Tag: Short Gamma – Sell Dip & Buy Rip

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Commentary

Daily Brief For October 6, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1000+ that read this report daily, below!

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Graphic updated 8:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

Good morning, team! Appreciate you opening up this email and reading through the newsletter. 

Over the span of two or so years, on Substack and Physik Invest’s website, issued daily was this letter you, alongside about 1,000 others, are subscribed to.

This newsletter went from about 400 subscribers in July to 1,000 in October, a 150% increase. Thank you to fx:macro, The Morning Hark, The Transcript, and twenty others who, in large part, made that increase happen.

From hereon, gun to the head, I (your letter writer) can’t tell where this newsletter is going. 

In short, this letter served as a tool for me to improve and keep me aware. It was years ago that markets were a dream I was in steadfast pursuit of; I sought mentorship, studied, saved money, and, ultimately, made it a successful full-time gig. 

This letter helped keep me committed to continuous improvement. Sure the money was great, but how do you keep that flow when times get tough? That is something this letter helped me achieve. I hope it’s done the same for you.

At the same time, to weather the storms (periods of inactivity or low earnings while trading like now), I continued my work at places like Benzinga and SpotGamma.

Probably shaved a few years off my life expectancy but the effect was a net positive, I believe. 

That said, in our own way, each and every one of us wants to level up, and that is what makes it difficult for me to promise where this newsletter may go. Speaking bluntly, I am faced with some good problems; e.g., should I raise money and build a fund? Work at an institution? Pivot to PE or, even, government work? Go back to school? Can’t tell you, yet.

What the next step will be I am not sure. Regardless, I intend to keep you fully in the loop. 

As I set out and travel over the next 30 days, I’ll be doing a lot of thinking and, though the frequency of issued letters may change, briefly, the result may be better letters potentially spanning areas far beyond the S&P and the factors that are driving it.

Definitely am open to feedback. Appreciate you for joining the community and staying on board! 

PS: Two things.

First, I’ll be in London and Lisbon over the next month. If you’re in either of the two cities, reach me on Telegram (@renatolcapelj) and/or Discord (Renato Capelj#8625). 

Maybe a coffee?

Second, I spent the past half-year helping Benzinga build an awesome fintech event coming to New York City this December 8, 2022. Organizations such as FIS, Fireblocks, Truist, Symbiont, State Street, Vanguard, Northern Trust, Partisia, and Apex Clearing are a few that will be there.

If you want to network with the best, let me know and I’ll try to get you a ticket!

Regards,

Renato

Fundamental

An eventful week. 

News, today, was focused on Federal Reserve (Fed) officials not planning to cut interest rates next year, the Organization of the Petroleum Exporting Countries (OPEC) agreeing to a supply cut, the UK mulling first-time home buyer program extensions, and Credit Suisse Group AG (NYSE: CS) seeking investment to help spin off its advisory and investment banking units.

Please check out the Physik Invest archives and upcoming letters for more on the impact.

Positioning

Bloomberg reported yesterday a big trade fired off mid-day propelling the S&P 500 higher into the close. The trade consisted of +20,000 OCT $4,500.00, +14,000 MAR $4,300.00 calls, and -48,000 JAN $4,500.00 calls. 

The trade leaves the participant(s) with positive Delta. The other side has exposure to negative Delta meaning they lose money if the S&P 500 is higher, all else equal. To hedge this negative Delta, counterparties buy futures (positive Delta) and that has a positive impact.

According to SpotGamma, though, there needs to be more impactful bullish call repositioning or a market rise that’s large enough to solicit volatility-dampening hedging from counterparties.

Until the last-mentioned happens, the market may continue to balance in a larger range.

Technical

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

In the best case, the S&P 500 trades higher.

Any activity above the $3,771.25 HVNode puts into play the $3,826.25 HVNode. Initiative trade beyond the last-mentioned could reach as high as the $3,862.25 HVNode and $3,893.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,771.25 HVNode puts into play the $3,722.50 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,671.00 VPOC and $3,610.75 HVNode, or lower.

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

Definitions

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

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

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, ex-Bridgewater Associate Andy Constan, 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 September 22, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 950+ that read this report daily, below!

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Graphic updated 8:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

An easy read, today. For more complex, see the September 20 and 19 letters. Also, there will not be a letter published for Friday, September 23, 2022. See you next week, team!

Fundamental

Equity markets traded down, yesterday, on the heels of the Federal Reserve’s (Fed) decision to raise interest rates by 0.75% and “keep at it” for longer, eyeing a 1.25% jump, in sum, by 2023.

This puts the current target rate at 3.00-3.25%.

Separately, if the “keep at it” quote sounds familiar, that’s because it is. The Fed Paul Volcker’s memoir is titled “Keeping at It.”

Graphic: CME Group Inc’s (NASDAQ: CME) FedWatch Tool shows higher odds of a 75 to 100 basis point rate hike in November, along the lines of what the futures market was pricing heading into the event.

The Fed Chair Jerome Powell admitted there may be below-trend growth and the potential for unemployment to reach 4.4% next year, up from the current rate of 3.7%. Projected increases, as of yesterday, show interest rates at 4.4% by 2023, and 4.6% in 2023, before moderation in 2024 to 3.9%, as well summarized by Bloomberg.

Graphic: Retrieved from Bloomberg.

Moreover, economists suggest that raising rates to 4.5% would cost the economy nearly 1.7 million jobs while rates at 5% would bring that number to 2 million. A higher savings rate and increased funds at the state level would likely cushion the blow, however.

In response, the likes of Ark Invest’s Cathie Wood, who we quoted recently regarding her thoughts on why the Fed needs to lower the pace of tightening and/or cut, said:

“Most disappointing about the Fed’s decision today was its unanimity. None of those voting on the Federal Reserve is focused on the significant price deflation in the pipeline. The Fed seems to be making decisions based on lagging indicators and analogies.”

She adds that the Fed is setting the stage for deflation:

“The Fed is solving supply chain issues by crushing demand and, in my view, unleashing deflation, setting it up for a major pivot.”

Graphic: Initially retrieved from Bloomberg. Taken from Ophir Gottlieb who concludes costs are dropping, as observed via shipping, gasoline, manufacturing, cars, and rent measures.

Moreover, it’s the case that “[a]s rates rise and debt servicing costs increase, ‘many zombie institutions, zombie households, corporates, banks, shadow banks, and zombie countries are going to die,’” said economist Nouriel Roubini, who predicted the 2008 financial crisis. 

Prior to the Fed event, Roubini forecasted a 75 basis point hike in September, followed by a 50 basis point hike in November. The market is pricing more than what Roubini thought the Fed would probably do after Wednesday’s Fed meeting.

In his opinion, stay “light on equities and have more cash, … [as] equities and other assets can fall by 10%, 20%, 30%.”

Positioning

In short, unexpected was the post-event response. In recent times, post-Fed moves have been positive, driven by the “rebalancing of dealer inventory,” per Kai Volatility’s Cem Karsan.

That didn’t happen and let’s unpack why.

Basically, into the event, traders demanded protection and bid implied volatility (IVOL). The assumption is that counterparties, who are likely on the other end, have exposure to positive Delta and negative Gamma, which they hedge through negative Delta trades in the underlying.

Should fears have been assuaged, the supply of that protection once demanded, would have decreased IVOL (and options Delta), providing the markets a boost.

Graphic: Retrieved from SqueezeMetrics.

That didn’t happen. Instead, traders added protection, as shown by this SpotGamma graphic tracking changes in put open interest on the S&P 500 (INDEX: SPX).

Graphic: Retrieved from SpotGamma. Updated September 22, 2022.

This bid some basic measures of IVOL into the close.

Graphic: Retrieved from VIX Central. Updated September 21, 2022.

That’s as these particular options, which were added at much lower prices, as I explained in a SpotGamma note, recently, “are far more sensitive to changes in direction and IVOL.”

These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly. “If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”

Graphic: Retrieved from SqueezeMetrics.

Notwithstanding, it’s still the case that a “reload on fresh short-dated downside” flows heighten the risk of a “negative Delta squeeze … into month end,” said Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

Therefore, “you have to consider a move up [to] $4,000.00 as part of your distribution of outcomes to the upside,” as that is near where “market makers are ‘long,’” as part of an impactful collar trade many are aware sits.

As an aside, some online conversation was sparked around placing cash into riskless trades for some small, but guaranteed, rates of return. In that conversation, Box Spreads were put forth as a solution to lend cash and earn a competitive interest rate.

For context, “Boxes allow market participants to create a loan structure similar to a Treasury bill. T-bills are ‘discount’ instruments that are purchased at a value less than the stated face value. Upon maturity, bills call for the return of the stated face value.”

“For example, one might buy a $1 million 90-day T-bill for $998,000. Ninety days later, the $1 million face or principal value is returned and the $2,000 discount is earned as interest. One may represent the rate on this transaction as a 0.80% or 80 basis point discount yield [= (360/90) x ($2,000/$1,000,000)]. The effective rate on a box represents a ‘discount yield’ similar to a quoted T-bill rate.”

Graphic: Retrieved from boxtrades.com.

IPS Strategic Capital’s Pat Hennessy explains that SPX boxes “typically yield[] 20-40 bps above [the] corresponding maturity risk-free rate.” Additionally, there are tax advantages to using the S&P 500’s 1256 contracts. 

For easier fills, use the “3K/4K line in an AM settled expiry,” Hennessy noted. “Helps if you know where the broker market is.”

Technical

As of 8:00 AM ET, Thursday’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 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.

Any activity above the $3,826.25 HVNode puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as high as the $3,893.00 VPOC and $3,936.25 ONH, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,826.25 HVNode puts into play the $3,770.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,722.50 LVNode and $3,688.75 HVNode, or lower.

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

Definitions

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

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

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

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, ex-Bridgewater Associate Andy Constan, 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 September 16, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!

Subscribe
Graphic updated 6:50 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. 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

A longer note so stick with me!

Updates are pending for the above dashboard. Exciting! Beyond this, the newsletter is getting a revamp in other parts. If you have any feedback on what should be changed, please comment!

Also, I am going to refer everyone to a conversation between Joseph Wang and Andy Constan, as well as some updates Cem Karsan of Kai Volatility made (HERE and HERE). That is, in part, a primer for what we will be talking more about, soon.

Fundamental

Talked about yesterday was the prospects of contractionary monetary policy reducing inflation and growth. BlackRock Inc (NYSE: BLK) strategists, even, put forth that a “deep recession” is needed to stem inflation. In short, “there is no way around this,” they claim.

Graphic: Retrieved from The Market Ear. FedEx Corporation (NYSE: FDX) sold 20% on warning about the global economy.

From thereon, we talked about how rates rising would “bring private sector credit growth down,” as well as “private sector spending and, hence, the economy.”

Based on where rates are at, the market may still be too expensive.

Graphic: Retrieved from Bloomberg via Michael J. Kramer. “What is amazing is how expensive this market is relative to rates. The spread between the S&P 500 Earnings yield and the 10-Yr nominal rate is at multi-year lows.”

On the other hand, some argue inflation peaks are in. ARK Invest’s Cathie Wood suggests “deflation [is] in the pipeline, heading for the PPI, CPI, PCE Deflator.” 

Tesla Inc’s (NASDAQ: TSLA) Elon Musk added that he thinks the Federal Reserve (Fed) may make a mistake noting “a major Fed rate hike risks deflation.” Musk suggested the Fed should drop 0.25%, basing his decision on non-lagging indicators, unlike the Fed.

That’s not in line with what CME Group Inc’s (NASDAQ: CME) FedWatch tool shows. Through this tool we see traders pricing an 80% chance of a 0.50-0.75% hike, all the while quantitative tightening (reducing Fed Treasuries and mortgage-backed securities holdings) accelerated on September 15. 

UST and MBS will roll off (which could turn into “outright sales”) at a pace of $95 billion per month, now, increasing competition for funding among commercial banks, and bolstering borrowing costs, as explained, below.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

According to Bank of America Corporation (NYSE: BAC), since 2010, nearly 50% of the moves in market price-to-earnings multiples were explained by quantitative easing (QE), the inverse of QT, through which the Fed (or central banks, in general) creates credit used to buy securities in open markets, MarketWatch explains.

Graphic: Retrieved from the Federal Reserve Bank of Richmond. “The Fed Is Shrinking Its Balance Sheet. What Does That Mean?”

The “purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risk assets as investors look elsewhere for higher returns. QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.”

Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via MarketWatch.

The liability side of the Fed’s balance sheet is what “matters to financial markets.” 

Thus far, “reductions in Fed liabilities have been concentrated in the Treasury General Account, or TGA, which effectively serves as the government’s checking account” to run the day-to-day business.

Given that we’re talking about balance sheets, here, Fed liabilities must match assets. Thus, a rise in the TGA must be accompanied by a decline in bank reserves (which are liabilities to the Fed). This, as a result, decreases the room banks have to “lend or to finance trading activity by hedge funds and other financial market participants, [which] further [cuts into] market liquidity.”

With the Treasury set to increase debt issuance, boosting TGA, it will effectively take “money out of the economy and put[] it into the government’s checking account.” The linked reduction in bank deposits and reserves bolsters “repurchase agreement rates and borrowing benchmarks linked to them, like the Secured Overnight Financing Rate,” per Bloomberg.

Graphic: Retrieved from the Federal Reserve Bank of New York. “The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.”

Adding, this may play into “an additional tightening of overall financial conditions, in addition to the increase in the main fed funds rate target that the central bank intends to continue boosting.”

This will “put more pressure on the private sector to absorb those Treasurys, which means less money to put into other assets” that may be riskier, like equities, said Aidan Garrib, the head of global macro strategy and research at Montreal-based PGM Global.

Positioning

As of 6:50 AM ET, Friday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.44%. Net gamma exposures decreasing may promote generally more expansive ranges.

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics.

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of options structures.

This is as there’s been a lot of speculation, particularly on the downside (put options), setting the stage for a more volatile and fragile market environment, says Kai Volatility’s Cem Karsan.

“On the index level, people are not well hedged,” a departure from what the case was heading into and through much of 2022. It’s the case that heading into 2022, traders were well hedged. Into and through the decline, traders’ monetization of existing hedges, as well as counterparty reactions, “compressed volatility” realized across US equities, as explained on July 15, 2022.

This made for some attractive trade opportunities seen here.

Graphic: Retrieved from The Market Ear. “VIX has decoupled from cross-asset volatilities.”

Now, given that the go-to trade is to sell stock and puts, short interest has grown, as have other risks, associated with this activity; essentially people are “los[ing] faith in convexity and risk premia’s ability to work,” as a result of “poor performance of vol,” and, the reaction to their “pain and financial loss,” is setting the stage for tail risks heading into the Q1 and Q2 2023.

The sale (purchase) of the front (back) expirations will bolster market pinning; as SpotGamma puts forth, “the positive impact of put closers and rolls, as well as decay,” is easing the market drop. However, this “positioning likely compounds drops and adds to volatility,” in the future.

To quote: “Though the removal of put-heavy exposures can boost markets higher, too add, the positive impacts are dulled via the demand for put exposures at much lower prices.”

Graphic: Retrieved from SpotGamma.

These particular options, which are at much lower prices, “are far more sensitive to changes in direction and IVOL,” as I explained in a SpotGamma note. These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly.

Graphic: Via Mohamed Bouzoubaa et al’s Exotic Options and Hybrids.

“If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”

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

Technical

As of 6:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a 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.

Any activity above the $3,909.25 MCPOC puts into play the $3,935.00 VPOC. Initiative trade beyond the latter could reach as high as the $3,964.75 HVNode and $4,001.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,909.25 MCPOC puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as low as the $3,826.25 and $3,770.75 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: A feature of this 2022 down market was responsiveness near key-technical areas (that are discernable visually on a chart). This suggested to us that technically-driven traders with shorter time horizons were very active. 

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

That’s changing. The key levels, quoted above, are snapping far easier and are not as well respected. That means other time frame participants with wherewithal are initiating trades. 

Those are the participants you should not fade.

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.

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.

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, ex-Bridgewater Associate Andy Constan, 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
Results

Case Study: How A Bearish S&P 500 Trade Turned Into A Multibagger

Heading into the 2022 equity market decline, institutions repositioned and hedged their downside, even allocating to commodities, which worked well for the first couple of quarters.

Due in part to this, the 2022 equity market decline was like no other experienced during 2021.

Instead, the monetization and counterparty hedging of existing customer options hedges, as well as the sale of short-dated options, particularly in some of the single names where implied volatility (IVOL) was rich, lent to lackluster performance in IVOL.

Eventually, entities were squeezed out of trades not working.

That means participants rotated out of options and commodities, all the while a macro-type re-leveraging ensued on improvements in inflation data, an earnings season that was better than expected, and “crazy tax receipts,” among other things.

The most recent advance climaxed the week of the August monthly options expiration (OPEX).

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE).

Why? Well, heading into that particular week, markets were rising at a fast rate, and call options (i.e., bets on the market upside) were highly demanded.

Graphic: Updated 8/15/2022. Retrieved from SqueezeMetrics.

Those, on the other side of those call option trades (i.e., counterparties), hedged in a manner that was supportive (i.e., counterparties sell calls to customers and buy underlying to hedge exposure).

Eventually, traders’ activity in soon-to-expire options became concentrated at certain strikes – particularly $4,300.00 in the S&P 500 – while IVOL trended lower. The counterparty’s response, then, did more to support prices and reduce movement.

This is because, with the passage of time and declining volatility, options Gamma (i.e., the sensitivity of an option to direction) became more positive and the range of spot prices, across which Delta (i.e., options exposure to direction) shifts rapidly, became a lot smaller.

When options Gamma exposure is more positive, market movements may have a positive impact on the counterparty’s position (i.e., movement is beneficial). If movement is beneficial, and the counterparty is not interested in realizing that benefit, they may hedge in a manner that can stifle market movement.

This is, in part, what happened, in the late stages of the rally. That said, however, soon after the S&P 500 hit $4,300.00, the near-vertical price rise began to sputter and follow-on support, both from a fundamental (e.g., liquidity) and volatility perspective was soon set to worsen.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

Why? There was an OPEX that would trigger “a big shift in market positioning,” Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott explained.

In short, participants’ failure to roll forward their expiring bets on market upside coincided with a message that the Fed would stay tough on inflation. So, it’s the case that after the OPEX, those same bets that were prompting counterparties to stem volatility and bolster equity upside were not rolled forward.

Instead, these bets expired and this is visualized by the drop in Gamma exposures, post-OPEX.

Graphic: Created by Physik Invest. Data by SqueezeMetrics.

Accordingly, this expiration, combined with technical and fundamental contexts that were prompting funds to “reload[] on short sales,” shocked the market into a higher volatility, negative Gamma environment. In this environment, put options, through which the vast majority of participants speculate on lower prices and protect their downside, solicited far more pressure from counterparties.

Adding, if markets were to continue trading lower, traders were likely to continue rotating into those put options that would bolster this pressure from counterparties.

This happened as shown, below.

Graphic: Retrieved from SpotGamma. “There was a huge surge in large trader put buying in the equities space last week as per the OCC data.”

This demand for put options protection was reflected by a bid in IVOL. To hedge against this demand for protection and rising IVOL, counterparties sold underlying, compounding bearish fundamental flows.

Graphic: Retrieved from SqueezeMetrics. Learn the implications of volatility, direction, and moneyness.

In late August, data suggested September would have “a very large options position as it is a quarterly OPEX,” SpotGamma said. With that position being “put heavy,” a slide lower, and an increase in IVOL, was likely to drive continued counterparty “shorting” with little “relief until Jackson Hole.”

In expecting markets to trade lower and more volatile, Physik Invest sought to initiate new trades.

At the time, in mid-August, call option premiums were attractive, in part due to interest rates, all the while IVOL metrics seemingly hit a lower bound.

This was observable via a quick check of skew, a plot of the IVOL levels for options across different strike prices. Usually, skew, on the S&P 500, shows a smirk, not a smile.

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE). Updated August 17, 2022. Skew steepened into $3,700.00 and below $3,500.00 in the S&P 500.

This meant it was likely that short-dated, wide Put Ratio Spreads had little to lose in a sideways-to-higher market environment. Additionally, call Vertical Spreads above the market were relatively more expensive.

Given the above context, the following analysis unpacks how Physik Invest traded options tied to the S&P 500 leading up to and through the August 19 OPEX, into the Jackson Hole Economic Symposium.

Note: Click here to view all transactions for all accounts involved.

Sequence 1: After a skew smile was observed, through August 12, 2022, the following positions were initiated, while the S&P 500 was still trending higher, for a net $7,616.68 credit.

Positions were structured in a way that would potentially net higher credits had the index moved lower.

  • SOLD 10 1/2 BACKRATIO SPX 100 (Weeklys) 26 AUG 22 3700/3500 PUT @ ~$0.13 Credit
  • SOLD 3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL @ ~$25.10 Credit

Sequence 2: While the S&P 500 was trading near $4,300.00 resistance, by 8/19/2022, all aforementioned Ratio Put Spread positions were rolled forward for a $452.26 credit.

The resulting position was as follows:

  • -17 1/2 BACKRATIO SPX 100 (Weeklys) 16 SEP 22 3700/3500 PUT
  • -3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL

From thereon the market declined and, by 9/1/2022, all positions were exited for a $6,963.84 credit.

  • BOT 17 1/2 BACKRATIO SPX 100 (Weeklys) 16 SEP 22 3700/3500 PUT @ ~$4.94 Credit
  • BOT 3 VERTICAL SPX 100 21 OCT 22 [AM] 4300/4350 CALL @ ~$4.57 Debit

Summary: In total, the sequence of trades net a $15,032.78 profit after commissions and fees.

The max loss (minus unforeseen events) sat at ~$6,790.00 if the S&P 500 closed above $4,350.00 in OCT. Because the Ratio Put Spreads were initiated at no cost, any loss, if the market went higher, would have been the result of the trade’s Vertical Spread component. Overall, this trade netted in excess of a 200% return; the trade’s profit was more than two times the initial debit risk, a multi-bagger.

Reflection: Heading into the trade, it was the case that IVOL performed poorly during much of the 2022 decline. This was likely to remain the case on a subsequent drop, hence the wide and short-dated Ratio Put Spread.

Still, in spite of the Ratio Put Spread exposing the position to negative Delta and positive Gamma (i.e., the trade makes money if the market moves lower, all else equal), if implied skew became more convex (i.e., implied volatilities grow more rapidly as strike prices decrease), the position could have been a large loss.

So, if the flatter part of the skew curve (where the position was structured) became more convex, which is not something that was anticipated would happen, then the only recourse would have been to (1) close the position or (2) sell (i.e., add static negative Delta in) futures and correlated ETFs.

In the second case, then, the trade would have been allowed time to work and turn into a potential winner, particularly amidst the passage of time.

Additionally, in accordance with Physik Invest’s risk protocol, more units of the Short Put Ratio Spread could have been initiated on the transition into Sequence 2. These units could have been held through Labor Day, then, and monetized for up to an additional ~$4.00 credit per unit.

Though additional units of the Vertical Spreads could not have been added, due to the strict limits to debit risks, there were still months left to that particular component of the trade. With lower prices expected, there was little reason the Verticals should have been removed fast.

Going forward, should the context from a fundamental and volatility perspective remain the same, only on a rally could Physik Invest potentially re-enter a similar position.

Categories
Commentary

Daily Brief For September 1, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 850+ that read this report daily, below!

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Graphic updated 8:15 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. 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.

Fundamental

In the past weeks and days, China and Taiwan tensions have seemingly worsened. Headlines this morning include China “simulating attacks on U.S. Navy ships,” and “Taiwan shoots down drone showing risk of escalation with China.”

This is all the while the conflict between Russia and Ukraine continues to rage, bolstering the structural issues contributing to the longer-lasting inflation we discussed on August 3 (HERE).

In that August 3 letter, we cited Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar on his perspectives regarding the weakening of “the pillars of the globalized, low inflation world.”

Since then, Pozsar wrote another note titled “War and Industrial Policy,” published on August 24 (HERE), alleging a “messy divorce” ongoing between large powers like the US and China.

For instance, the note said: “Pentagon chief’s calls to China go unanswered amid Taiwan crisis.” 

Yikes! Let’s unpack what’s going on a bit, further.

Basically, it’s the case that powers like Russia became “rich selling cheap gas” to countries like Germany who became “rich selling expensive stuff produced with cheap gas,” the note says.

Per Andreas Steno Larsen, now, countries like Germany are in a precarious position. 

It’s possible that the country “will likely make it through winter unless Russia 1) halts the gas flow completely and 2) the winter is extremely severe.”

No matter what, the “Germany economy will take a hit, … [and], given current forward prices, we are looking at CPI numbers well above 10% y/y. In France and Spain, that picture is even worse with numbers above 15% y/y.”

To dampen the impact of this inflation, countries like Denmark have resorted to “handing checks out almost randomly,” which does less to take from “inflationary pressures down the road.”

Graphic: Via Andreas Steno Larsen. “German energy component of CPI is only getting worse.”

In short, via de-globalization and populism, “the pillars of the low inflation world are changing,” per Pozsar and, the recourse, now, is a fight via asset price deflation, put forth on August 3.

In other words, de-globalization and populism have prompted an “inward shift of supply curves across multiple fronts (labor, goods, and commodities).” Accordingly, the economy is on a path that is “L”-shaped (i.e., vertical drop in activity via recession, and flatline for a period of time as rates remain higher for longer to prevent a sharp rise in inflation, again).

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

As Pozsar summarises: “we [have] to generate a big, “L”-shaped recession to slow inflation down; we [have] to generate a round of negative wealth effects to lower demand such that it becomes more in line with the new realities of supply.”

Separately, a Minsky Moment looms, Pozsar said.

“Minsky moments are triggered by excessive financial leverage, and in the context of supply chains, leverage means excessive operating leverage: in Germany, $2 trillion of value added depends on $20 billion of gas from Russia…that’s 100-times leverage – more than Lehman’s.”

Moreover, it is the case that, ultimately, after inflation is reduced, a “recovery [will be driven by] fiscally funded industrial policy” that: 

(1) Re-arms (to defend the world order); (2) re-shores (to get around blockades); (3) re-stocks and invests (commodities); (4) re-wires the grid (energy transition).

Graphic: Text retrieved from Kai Volatility’s Second Quarter (2022) Market Commentary And Outlook. Annotated by Physik Invest’s Renato Leonard Capelj.

With that in mind, Pozsar ends that there will likely be a commodity supercycle that is part of a new regime, Bretton Woods III. Read the full note, here, and/or listen to the below podcast.

Positioning

As of 6:35 AM ET, Thursday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.42%. Gamma exposures falling, at an increasing pace, may add to ranges and pressure.

Graphic: Created by Physik Invest. Data by SqueezeMetrics.

As discussed thoroughly in our August 31 (HERE) and August 18 (HERE) letters, our analyses had us structuring spreads against the $3,700.00-$3,500.00 area in the S&P 500 (INDEX: SPX).

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE). Updated August 17, 2022.

To quote the August 18 letter, it was “beneficial to be a buyer of options structures to protect against (potential) downside (e.g., S&P 500 [INDEX: SPX] +1 x -2 Short Ratio Put Spread | 200+ Points Wide | 15-30 DTE | @ $0.00 or better).”

This trade is near-finished and it is time to monetize (i.e., closing and converting a position to cash) as there is a risk of losing the Deltas built up this decline on a fast move higher, should one probably occur here, soon, with the S&P 500 trading into a key support zone we outlined.

Graphic: Retrieved from VIX Central. Compression in implied volatility would solicit positive delta hedging flows (vanna), and this could provide markets with a boost.

In short, it is beneficial to be a seller of those options structures (e.g., S&P 500 [INDEX: SPX] -1 x +2 Ratio Put Spread | 200+ Points Wide | 15-30 DTE).

Note: Trades Renato has personally taken remain to be unpacked in subsequent commentaries. Both the mistakes and successes, as well as what to do better.

Technical

As of 8:10 AM ET, Thursday’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 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.

Any activity above the $3,943.25 HVNode puts into play the $3,987.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,064.00 RTH High and $4,107.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,943.25 HVNode puts into play the $3,909.25 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,867.25 LVNode and $3,829.75 MCPOC, or lower.

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

Definitions

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

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

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

Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.

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

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, ex-Bridgewater Associate Andy Constan, 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 August 31, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 850+ that read this report daily, below!

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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. 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.

Fundamental

Working on a detailed fundamental write-up this week. Report back, soon.

Positioning

As of 6:30 AM ET, Wednesday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.38%. After the August monthly options expiration (OPEX) date, gamma exposures have trended (and continue to trend) lower which does more to take from market stability.

Graphic: Created by Physik Invest. Data by SqueezeMetrics.

Previously, based on our reads of realized (RVOL) and implied (IVOL) volatility, as well as skew, it was beneficial to be structurer of complex options structures like the Short Ratio Put Spread, down at S&P 500 prices between $3,700.00 and $3,500.00, to play contexts we (think we) have a solid read on.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

To quote the August 18 letter, “it is beneficial to be a buyer of options structures to protect against (potential) downside (e.g., S&P 500 [INDEX: SPX] +1 x -2 Short Ratio Put Spread | 200+ Points Wide | 15-30 DTE | @ $0.00 or better).”

Graphic: Retrieved from Cboe Global Markets Inc (BATS: CBOE).

Into the decline, those structures expanded and, now, the time has come to monetize. Though the decline (or increases in demand for options protection) may not be over, the trades are ripe for monetization (i.e., closing and converting a position to cash).

Graphic: Retrieved from The Market Ear. Via VIX Central. IVOL term structure. Expansion solicits bearish delta hedging flows with respect to changes in IVOL.

We buy (sell) when others are sellers (buyers), in short. Despite a bid in IVOL, personally, the concern is that the passage of time may do more to impact the trades negatively, all the while the trade’s exposure to changes in direction is very sensitive. 

Graphic: Retrieved from Bloomberg. “The number of outstanding bearish options contracts on an exchange-traded fund that tracks the Nasdaq 100 spiked on Aug. 19 to the highest level since the aftermath of the dot-com bust,” while “recent weakness in equities has been broad based, with almost 70% of Nasdaq 100 components making new four-week lows.”

In other words, the trade has a lot to lose on a move higher while a lot of big and unrealistic things have to happen for the trade expand much further.

So now, it is beneficial to be a seller of those options structures to monetize downside (e.g., S&P 500 [INDEX: SPX] -1 x +2 Ratio Put Spread | 200+ Points Wide | 15-30 DTE).

Note: Trades Renato has personally taken will be unpacked in subsequent commentaries. Both the mistakes and successes, as well as what to do better.

Technical

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

In the best case, the S&P 500 trades higher.

Any activity above the $3,978.25 LVNode puts into play the $4,006.25 ONL. Initiative trade beyond the ONL could reach as high as the $4,064.00 RTH High and $4,107.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower.

Any activity below the $3,978.25 LVNode puts into play the $3,921.00 VPOC. Initiative trade beyond the $3,921.00 VPOC could reach as low as the $3,867.25 LVNode and $3,829.75 MCPOC, or lower.

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

Definitions

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

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

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

Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 20, 2022

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

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What Happened

Ahead of a $1.9 trillion options expiration, which we unpack later in the letter, the equity index and commodity futures, as well as yields, were bid.

This activity was on the heels of good news coming from overseas. China lowered prime rates on the five-year by a record to boost mortgages and loans amid an ongoing pandemic slump.

In other news, China warned the U.S. over a ‘dangerous situation’ forming over Taiwan, and the U.S. is set to block Russian debt payments, raising concerns of default. 

This is as Russian forces, per Michael Horowitz of Le Beck Int’l, broke “Ukrainian defenses west of Popasna in the Donbass, … a tactical success for Russia, the first in a very long time.”

Ahead, there is no data scheduled for release. Enjoy your Friday!

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: Fundamentally, the narrative remains the same, albeit there has been a rise in concern over global growth given persistent supply chokepoints and a commitment to reducing liquidity and credit.

Moody’s Corporation’s (NYSE: MCO) Mark Zandi explains “the odds that the economy will suffer a downturn beginning in the next 12 months at one in three with uncomfortable near-even odds of a recession in the next 24 months.”

Graphic: Via The Macro Compass. “Analyst consensus for the 2022 US real GDP growth has been consistently revised down this year.”

Per Bloomberg’s John Authers, U.S. housing is slowing down in the context of still-heightened sales. Data on home building suggests builders “aren’t running scared” while chokepoints still are feeding into support for house prices.

“Now, with inflation rising, the Fed is more concerned about wealth effects,” Authers explained. 

“The rise in asset prices has made a lot of people wealthier and encouraged them to spend accordingly. It’s also stoked inequality. A fall in home values would be helpful at this point,” and it’s something the Fed is keen on “pursuing,” as talked about in letters earlier this week.

Graphic: Via Bloomberg.

Positioning: Friday marks the roll off of $460 billion of derivatives across single stocks and $855 billion of S&P 500-linked contracts, according to a Bloomberg report quoting Goldman Sachs Group Inc (NYSE: GS) research.

Graphic: Via Goldman Sachs Group Inc. Taken from Bloomberg.

Into this event, participants are hedged and volatility remains well-supplied, due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

Consequently, the market’s descent has been orderly and not exacerbated by the demand for hedges and associated repricings of volatility.

This was expected, per Kai Volatility Cem Karsan’s commentary published in December 2021.

“If a meaningful volatility event has recently transpired [e.g., COVID-19], implied volatility demand tends to be high,” as sellers of it were liquidated in previous declines and “buyers have been rewarded with profits and demand for their services.”

Graphic: Via Bloomberg. “2022 is shaping up to be the busiest year for option trading. Almost 40 million contracts have changed hands daily on average, 6% above last year’s record, data compiled by Bloomberg show.”

“Market participants are thus overly hedged going into the second move, resulting in the suppression of implied volatility and skew along with a dampening of realized volatility.”

Graphic: Commentary published by Kai Volatility.

Given the aforementioned supply and demand dynamic, as well as illiquidity, we continue to observe a “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says.

Graphic: Via @ftx_chris. “The relationship between illiquidity & volatility is a critical market driver for traditional markets now. In simple terms: lower liquidity creates increased volatility.”

“For some of these reasons – tempered measures of implied volatility – the market’s missing a lot of the ‘stored energy’ or ‘vanna fuel’ that’s helped support it in past periods of turmoil.”

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

So, barring changes in fundamentals, the catalysts to a potential rally are few and far between, and we elaborated on this in an earlier commentary.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

Heading into Friday, Bloomberg quotes the $4,000.00 S&P 500 (INDEX: SPX) strike having “93,000 open positions set to run out, … includ[ing] 41,024 calls and 52,269 puts.”

Graphic: Via SpotGamma.

An open well below $4,000.00 means that this expiration will coincide with the removal of a lot of in-the-money put-delta. That means, post-expiration, per SpotGamma, “market makers will be free to buy back stocks to cover the short exposures that are no longer needed.” 

“Any ultimate rally off of Opex, we’d consider to be short covering, and subject to swift reversals into the end of next week.”

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

In the best case, the S&P 500 trades higher; activity above the $3,943.25 high volume area (HVNode) puts in play the $4,061.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,095.00 overnight high (ONH) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,908.75 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as low as the $3,862.75 and $3,836.25 low volume areas (LVNodes), or lower.

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

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

Such traders often lack the wherewithal to defend retests.

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 19, 2022

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

Subscribe

What Happened

Overnight, equity index futures continued lower as weakness spread overseas. Commodities were mixed and yields were lower. At a high-level, measures of implied volatility held their bid.

Apart from the removal of structural forces underpinning a rally into mid-week, earnings reports played into “fears of the consequences of if inflation is brought under control,” per Bloomberg.

Ahead is data on jobless claims and manufacturing (8:30 AM ET). Later, existing home sales and leading economic indicators (10:00 AM ET). No events are scheduled for tomorrow.

Graphic updated 8:30 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: On the heels of Target reporting lower profits on costs and tighter margins, the beloved Cathie Wood of Ark Invest chimed in with a note on an explosion in inventories. Late last year, we quoted Wood suggesting businesses were scrambling to increase inventories.

Graphic: Via Bloomberg. “Target announced that sales were up, but profit was down thanks to increasing costs and tightening margins. Also like Walmart the day before, the market rewarded the stock with its biggest one-day decline since the Black Monday crash of October 1987. That’s alarming, although it’s worth pointing out that Target had been a conspicuous beneficiary of the pandemic to date.”

Though early, she said inflation would eventually be on its way out and inventory build-ups were one of the indicators to watch.

“Walmart Inc’s (NYSE: WMT) inventories increased 33% in nominal terms on a year over year basis, translating into 20-25% in real or unit terms, as Target Corporation’s (NYSE: TGT) inventories increased by 42% and 30-35%, respectively,” Wood said.

At the same time, sentiment has plunged to Great Recession levels, all the while consumers are “rebelling against their loss of purchasing power,” and China is in turmoil (talked about May 16).

These comments play into the recession narratives we unpacked earlier this week (May 17 and May 18). Monetary policies sent money to capital and that bolstered deflationary trends. 

Then came the pandemic and the increasing effects of inequality; money was sent to labor, and that bolstered inflationary trends.

Graphic: Via Bloomberg. “Overall wage increases were 6% in April, for the second month running — too high for the Fed’s comfort but at least with no increase. It is the least well paid who are commanding the highest percentage rises.”

As we quoted Kai Volatility’s Cem Karsan explaining, today’s contractionary monetary policy is a blunt tool and is not equipped to “address the main problem which is a lack of supply to absorb the demand.”

Graphic: Via Bloomberg. “China appears to be gradually easing its lockdown of Shanghai, but that won’t bring immediate relief to global supply-chain congestion.”

Likewise, Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar explained what he felt was “the Fed is pursuing demand destruction through negative wealth effects,” as the “central banks can only deal with nominal” chokepoints.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear. “A stronger dollar, lower equity prices, and higher mortgage rates will weigh on demand growth [and] Over time weaker output demand should lead to weaker labor demand Don’t fight the Fed as this is what Fed wants (slower growth).”

By that token, we must “[c]onsider at least the possibility that the extreme volatility and lack of liquidity [we] see in markets is by design, and the Fed will not be deterred by it, but rather that it will be emboldened by it in its singular pursuit of price stability.”

Why does any of this matter? 

As quoted, yesterday, “[w]ith supply-side economics, the only way that they can control [price stability] is to pull back. And slow capital markets decrease via the wealth effect. Ultimately, there’s a significant lag, so [the Fed is] not in a position to ultimately control inflation without bringing down markets.”

By that token, a stock market drop is both a recession and a direct reflection of the unwind of global carry. It is the manifestation of a deflationary shock, and today’s sentiment, the gradual build-up of inventories, tightening of financial conditions, and the like, are a reflection of this.

Graphic: Via Guggenheim Partners. Taken from MarketWatch. The “ Fed is headed toward overtightening financial conditions just as employment show some softness.”

Perspectives: Recall that the indexes are trading relatively strong, in comparison to constituents, especially those that are smaller technology and growth companies.

Essentially, “we’re two-thirds of the way through a dot-com type collapse,” we quoted Simplify Asset Management’s Mike Green explaining.

“It’s just happened underneath the surface of the indices which is [that] … dynamic of passive flows supporting the largest stocks within the index, whereas the smaller stocks can be influenced to a greater extent by the behavior of discretionary managers.”

Pursuant to those remarks, JPMorgan Chase & Co’s Marko Kolanovic says there are significant opportunities in the beaten areas of the market.

“I almost refuse to talk about ‘where should I buy S&P?’” he said adding that “[m]ost of the bad things have happened already this year.”

“There will be no recession this year, some summer increase in consumer activity on the back of reopening, China increasing monetary and fiscal measures.”

Per the earlier quoted Pozsar, Kolanovic, like Wood, maybe too early in his calls.

“Banks’ stock buybacks are lowering SLRs [], and the Fed is about to embark on QT,” Pozsar says. For context, QT (Quantitative Tightening) is the central banking authorities’ removal of balance sheet assets via sales or the non-reinvestment of the principal sum of maturing securities. 

The dynamic is as follows: if bonds are sold, their values fall and yields rise, thus pushing yield-hungry investors into less risky asset categories.

“These nominal balance sheet and liquidity trends, will at some point clash with the realities of a garden variety of supply chain issues,” as a result of geopolitical chokepoints.

Graphic: Per Bloomberg, “[E]very $1 trillion of QT will equate to a decline of roughly 10% in stocks over the next 12 months or so.”

Given Pozsar’s findings, the Fed is likely to do QE again in the summer of 2023. 

Checking Eurodollar (FUTURE: /GE), a reflection of participants’ outlook for U.S. interest rates, shows the peak of the Fed-rate-hike cycle – terminal rate – at around June 2023.

Positioning: This week’s expiration of options on the Cboe Volatility Index (INDEX: VIX), per SpotGamma, pulled forward the positive effects of volatility compression heading into the large May monthly equity and index options expiration (OPEX).

“Barring a forced re-pricing, we saw what was already little fuel to the upside drained into the weighty VIX options expiration (as bets on the VIX decay, this leads to hedging that bolsters S&P 500 upside),” SpotGamma said. 

“Following this event (and the coming monthly May OPEX), we see the door open to lower prices amid the removal of “max put” positioning which “clears the way for lower-lows.”

Heading into the monthly OPEX, if the S&P 500 Index (INDEX: SPX) is well below $4,000.00, “the buyback of short futures to short put exposures that no longer require liquidity providers to hedge,” may bolster a sharp reversal.

Graphic: Via SpotGamma. Taken from The Market Ear. “Deep short gamma where dealers are trapped in selling low and buying high and the poor liquidity environment, where the pushing of deltas (both ways) gets even more magnified due to non-existent volumes. This dynamic works both ways.”

Technical: As of 8:30 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.

In the best case, the S&P 500 trades higher; activity above the $3,862.75 low volume area (LVNode) puts in play the $3,908.75 micro composite point of control (MCPOC). Initiative trade beyond the MCPOC could reach as high as the $3,943.25 high volume area (HVNode) and $4,061.00 virgin point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,862.75 LVNode puts in play the $3,836.25 LVNode. Initiative trade beyond the LVNodes could reach as low as the $3,795.75 and $3,727.25 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.

Definitions

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

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

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

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

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 May 16, 2022

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

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What Happened

Overnight, equity index futures auctioned lower after a failed attempt to solicit strong buying on a break of Friday’s regular trade high. 

Coincidentally, after a test of an anchored volume-weighted average price level, some measures from China had traders concerned about global growth, and that fed into a risk-off sentiment and probe further into Friday’s range.

Moreover, ahead is data on Empire State Manufacturing (8:30 AM ET).

Today, we add light context to our narratives with an aim to elaborate further in letters later this week. Take care!

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

What To Expect

Fundamental: Data from China shows contraction in light of COVID-19 troubles.

Graphic: Via Bloomberg. 

Bloomberg’s John Authers explains that a contracting China “would be a deflationary force for the rest of the world.”

Graphic: Via Stenos Signals. “China imports vs. Commodities – the most important macro chart in the world right now.”

Andreas Steno Larsen, of the Stenos Signals letter, recently talked about this “lack of economic activity in China,” as well as “slowing demand in the West,” both of which are to “lead inflation expectations lower.”

Graphic: Via CrossBorder Capital. “Latest weekly Fed liquidity injections and the S&P 500. Bigger the bull, the harder they fall? Fed trying to crash [the] economy to kill inflation [and] Wall Street is the victim.”

Notwithstanding, the Federal Reserve (Fed) remains on track “to deliver substantial QT and rate hiking,” all the while investors “hold a relatively risk-friendly position in equities and credits.”

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear.

Steno Larsen explains: “That disconnect [between sentiment and exposure to risk] will have to wane before I truly dare to re-add risk asset exposure to my list of recommendations.”

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

Pursuant to that remark, Authers notes that the latest Chinese data emboldens the risks of a recession which Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar explains is not enough.

“[T]he risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects, and signs of a recession might not mean immediate rate cuts to ramp demand back up.”

“Rallies could beget more forceful pushback from the Fed – the new game.”

Graphic: Via @TheBondFreak. “2/10s spread has delivered its message. The long end is beginning to trend lower. NOW…it’s time to start watching the 3m/10yr spread, which will likely invert as the Fed continues with its rate hikes to kill demand, cause a recession, but “us” from inflation.”

Per Goldman Sachs Group Inc (NYSE: GS), baseline forecasts assume “no recession” and imply the S&P 500’s P/E ends unchanged at 17x. 

“A recession would see the index fall by 11% to $3,600.00 as the P/E drops to 15x.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear. A recession brings S&P 500 to $3,600.00.

Positioning: Early on Friday morning, we approached trade too optimistically but, to our credit, we focused on participating with as little risk as possible, via the use of complex strategies, as validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Heading into Monday’s regular trade, little has changed and indexes are holding well, relative to some constituents.

This is as participants are hedged and volatility markets remain well-supplied, due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

Kai Volatility’s Cem Karsan hypothesizes: “If a meaningful [volatility] event has happened within the last year, participants are more likely to be prepared for the move. So the ‘2nd event’ dramatically underperforms [implied volatility] skew expectations.”

“Take Jan/Feb 2016, Oct-Dec 2018, &…Sep 2020? All these ‘2nd Events’ ended up being as meaningful as their 1st events, if not more, for markets, but were much more orderly [and] accompanied by poor [volatility] performance.”

Graphic: Via Bloomberg. “For all the recent declines — the S&P 500 is down more than 13% from its high on March 29 — stress indicators also aren’t at levels seen during comparable slumps. Fewer than 30% of the benchmark’s members have hit a one-year low, compared with nearly 50% during the growth scare in 2018 and 82% during the global financial crisis in 2008.”

Given the aforementioned supply and demand dynamic, we continue to observe “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says. 

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

For “divergences in volatility realized and implied to resolve, it would likely take forced selling. Liquidity providers’ response to demand for protection would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

All else equal, SpotGamma adds, there is no catalyst to rally until the May 20, 2022 options expiration (OPEX). Till then, rallies are subject to failure.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

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

In the best case, the S&P 500 trades higher; activity above the $4,013.25 micro composite point of control (MCPOC) puts in play the $4,036.00 regular trade high (RTH High). Initiative trade beyond the $4,069.25 high volume area (HVNode) could reach as high as the HVNode and $4,119.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,013.25 MCPOC puts in play the $4,3978.50 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,943.25 HVNode and $3,899.00 VPOC, or lower.

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

Definitions

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

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

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

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 May 3, 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!

Subscribe

What Happened

Overnight, equity index futures were sideways, inside of the prior range, after exploring much lower, Monday. Measures of implied volatility, bonds, and most commodities were bid.

This is alongside news that Russia is dodging default, the necessity for the Fed to drop inflation down to 4% by year-end per Citadel’s Ken Griffin, the U.S. Treasury’s intent to scale back sales of longer-term debt, falling earnings estimates, Taiwan preparing to fend-off a potential invasion as Beijing ordered officials to find ways to fight against western sanctions, similar to those used against Russia, among other things including Fitch trimming China’s 2022 growth forecast.

Also, near risk-free, inflation-protected I bonds will pay 9.62% through October, the Treasury said, and here’s more on the Citigroup Inc (NYSE: C) trader that’s behind a European crash.

Ahead is data on job openings and quits, as well as factory and core capital goods orders (10:00 AM ET).

Read on for coverage on the fundamental and technical position of the market, as well as ways to position for future trade.

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

What To Expect

Fundamental: The Federal Reserve (Fed) is expected to raise its target overnight rate by about 50 basis points and provide updates on quantitative tightening (QT).

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Market participants expect a near-100% chance the fed moves its target rate to 75 or 100 basis points.

The expectations of the aforementioned have played into a tightening of financial conditions which, as Columbia Threadneedle’s Gene Tannuzzo explains, “reduces demand and ultimately slows inflation.”

Graphic: Via Bloomberg. “Tighter financial conditions are the mechanism that reduces demand and ultimately slows inflation,” said Tannuzzo, the firm’s global head of fixed income. “If financial conditions don’t tighten and inflation remains high, in their eyes, they need to hike more.”

The key is the update on QT. As Bloomberg’s John Authers puts it well, “what the Fed does with its balance sheet at the margin [] matters for asset prices, and there is little or no lag.”

Graphic: Via Crossborder Capital Ltd. Taken from Bloomberg.

The Fed’s liquidity reductions, thus far, have played into the market’s troubles since the start of the year. This is as QT has an impact on the “ability to roll over or refinance investments.”

Graphic: Taken from The Market Ear. “46% of non-earnings driven market cap changes were explained by Fed balance sheet expansion since GFC.”

Perspective: JPMorgan Chase & Co (NYSE: JPM) strategists note that investors’ fears are unwarranted. The U.S.’s economic expansion has not been derailed. 

“Worries about China’s growth outlook, a negative take on the Q1 earnings reporting season, concerns about higher bond yields and further tightening of financial conditions from a strong dollar, all appear to have soured equity and credit investors’ sentiment,” the strategists said. 

“We find these fears overblown.”

Positioning: Comments from yesterday’s morning letter remain valid, today.

Participants’ bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and extremely sensitive to changes in implied volatility and direction.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “Retail Investors buyers of 0-1 DTE (days-to-expiry) puts are largest on record.”

Those options carry a lot of gamma and are exposed to the potential for asymmetric or convex payouts. This is not good for those who are on the other side.

In hedging a short put, for instance, a positive delta and negative gamma trade, counterparties sell underlying if there is weakness or jumps in implied volatility. If the underlying trades higher, or dips in volatility, the counterparty will buy the underlying, all else equal.

Taken together, in such an environment, the counterparty leans toward taking liquidity and this exacerbates underlying movement if there’s a thinning liquidity environment, SpotGamma says.

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

In other words, hedging matters more in such an environment. This was clear during Monday’s trade when a bout of put selling and light call buying appeared in both the SPDR S&P 500 ETF Trust (NYSE: SPY) and Invesco QQQ Trust Series 1 (NASDAQ: QQQ).

This, ultimately, too, fed into the compression of volatility at the short-end of the term structure, yesterday. To re-hedge, counterparts likely bought into the market’s weakness and bolstered the near-vertical reversal, and close higher.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. A rising blue and orange denote put selling and call buying, respectively.

The odds of follow-through, to the upside, come back to the fundamental situation and Fed announcements this week. Should fears with respect to monetary policy be assuaged, then volatility can compress and that, alone, will spur a buy-back of those underlying short hedges.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,123.00 untested point of control (VPOC) puts in play the $4,176.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 VPOC and $4,279.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,123.00 VPOC puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,978.50 LVNode and $3,943.25 high volume area (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.

Considerations: Most interesting was Monday’s response at a key technical level ($4,055.75) outlined in the morning letter.

Specifically, the E-mini S&P 500 probed $4,056.00 before staging a sharp reversal and closing higher. This is noteworthy as it tells us a lot about who has (or is 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 and, additionally, this type of trade may suggest other time frame participants are waiting for more information to initiate trades.

Adding, the Federal Reserve’s meeting this week concludes with statements to be shared on Wednesday. For weeks heading into this event, (larger) participants (that move by committee) have de-grossed and hedged. For that reason, the reliability of our technical levels took a hit.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear. Per Bloomberg, “Hedge funds tracked by Morgan Stanley have also cut their net leverage — a measure of risk appetite that takes into account long versus short positions — to a two-year low.”

In the very near term, until more fundamental information is revealed, these technical-driven traders may play a larger role in the volatility. These traders, given capital constraints and tolerances, often trigger sharp moves in their entry and exit on news. Caution on whipsaw.

How I’m Playing: Presently, the market is stretched to the downside and participants are leaning, heavily, one way.

Graphic: Via SpotGamma, “Put vs Call gamma suggests stretched positioning.”

Pursuant to that remark, as SpotGamma says, “traders are underpricing right-tail risk,” and that opens the window for unique ways to play a returns distribution that is skewed positive (albeit with large negative outliers).

Consider zero- or low-cost bets that deliver asymmetric payouts in case of reversals.

This letter’s writer presently is structured positive delta and gamma in the Nasdaq 100 (INDEX: NDX) via ratios spread (1×2) and butterfly (1x2x1) structures. 

The concern with these strategies is the width and time to expiry. Should either of those be wrong, then spreads initially positive gamma turn negative, meaning losses are amplified.

For instance, in the Nasdaq 100, to put in short, 500-1000 points wide ratio spreads (buy the closer leg, sell two of the farther legs) expiring in ten to fifteen days work well. 

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk. Read more about these strategies, here.

Please note that the above is NOT a trade recommendation or advice.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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