.00 LVNode. Initiative trade beyond the LVNode could reach as low as the $4,212.50 regular trade low (RTH Low) and $4,177.25 HVNode, or lower.

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

What People Are Saying

Definitions

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

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

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

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

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For January 24, 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!

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What Happened

Overnight, equity index futures auctioned sideways to lower while measures of implied volatility expanded, which suggests increased fear and demand for protection.

This is in the context of an environment wherein the equity market, in particular, is positioned for heightened volatility, albeit potential strength, after Friday’s large monthly options expiration.

Ahead is data on Markit Manufacturing and Services PMI (9:45 AM ET).

Graphic updated 6:15 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: “The ratio of stocks hitting 52-week lows is at the highest since March 2020,” according to The Market Ear. 

In fact, in the face of a traditionally bullish period, seasonally, this is the worst January on record for the Nasdaq.

Graphic: Per Bloomberg, “Down almost 12% in January, the Nasdaq 100 is on course for its worst month since the 2008 global financial crisis. On any four-day basis, the current streak of 1% drops was the first since 2018.”

This weakness is in the context of months of divergent breadth by lesser weighted index constituents, geopolitical tensions, the prospects of reduced stimulus to combat high inflation, poor responses to earnings results, and disappointments in real demand and growth.

Graphic: @MacroAlf plots credit impulse as a percent of GDP and SPX year-over-year earnings.

The tone amongst retail participants is changing, too, with outflows starting for the first time since a major rush in account openings. When asked whether the selling is over, JPMorgan Chase & Co’s (NYSE: JPM) prime brokerage data suggests no.

This is in opposition to the typical trend into the start of the Federal Reserve (Fed) hiking cycles.

“U.S. equities have stumbled significantly on their way toward the first hike of this cycle, which is not the norm,” Jefferies Financial Group (NYSE: JEF) explained. “Performance tends to be poor immediately after the first hike, and can be worse if stocks are weakly into the first hike.”

Notwithstanding, Jefferies adds, “the SPX was higher in the 12 months that followed the start of each of the last 7 hike cycles.”

Graphic: S&P 500 performance before and after rate hikes.

With some of that context in mind, what is there to look forward to? The corporate buyback blackout window ended after the close of business, Friday, and equity inflows remain robust.

What is there to be wary of? 

Well, given that “risk is being repriced to fit the world where real rates are a lot higher, and the Fed put [is] much lower thanks to the Fed’s need to fight inflation,” this week’s Federal Open Market Committee (FOMC) meeting shall provide market participants more context as to the “timing and pace of QT” which may assuage fears unless the Fed is all out to “drop QE next week itself.”

The odds of that happening are low.

Graphic: Per Bloomberg, “As Savita Subramanian of Bank of America Corporation (NYSE: BAC) shows in the following chart, expected earnings are far less helpful in explaining market outcomes since 2010 than they were before. Meanwhile, changes in the Fed’s balance sheet, the amount of money it’s making available to markets, have become hugely important.”

As Bloomberg’s John Authers puts it well: “Despite many scares, money has stayed plentiful for the last decade, rates have fallen, and anyone who did much to protect themselves against the risk of a decline would have done badly by it.”

Graphic: As Goldman Sachs Group Inc (NYSE: GS) “shows in this chart, companies are becoming ever more profitable in a way that seems to be sustained.”

Positioning: The major broad market indices – the S&P 500, Nasdaq 100, and Russell 2000 – are in an environment characterized by negative gamma and heightened volumes. 

Graphic: Per Tom McClellan, “Persistently high volume late in QQQ is a sign of overly bearish sentiment worthy of a bottom. Key caveat: just because one notices a sentiment indication which should matter does not mean it has to matter right away.”

The negative gamma – in reference to the options counterparties reaction “when a position’s delta falls (rises) with stock or index price rises (falls)” – is what compounds the selling. 

With measures of implied volatility expanding, as is the case when there is heightened demand for downside put protection (a positive-delta trade for the dealers), protection is bid and the dealer’s exposure to positive delta rises, which solicits more selling in the underlying (addition of short-delta hedges).

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).

Moreover, in negative-gamma, dealers are selling weakness and buying strength, taking liquidity. 

That’s destabilizing but it appears that “Friday in the markets did not have abnormal liquidity across S&P500 stocks.”

Graphic: Per @HalfersPower on Twitter, liquidity rankings for S&P 500 components. 

High readings in indicators like the put/call volume ratio, which denotes heightened trade of puts, relative to calls, as well as how calm equity market volatility is relative to rate volatility, could be the result of adequate hedging into the monthly options expiration (OPEX) and this week’s FOMC meeting.

“A very nasty flush out on a key polarized psychological level (S&P 500 $4,500.00) on the highest negative gamma day on an OPEX,” said Kris Sidial of The Ambrus Group on the increased potential for relief as a result of aggressive dip-buying. 

“Aggressive shorts piling in on an already dismantled tech selloff, leading into FOMC meeting after an 8% decline in the market, and Apple Inc (NASDAQ: AAPL) reporting earnings.”

Sidial’s opinion that the market is due for a counter-trend rally, in the face of an environment in which “there does not seem to be a direct hazard,” is aligned with the expectation that removal of put-heavy exposure, post-OPEX, and a reduction in embedded event premiums tied to the approaching FOMC, opens up a window of strength, wherein dealers have less positive delta exposure to sell against.

Technical: As of 6:15 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a balanced 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 $4,381.50 regular trade low (RTH Low) puts in play the $4,449.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,486.75 RTH High and $4,526.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,381.50 RTH Low puts in play the $4,349.00 VPOC. Initiative trade beyond the $4,349.00 VPOC could reach as low as the $4,299.00 and $4,233.00 VPOC, or lower.

Considerations: The daily, weekly, and monthly charts are in alignment. 

The loss of trend across higher timeframes suggests a clear change in tone. This does not discount the potential for fast, but short-lived counter-trend rallies.

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.

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure.

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For December 6, 2021

What Happened

Overnight, equity index futures auctioned sideways to higher after Friday’s liquidation had the S&P 500 undercutting its 50-day simple moving average (SMA), a visual go/no-go level.

Strength shifted, again, to the Russell 2000 while the tech-heavy Nasdaq 100 was underwater. This comes as policymakers look to temper inflation with the tightening of monetary policy.

In regards to news, China’s central bank looked to boost liquidity for its slowing economy. It was also found that a new virus variant was not fueling a surge in hospitalizations; the U.S.’s adviser on the issue, Anthony Fauci, said there wasn’t “a great degree of severity to omicron.”

That didn’t stop the economists at Goldman Sachs Group Inc (NYSE: GS) from cutting their forecasts for U.S. GDP next year; the estimates were revised down on an expectation the omicron strain would drag growth.

Ahead are no important releases on fundamental data.

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

What To Expect

On weak intraday breadth and divergent market liquidity metrics, the worst outcome occurred; there was an expansion of range, to the downside, and participants spent the majority of the session building value at lower prices (i.e., levels at which 70% of that day’s volume occurred).

The lower bound of Friday’s range was $4,500.00 or so, at which the 50-day SMA corresponded with a large base of resting liquidity. 

To note, the 50-day is visual level at which short-term, technically-driven participants were likely buying in response to probes below developing balance. 

Successfully auctioning beneath the 50-day is a concern. Those short-term participants lack the wherewithal (both emotional and financial) to defend retests.

Continuation lower, in such a case, is likely.

Graphic: Divergent delta (i.e., non-committed selling as measured by volume delta or buying and selling power as calculated by the difference in volume traded at the bid and offer) in SPDR S&P 500 ETF Trust (NYSE: SPY), one of the largest ETFs that track the S&P 500 index, via Bookmap. The readings are supportive of responsive trade (i.e., rotational trade that suggests current prices offer favorable entry and exit; the market is in balance).

Context: The Fed’s intent to moderate stimulus and uncertainty with regards to how a new COVID-19 variant will impact the global recovery.

According to Bloomberg, “the Fed is seen responding to the inflation fears stalking businesses by leaning toward an older playbook of prioritizing the fight against price pressures — even if that risks weaker growth over the longer term.”

In line with the aforementioned, traders already started pricing in potential rate overshoots with the “December 2024 eurodollar yields [rising] above December 2025 contracts, a curve inversion that signals expectations the central bank may consider cutting rates in 2025.”

The result is that the U.S. may realize the swiftest tightening in financial conditions since 2005 if the Fed was to hike rates three times next year.

Graphic: Via Bloomberg, trades price in a rapid increase in the real Fed rate.

This development carries weight; now, more than during the tech-and-telecom bubble, low rates support current valuations.

Graphic: Low rates support current valuations better than the ‘90s, according to Nasdaq.

The reason being? 

“Lower interest rates lead to future cashflow discounting less – leading to higher valuations. From another perspective, a company with a 5% profit margin is a much more attractive investment when long-term borrow costs are less than 2%, as they are now than when it costs 5%-7% to borrow money back in the ‘90s.”

The Fed’s intent to taper faster, and eventually hike rates, just as liquidity conditions have deteriorated, pushed “the orange dot [in the above graphic] toward the right during the year.”

Notwithstanding, “growth in earnings is so far stronger than the multiple compression caused by rising rates (blue line),” and that is helping support this year’s rally.

The intent to moderate stimulus is likely to serve as a headwind; there’s always a possibility of unanticipated policy adjustments, in the face of a resurgent COVID-19 digging further into the economy’s growth.

That’s partially why we saw Goldman Sachs cut their forecasts for GDP. 

Graphic: Via The Market Ear. Goldman Sachs cut its forecast for GDP.

But, for every negative view, there is a positive (either by the same institution or a competitor).

We see JPMorgan Chase & Co (NYSE: JPM), among others, doubling down on their bullishness.

“We are calling for another year of positive earnings surprises, relative to current consensus estimates.”

Similarly, the market may shrug off omicron just as it did beta and delta. 

Graphic: Via The Market Ear, the market shrugs off COVID-19 variants with ease.

And, despite the market’s trade in short-gamma (a “negative [gamma] implies the opposite [selling into lows, buying into highs], thus magnifying market volatility”) destabilizing demand for downside protection is concentrated in shorter-dated options. 

Graphic: A roll lower in the VIX term structure brings in supportive flows. Via The Market Ear.

Once that short-dated protection rolls off the table (and/or is monetized), counterparties will quickly reverse and support the market, buying to close their existing stock/futures hedges.

This flow is stabilizing and may play into a seasonally-aligned rally into Christmas as participants see defenses rolled out against the new COVID-19 variant, and the positive effects of pro-cyclical inflation, economic growth, and improvements in global trade.

Such development plays into a thesis held by Moody’s Corporation (NYSE: MCO). 

“The forecast is that the Dow Jones Industrial Average increases this quarter and peaks in early 2022. However, the rest of the contours of the forecast didn’t change. We expect the DJIA to steadily decline throughout 2022, but because it will now peak later than previously thought, the level of the DJIA will be higher at the end of next year and over the near-term forecast.”

Similarly, here are some views by Morgan Stanley (NYSE: MS), compiled by The Market Ear. 

“The Morgan Stanley’s Global Risk Demand Index (GRDI) [fell] to a 10Y low reading of -4.2SD, last Friday (currently -3.SD). Historically, such a level has proved to be a solid buy signal over the next 3m. Other signs that investor sentiment has overshot to the downside include the VIX > 30, a steep put-call skew, and the AAII survey where 42% of respondents are bearish (90th percentile reading). Over the last decade, MSCI ACWI has risen 98% of the time over the next 3m post this signal and by an average of 10%.”

Expectations: As of 6:30 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, 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 occur.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the developing 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 sideways or higher; activity above the $4,523.00 untested point of control (VPOC) puts in play the $4,551.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,574.25 high volume area (HVNode) and $4,590.00 balance area high (BAH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,523.00 VPOC puts in play the $4,492.25 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,471.00 and $4,425.00 VPOC, or lower.

Click here to load today’s updated 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. Learn about the profile.

What People Are Saying

Definitions

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

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

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

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

About

After years of self-education, strategy development, 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.

Additionally, Capelj is a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor, developing insights around impactful options market dynamics.

Disclaimer

At this time, Physik Invest does not manage outside capital and is not licensed. 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.

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