US consumer prices rose by 4.9% in the 12 months to April, down from the previous month’s 5%. Wednesday’s figures suggest inflation is moderating and emboldens the case for a pause to interest rate increases.
Graphic: Retrieved from CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
“The Fed will want to see declines in these statistical measures for a few more months before it could feel comfortable about cutting rates,” John Authers writes.
Notwithstanding “sticky price inflation” falling (only “if shelter prices are excluded,” the most challenging “front in the battle on inflation”), applications to purchase and refinance homes rose with yields falling, and that’s exactly what the Fed doesn’t want.
Many maintain the Fed is looking to walk-up long-end yields, and that’s problematic for assets; higher interest rates portend lesser allocations toward risky assets.
Pimco’s Erin Browne and Emmanuel Sharef add that “12-month returns following the final rate hike could be flat for 10-year U.S. Treasuries, while the S&P 500 could sell off sharply.”
Accordingly, bonds look attractive “for their diversification, capital preservation, and upside opportunities,” while “earnings expectations appear too high, and valuations too rich,” warranting “underweight” equities positioning.
Compounding the risks are flows “that eventually will constrain lending and nominal growth on a 6- to 12-month horizon,” writes Goldman Sachs Group Inc (NYSE: GS).
Graphic: Retrieved from Bloomberg via The Market Ear. “The bull in money market funds refuses to cool down.”
In other news was worry over a US debt default.
The US government has been using accounting measures to provide cash after reaching a borrowing limit. Treasury Secretary Janet Yellen informed Congress that these measures might be exhausted by June, resulting in payment disruptions; a default would cause an economic disaster and “global downturn,” threatening “US global economic leadership” and “national security,” Yellen says. A solution (e.g., to raise the debt ceiling) could manifest issuance of “a substantial amount of bills in 2H23 … that would drain liquidity,” Morgan Stanley (NYSE: MS) writes.
Despite the worry, markets are contained in part due to positioning contexts. Decline in realized volatility (RVOL), coupled with implied volatility (IVOL) premium, makes it difficult for the market to resolve directionally.
In fact, Nomura Holdings Inc (NYSE: NMR) said it sees “significant further potential for additional equities re-allocation buying from the vol control space over the next month if this ongoing rVol smash / tight daily ranges phenomenon holds—i.e., +$37.8B of US Equities to buy on theoretical 50bps daily SPX change).”
Options are sold systematically as traders aim to extract the premium; the Ambrus Group’s Kris Sidial says there is a puking off options exposures and short-bias activity (i.e., selling options) used as yield enhancement as traders call bluff on authorities not being there to prevent crises.
Graphic: Retrieved from Sergei Perfiliev. “This is a 1-month vol – it’s 30 calendar days for implied and I’m using 20 trading days for realized – both of which represent a month.” Note that “juicy VRP = big difference between options’ implied vol (what you pay) and realized vol (what you got). Options are cheap historically, but expensive relative to realized vol.”
Should readers wish to hedge the debt ceiling debacle, June call options on the Cboe Volatility Index appear attractive, some suggest. But, with RVOL as low as it is, owning optionality is not generally warranted. The risk is lower volatility, not higher.
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
The Federal Reserve moved the fed funds target rate by 25 basis points to 5-5.25%. They also indicated a likely pause.
“Over the last 30+ years, every time fed funds were raised above the levels of core sticky inflation, policy turned out to be restrictive enough to cool inflationary pressures back to 2% or below,” explained Alfonso Peccatiello. “By summer, core sticky inflation should be trending in the 4% annualized area while fed funds will be sitting at 5% – and history suggests that means the Fed has tightened enough.”
Following a wait-and-see period, which Peccatiello thinks may last about five months, Powell said rates might loosen; measures indicate that financial conditions are tight, leading to predictions of negative economic consequences and cuts.
Graphic: Retrieved from Bloomberg.
“Chairman Powell’s message remains sobering — the Fed’s policy rates will only come down with a greater economic slowdown or credit crunch from tightening bank lending standards,” said Yung-Yu Ma of BMO Wealth Management. “The equity market has faded in the wake of Chairman Powell’s press conference. The market may be realizing that there’s a fine line between getting the rate cuts it wants and maintaining an economic trajectory that doesn’t invoke buyer’s remorse. A classic case of be careful what you wish for.”
Graphic: Retrieved from Charles Schwab Inc-owned (NYSE: SCHW) thinkorswim platform. Three-Month SOFR Futures (FUTURE: /SR3). Implied interest rate = 100 – future price; the implied interest rate calculated using the 3-month SOFR future is an annualized rate. Based on the shape of the curve, /SR3 trader’s price an easing in the coming months.
Markets closed lower after the Fed’s decision, amid PacWest Bancorp’s (NASDAQ: PACW) examination of strategic options, including a possible sale, confirming that the problem of high bond yields is still around in the banking sector.
“It looks like the markets are moving from one bank to the other, and vulnerable deer in the herd are being kicked off,” Dennis Lockhart, a former Atlanta Fed President, said. “But I would like to believe that Jay Powell has information that suggests that the situation is contained or containable.”
Graphic: Retrieved from Tier1Alpha. Measure suggests traders’ fears and demands to protect/speculate on movement are higher (but restrained) after rate hike, a pressure on underlying markets that could be a catalyst for upside, too, if volatility were to compress/fall again.
As explained in recent letters and our detailed trade structuring report, the markets may trade stronger for longer. However, the risks grow “as recessionary conditions proliferate.” Some, including Andy Constan of Damped Spring Advisors, think a hard landing is 100% a likely outcome over the long term, while, over the short term, our recent letters point to context that may keep markets contained.
As a reminder, there will be only updates to levels tomorrow and Monday. Stay well.
Graphic: Retrieved from Sergei Perfiliev. A persistent spread in realized and implied volatility may contain markets.
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
TD Securities said traders are not pricing in a large enough pivot.
Graphic: Retrieved from Bloomberg. The Secured Overnight Financing Rate future tracks “expectations for the Fed’s policy path.”
“We look for cut pricing to increase even further,” strategists led by Priya Misra said, noting they expect cuts totaling 2.75% from December 2023 to September 2024.
This opposes Goldman Sachs’ view that investors have priced too much easing and will reverse their position in response to improving data and high inflation readings.
Regardless, a consensus is that rates will fall in the future and the economy will slow. Some traders are betting big on volatility, accordingly. The Ambrus Group’s Kris Sidial appeared on CNBC and elaborated.
Before the last time the Cboe Volatility Index or VIX spiked to 30 from similarly low levels, very large VIX call buying was observed. Recently, a large buyer of June 26 calls at $1.71 on 94,000 contracts, worth about $16 million in premium, was seen.
Graphic: Retrieved from Bloomberg via The Ambrus Group’s Kris Sidial.
“This is a pretty big bet in the VIX complex,” Sidial explained, adding that the VIX is a measure of variance. “When volatility starts to move, it moves at a higher rate than S&P volatility which is something that’s really important for the call option buyers.”
Bloomberg’s John Authers adds that the market’s hope of easing in the second half of the year is a reason for the low VIX. However, history suggests that rate cuts tend only to occur when the VIX exceeds its long-run average of 20.
Graphic: Retrieved from DataTrek Research via Bloomberg.
Authers explains that the widening gap between the implied volatility (IVOL) metrics of Treasury and equity markets, which have historically had a high correlation, is also a concern. This is partly what may have inspired the purchase of the VIX protection Sidial elaborated on; such gaps could portend more equity volatility.
Graphic: Retrieved from Bloomberg.
Notwithstanding, with the VIX near its average and trading at some premium to one-month realized volatility (RVOL), we may “see more systematic vol sellers make a comeback amid VIX contango, juicy VRP, and vol underperformance,” says Sergei Perfiliev. In such a case, markets may remain contained and bets on big market movements (e.g., the VIX trade detailed by Sidial) may not work that well.
It may be better for traders to limit their expectations and stay the course: buy call structures on weakness and monetize them into strength to finance put structures. Alternatively, define risk and enhance yield with short volatility bets, skewing them based on directional opinion (e.g., skewed iron condor), or get into risk-free and interest bearing assets (e.g., money market funds or box spreads). We covered this and more much better in a detailed research-type note soon to be released for public viewing. Stay tuned and watch your risk. PS: Sorry for the delay and rushed note!
Graphic: Retrieved from Sergei Perfiliev. “This is a 1-month vol – it’s 30 calendar days for implied and I’m using 20 trading days for realized – both of which represent a month.” Note that “juicy VRP = big difference between options’ implied vol (what you pay) and realized vol (what you got). Options are cheap historically, but expensive relative to realized vol.”
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
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Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /MES open is above the prior day’s range. Click here for the latest levels. /MES levels are derived from the profile graphic at the bottom of this letter. 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
The newsletter format needs to evolve a bit. Feedback is welcomed! If you are looking for the link to the daily chart, see the caption below the graphic above. Take care!
Positioning
Fear of contagion prompted demands for protection. Measures of implied volatility or IVOL rose, and consequently, these demands for protection pressured markets.
Previously, this letter explained for protection to keep its value, there would have to be a shift higher in realized volatility or RVOL. Well, RVOL did not come back in a big way at the index level, as many expected.
Thus, the positive effects of the bank-related stimulation and traders’ pulling forward their timeline for easing were compounded by the unwinding of hedging strategies.
Graphic: Retrieved from Bloomberg via SpotGamma. “This drop in 5-day realized vol (orange) is pretty sharp, given it occurred from such a low relative level. ‘Can’t short it, don’t want to buy it.’ This vol decline comes as SPX put open interest was cleared with March OPEX, and big VIX call interest expired last week.”
Previously depressed products like the Nasdaq 100 or NDX, which are generally very sensitive to monetary tightening, have performed well.
Graphic: Retrieved from Callum Thomas’ Topdown Charts.
As we near month-end, there is a quarterly derivatives expiry. Above current S&P 500 or SPX levels is a significant concentration of soon-to-roll-off open interest held short by investors. This means the counterparties are dynamically hedging a call they own; they’re selling strength and buying weakness, albeit in a less and less meaningful way, as those options near this expiration and their probability of paying out (i.e., delta or exposure to direction) falls.
Some would allege that volatility compression and time decay would have solicited a more meaningful response from options counterparties at those strike prices above; the absence of downside follow-through had traders supplying previously demanded downside put protection and catalyzing a rally. However, there are not many things for the market to rally on, and so much time has passed that the charm effects (i.e., the impact of time passing on an options delta) have lessened dramatically, some explain.
Graphic: Retrieved from Bloomberg via Liz Young. “The Nasdaq’s Cumulative Advance-Decline line has parted ways with index direction in recent days. In other words, the index has rallied despite weak breadth (more stocks falling than rising), the two lines are likely to find their way back together somehow…”
Therefore, it’s probably likely that the market remains contained through month-end. After, movement may increase. This letter acknowledged RVOL might come back in a big way, particularly with the bank intervention doing more to thwart credit creation.
The caveat is that markets can trade spiritedly for far longer. There is a potential for the markets to move into a far “more combustible” position. With call skews far up meaningfully steep, still-present low- and zero-cost call structures this letter has talked about in the past remain attractive.
Graphic: Retrieved from Charles Schwab Corporation-owned (NYSE: SCHW) thinkorswim.
If the market falls apart, your costs are low, and losses are minimal. If markets move higher into that “more combustible” position, wherein “volatility is sticky into a rally,” you may monetize your call structures and roll some of those profits into bear put spreads (i.e., buy put and sell another at a lower strike).
The signs of a “more combustible situation” would likely show when “volatility is sticky into a rally,” explains Kai Volatility’s Cem Karsan. To gauge combustibility, look to the options market.
Remember, calls trade at a lower IVOL than puts. As the market trades higher, it slides to a lower IVOL, reflected by broad IVOL measures. If broad IVOL measures are sticky/bid, “that’s an easy way to say that fixed-strike volatility is coming up and, if that can happen for days, that can unpin volatility and create a situation where dealers themselves are no longer [own] a ton of volatility; they start thinning out on volatility themselves, and that creates a more combustible situation.”
To explain the “thinning out” part of the last paragraph, recall participants often opt to own equity and downside (put) protection financed, in part, with sales of upside (call) protection. More demand for calls will result in counterparties taking on more exposure against movement (i.e., negative gamma) hedged via purchases of the underlying. Once that exposure expires and/or decays, that dealer-based support will be withdrawn. If the assumption is that equity markets are expensive now, then, after another rally, there may be more room to fall, all else equal (a simplistic way to look at this), hence the increased precariousness and combustibility.
Graphic: Retrieved from Callum Thomas’ Topdown charts.
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.
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 are non-professional advisors managing their own capital. They will never openly solicit others for capital or manage others’ capital to collect fees and disbursements.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /MES open is above 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
Not all doom and gloom. Make sure to read to the end!
Fundamental
In the Daily Brief for 3/20, we summarized the financial industry and policymaker responses that would turn asset fire sales into managed, orderly asset sales.
The net result of the intervention would be a reduction in credit creation, a tightening of financial conditions, as well as a slowing of the economy and inflation while, potentially, setting “a dangerous precedent that simply encourage[s] future irresponsible behavior” (e.g., risky lending/borrowing), the House Freedom Caucus put eloquently. Basically, the fear is in policymakers underwriting the losses of prevailing carry-type strategies and setting the stage for an even bigger unwind or so-called “Minsky moment,” the “sudden crash of markets and economies that are hooked on debt,” Bloomberg reports.
"Regional banks relied on a business model that relied on uninsured deposits," says @Lazard's @porszag. "The government needs to make explicit what a lot of people are assuming: that for the foreseeable future, uninsured deposits don't exist. Everything is insured." pic.twitter.com/GgZ9ZF2f7r
A systemic credit event is among strategists’ biggest fear, indeed. A Bank of America Corporation (NYSE: BAC) survey shows a credit event happening on the heels of a US shadow banking, corporate debt, and developed-market real-estate collapse. Recall this letter writer’s conversation with Simplify Asset Management’s Michael Green who said he sees “cracks in bubbles like commercial real estate” already appearing, too.
Bloomberg adds that JPMorgan Chase & Co (NYSE: JPM) strategists think the inverted yield curve signals recession and the stocks are likely nearing their high point.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
JPM adds that market lows won’t occur until interest rate cuts ensue.
Graphic: Retrieved from BNP Paribas ADR (OTC: BNPQY).
Recall 3/20’s letter citing BAC research that finds selling markets on the last Fed rate hike is a good strategy. The “Minsky moment” comment/fear has others at JPM adding that investors should sell into relief bounces.
Graphic: Retrieved from Bank of American Corporation (NYSE: BAC) via The Market Ear.
Most participants foresee rates continuing to rise by at least 25 basis points, per the CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Following Wednesday’s (expected) hike, the path forward appears uncertain. Yesterday, the terminal/peak rate was at 4.75-5.00%. Today, the peak has shifted higher to 5.00-5.25%.
Graphic: Retrieved from CME Group Inc (NASDAQ: CME).
Financials look ready to fall off a cliff, to add. If they do, the whole market likely goes.
Graphic: Retrieved from Callum Thomas’ Weekly S&P 500 ChartStorm.
Positioning
We keep referring back to our Daily Briefs published last week (e.g., 3/13 and 3/14). In those letters, we talked about the growing concern about markets enduring some exogenous shocks.
We opted to take the less extreme side since policymakers’ response was likely to stem (or push into the future) turmoil. Additionally, with participants easing up on their long-equity exposure, equity markets were likely to stay contained, relative to bond markets where the lack of liquidity is an issue, some believe. Anyways, following important events including inflation updates (i.e., CPI) and derivatives expiries, short bursts of strength (particularly in some of the previously depressed products such as the Nasdaq 100 or NDX, as explained 3/17) were likely to ensue heading into the end of this month and next month. Additionally, certain rates trades via options we set forth on 3/14 were ripe for monetization, too.
Rotating into a money market or T-bill fund or box spreads, while allocating some remaining cash to leverage potential by way of some call options structures, appeared attractive. While the T-bill or box spread exposures did not budge much, call options structures as proposed on 3/14 worked (and are likely to continue to work) rather well. The monetization of the rate structures discussed on 3/14 was timely, also.
The potential for coming events including the Federal Reserve’s (Fed) interest rate decision on Wednesday 3/22 to assuage participants’ fears of slowing may, accordingly, prompt fears of missing out on the upside, Bloomberg reports. A response may be FOMO-type demand for call options exposures, coupled with CTAs further “raising their equity exposure” on trend signals and lower volatility, boosting markets into a “more combustible” state as explained on 2/17. This fear of missing out is visible in options volatility skew; traders are hedging those tail outcomes.
Technical
As of 7:00 AM ET, Tuesday’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 the prior day’s range, suggesting a potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,004.75.
Key levels to the upside include $4,026.75, $4,037.00, and $4,045.25.
Key levels to the downside include $3,994.25, $3,977.00, and $3,959.25.
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.
Options Expiration (OPEX): Reduction in dealer Gamma exposure. There may be an increase in volatility after the removal of large options positions and associated hedging.
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.
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.
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Overnight, equity index futures rotated higher, along with commodities. Implied volatility was bid. Bonds were lower.
In the news were some changes to China’s COVID policies, the European Central Bank’s (ECB) intent to follow its peers and raise interest rates in July by 25 basis points, and the Group of Seven (G-7) leaders are talking about geopolitics and placing limitations on Russia.
At home, mortgage lenders are turning “desperate” as soaring rates roil their industry. Some are bracing for a 20% reduction in business as 30-year mortgage rates level out below 5.75%.
Pursuant to some of our analyses last week, Scion Asset Management founder Michael Burry suggested a “supply gut at retail is the bullwhip effect.” More on this, later.
Ahead is data on trade in goods (8:30 AM ET), S&P Case-Shiller U.S. home price index (9:00 AM ET), consumer confidence index (10:00 AM ET), as well as updates by Federal Reserve (Fed) members (8:00 AM ET and 12:30 PM ET).
Graphic updated 6:30 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: Though badly timed, last year ARK Invest’s Cathie Wood said inflation would be on its way out due in part to inventory build-ups and their impact on commodity prices.
Graphic: Via Societe Generale SA (OTC: SCGLY).
At the time, she asked whether the velocity of money was depressed given pent-up savings and demand for assets, putting forth disappointing GDP updates (which grew, mostly, on the back of inventories) and slightly negative retail final sales as support for her broader thesis.
Recall happenings in real estate – the iBuying debacle – late last year. Wood said this:
“This is unsustainable, … and I’m wondering if even the housing market inflation is going to give way, here.”
Participants were extending moneyness to nonmonetary assets, given monetary policies and an environment of debt and leverage that ultimately cuts into asset price volatility. Ultimately, these trends bolster the risks of carry when volatility does rise and the demand for money pushes deflation, particularly in asset prices.
Graphic: Via the Investment Company Institute. Taken from Joseph Wang. “Investors are selling everything for cash.”
With bank deposits to drain about $1 trillion or so by year-end, that volatility is happening, now, as investors “continue to lower their selling prices to compete for the cash they want.”
Scion Asset Management’s Michael Burry nods at the “supply gut” in retail. Like Wood, he thinks that it is a deflationary pulse that manifests disinflation in consumer prices, prompting the Fed to reverse itself on rates and quantitative tightening (QT).
Read: DC’s Chartbook #16 on the “fundamental evolution in the global money markets.”
Graphic: Via Societe Generale SA (OTC: SCGLY).
That’s as Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, who gained much attention this year on his bold market commentary, said the Fed is likely to change course as it “can only deal with nominal [and] not real chokepoints.” This is as “nominal balance sheet and liquidity trends will, at some point, clash with the realities of a garden variety of supply chain issues.”
Graphic: Via @BarnabeBearBull. “[L]ast week 18 Central Banks tightened their monetary policy (12% of all monitored CBs), including 4 of the top 9. Strongest move in a while.”
Positioning: Incredible is the still-depressed volatility skew we’ve talked about ad nauseam on.
Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear. “Overwriting longs and using the premium to buy downside protection is relatively cheaper now.”
It’s the strong supply of volatility. Participants are hedging, buying into volatility that is closer to current prices, and selling (skew) that which is farther out.
The counterparts are long that volatility further out, which they may sell into declines, and all of this, together, “results in vol underperformance on market declines,” per Sergei Perfiliev.
Graphic: Via Physik Invest. Taken from TradingView. The top is S&P 500 (INDEX: SPX). The second, from the top, is the Nations SkewDex (INDEX: SDEX), a clearer measure of options skew. The second from the bottom is the Cboe Volatility Index (INDEX: VIX). The bottom is the Cboe VVIX index (INDEX: VVIX), a naive measure of skew.
For that reason, the volatility that the markets are realizing (RVOL) is heightened and, at times, in excess of that implied.
Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “SPX 6-month realized volatility is at a level rarely seen outside of major crises; current 6-month implied volatility has been exceeded in just 3 periods since 1940.”
As said, yesterday, given these dynamics, it makes sense to lean toward owning volatility, rather than selling it. A “higher starting point” in IVOL, and a still-present right-tail (from the positioning for a bear market rally), make it so we may position, for less cost, in short-dated structures with asymmetric payouts (call and put side), precisely as we’ve been talking about for half-a-year.
Graphic: Via Pat Hennessy. “[T]he performance of short-dated 1×2 put ratios in SPX this year. Despite being short the tail, the grind lower has been well captured by this trade structure.”
In the near term, from a positioning perspective, the front-running of quarter-end repositioning flow is (and is expected), in part, to add to the equity market upside.
Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR) on 6/24/2022. Multi-expiry skew in the Invesco QQQ Trust Series 1 (NASDAQ: QQQ). Notice the v-shape in the shorter maturity and smirk in the longer maturity. Here’s what that means.
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 mid-to-upper part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,909.25 MCPOC puts in play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as high as the $3,982.75 LVNode and $4,016.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,909.25 MCPOC puts in play the $3,885.75 ONL. Initiative trade beyond the ONL could reach as low as the $3,821.50 LVNode and $3,793.25 Ledge, 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.
Balanced (Two-Timeframe Or Bracket) Trade The Status Quo: Rotational trade that denotes current prices offer favorable entry and exit.
Balance areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).
Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).
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.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
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Overnight, markets were calm as most equity index, commodity, and bond futures traded in tandem.
Ahead is data on consumer credit (3:00 PM ET).
Graphic updated 7:50 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: On the back of divergent breadth, geopolitical tensions, the prospect of reduced stimulus to combat inflation, wild responses to earnings, and disappointments in real demand and growth, 2022 has panned out as an incredibly bearish year for the stock and bond market.
Amidst this deleveraging of sorts, the S&P 500, in particular, traded well into correction territory, albeit in line with the average non-recessionary pullback of about 15%, and seasonality patterns of mid-term election years.
Graphic: Via Seth Golden, “Not sure investors realize just how BEARISH this year has been to date.”
According to an article from Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh, retail investors have become even more active, setting “a new record for gross trading (buying and selling).”
To note, despite the recent “3.9 standard deviation share disposal,” when “retail investors offloaded a net $1.36 billion worth of stock by noon,” January 24, as discussed in prior Daily Briefs, retail investors “were still net buyers of stocks in January, adding $5 billion to their holdings for the month.”
What’s interesting though is retail’s reduced interest in ETF products tracking growth (those which have the most to lose in a higher rate environment).
Graphic: “Suddenly retail have less interest in growth ETFs,” via Nasdaq.
That’s amidst the fear of contractionary monetary policy, so to speak.
To explain, with additions in money supply, there were increases in consumer prices and monetary policymakers are now looking to temper those (supposed non-transitory) increases.
According to ARK Invest’s Catherine Wood, “we’ve seen money growth go from 27% at its peak during the coronavirus, to 13%, recently.”
In tempering this inflation, Wood, too, thinks that rate hikes are on the table heading into the mid-term election cycle.
Contrary to commentary that alludes to the Federal Reserve (Fed) hiking between 4 and 7 times, Wood thinks that “50 basis points is the number that the Fed will basically [use to] telegraph that it means business and that it’s going to head inflation off.”
Graphic: Per Bloomberg, “Wall Street expects front-loaded hikes: Goldman Sachs Group Inc. and JPMorgan Chase & Co. are aligned on five hikes in 2022, while Bank of America Corp. is out front with a seven-hike forecast.”
“They might want to do the 50 basis points just to say: ‘Okay, we’re done for a while, now,’ … [because] I think the Fed could overdo it quite quickly.”
“If the fast increase in the rate of change of money supply (M2) led to a sharp increase in the rate of change of prices (CPI),” what happens to inflation if M2 is falling?
Pursuant to Wood and @MacroAlf’s comments are large outflows from Treasury Inflation-Protected Securities (TIPS) that “protect against inflation because they mirror the movements of the consumer price index (CPI),” according to Nerd Wallet.
Graphic: @MacroAlf notes: “Largest weekly outflow from TIPS since the pandemic crash in March 2020. CPI might be 7% today, but markets are forward-looking.”
Positioning: Over the past weeks, measures of implied volatility (IV) expanded amidst heightened demand for negative-delta (short call and long put) exposure on the part of customers.
Counterparties, in hedging their positive-delta (long call, short put) risk, sold stock and futures (added negative delta hedges), and this pressured markets.
However, as SqueezeMetrics puts it well, “When investors buy puts, but the underlying doesn’t violently go down, those puts decay.”
Graphic: Ratio of puts bought to sold, via SqueezeMetrics.
Basically, demand for protection can result in options decay briefly taking a back seat, if you will.
As markets settle, though, “decay returns with vengeance,” according to SpotGamma.
“As time and volatility trend to zero (as all options expire), given the current market environment, dealers’ exposure to the risk of out-of-the-money protection will decline. All that means is that the market ought to be supported by positive vanna and charm flows as dealers unwind short-delta hedges to decaying positive-delta protection (they are short).”
Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”
Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics point to “[m]odest bullishness on the 1-month timeframe.”
Technical: As of 6:20 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $4,474.75 point of control (POC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,555.00 untested point of control (VPOC) and $4,586.00 regular trade high (RTH High), or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,474.75 POC puts in play the $4,438.25 HVNode. Initiative trade beyond the $4,438.25 HVNode could reach as low as the $4,393.75 HVNode and $4,365.00 VPOC, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
What People Are Saying
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Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.
Vanna: The rate at which the delta of an option changes with respect to volatility.
Charm: The rate at which the delta of an option changes with respect to time.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.
Disclaimer
Physik Invest does not carry the right to provide advice.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
