Categories
Commentary

Daily Brief For August 12, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 750+ that read this report daily, below!

Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

We’ll skip the fundamentals section, today, and do an in-depth review, sometime next week.

Positioning

As of 7:00 AM ET, Friday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.06%. Net gamma exposures generally rising may promote tighter trading ranges.

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics.

As stated yesterday, it may be beneficial for traders to shift their focus to dynamic structures. In other words, be a buyer of options structures (i.e., replace static directional exposures or Delta with those that are dynamic).

This is (1) due to where realized (RVOL) and implied (IVOL) volatility measures, and skew. 

Graphic: Retrieved from Interactive Brokers Group Inc’s (NASDAQ: IBKR) Trader Workstation.

As well as (2) increased average stock correlation and lower return dispersion which, per Societe Generale SA (OTC: SCGLY) research, make stock picking hard(er).

It can be the case that Delta hedging becomes easier, too, as one asset, in a more correlated environment, can better offset the first-order sensitivities elsewhere.

Graphic: Retrieved from Bloomberg. Via Societe Generale.

The reason why? 

In regards to the correlation and dispersion remark, that’s more to do with the risk-off sentiment and the impact of tightening liquidity affecting all risk assets, basically.

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.

Regarding the volatility issue (RVOL, IVOL, and skew), that’s more to do with hedging trends. 

Essentially, the monetization and counterparty hedging of existing customer hedges, as well as the sale of short-dated volatility, particularly in some of the single names where there was “rich” volatility, into the fall, lent to lackluster performance in IVOL and index mean reversion.

Accordingly, “if commodities are not performing … as a hedge, that opens the door,” to markets falling and traders demand equity volatility hedges, per The Ambrus Group’s Kris Sidial.

Learn about options dealer flows, inflation, and investing in a changing world with Cem Karsan.
Graphic: Retrieved by Physik Invest from TradingView. S&P Goldman Sachs Commodity Index.

Adding, per to SpotGamma, “a lot of the boost from volatility compression has played out. With IVOL at a lower bound, it may be opportune to replace static Delta bets for those that are dynamic (i.e., long option exposures) and have less to lose in this lower volatility environment.”

Graphic: Retrieved from Vix Central. The term structure of IVOL.

“In a case where market participants see the Fed keeping its commitment to aggressive monetary policy action, negative Delta options exposures may outperform static short equity (bets on the downside).”

Graphic: Retrieved from Bloomberg. “Thursday’s message was that on mature reflection, the progress on the economy didn’t justify taking the stock market any higher than it was at the start of the day.”

If bullish, sample structures to consider, given a smiley skew, include low- or zero-cost bullish call ratio spreads, against the trend resistances in products like the S&P 500 (INDEX: SPX).

Graphic: Retrieved from Bloomberg. Drawn on by Physik Invest.

Technical

As of 7:00 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a nearly 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 $4,227.75 HVNode puts into play the $4,253.25 HVNode. Initiative trade beyond the latter could reach as high as the $4,275.75 LVNode and $4,303.00 Weak High, or higher.

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

Any activity below the $4,227.75 HVNode puts into play the $4,202.75 RTH Low. Initiative trade beyond the RTH Low could reach as low as the $4,189.25 LVNode and $4,153.25 HVNode, or lower.

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

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, 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 4, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 750+ that read this report daily, below!

Graphic updated 7:10 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

A heavy week content-wise. 

Monday, we talked about some of the big narratives participants are seeking to price. Tuesday and Wednesday we elaborated, providing information on the calculation of net liquidity and its relationship with equity index prices, as well as the probable paths the economy may traverse.

Today, we’ll add context with respect to some of the big headlines heading into today’s trade.

At the top of the list is geopolitical tension. US House Speaker Nancy Pelosi traveled to Taiwan. 

It’s the case that “China views Taiwan as a breakaway island” subject to mainland rules. The visit by Pelosi, who, per NPR, “has long been a critic of China and an advocate for Taiwan’s democracy,” China viewed as a provocation.

Accordingly, China responded with trade boycotts and military exercises such as the firing of 11 missiles into the sea around Taiwan.

Graphic: Retrieved from Bloomberg.

White House officials, per Bloomberg, were said to be “fuming” at Pelosi. In response, the Biden administration was seeking to put brakes on friendlier US and Taiwan policies.

In other news, an ISM Services reading climbed unexpectedly, easing the concern of economic slowing while other data showed material and commodity prices falling.

Graphic: Retrieved from S&P Global Inc’s (NYSE: SPGI) commodity insights.

Still, more firms, from the likes of Credit Suisse Group AG (NYSE: CS) to Robinhood Markets Inc (NASDAQ: HOOD), are seeking to cut thousands of jobs and restructure.

Graphic: Retrieved from The Daily Shot.

And, though equity markets are enjoying some relief, profit forecasts continue to be cut, and broad measures of the supply of money are falling.

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.

Additionally, many maintain that conditions are set to get tighter with the Bank of England raising rates the most since 1995 and a Fed funds rate of 5-6% not out of the realm of possibilities.

Graphic: Retrieved from @ConvexityMaven. “Home buyers don’t panic, retail Mortgage rates should soon be under 4.90%. MBS (mortgage bonds) usually trade ~75bp above the 10yr swap rate  (~85bp above the UST10yr rate). The retail Home loan rate should be ~100bp above MBS rate (chart). Mortgage brokers will be begging soon.

Positioning

As of 7:10 AM ET, Thursday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.14%. Net gamma exposures increasing may promote tighter ranges at higher price levels.

Context: Customers concentrate bets at and above current S&P 500 (INDEX: SPX) prices. 

Taking the naive view and assuming this activity is, indeed, aligned with historical trends (i.e., customers sell calls and use those proceeds to finance protection, down below), then counterparts are likely taking on exposure to more long call positions, which they hedge by selling underlying. Into strength, some more underlying will be sold. Into weakness, some underlying will be bought. This activity can promote mean-reversion at higher prices.
Graphic: Retrieved from SpotGamma. Changes in call open interest.

As well put in our August 3 letter, given where realized (RVOL) and implied (IVOL) volatility are, as well as skew, it is beneficial to be a buyer of options structures (e.g., put back spread).

Graphic: Updated 8/3/2022. Time-lapse skew on the S&P 500 (INDEX: SPX) for Tuesday, Monday, and one week ago. Retrieved from Interactive Brokers Group Inc’s (NASDAQ: IBKR) Trader Workstation.

According to SpotGamma, “data suggests markets have entered into a period of normalization” and “IVOL likely reached a lower bound (see the bid skew).”

Graphic: Retrieved from Bloomberg. “The CBOE VIX index shows price swings usually rise in the summer and early autumn, and the S&P 500 is now entering its period of the worst historical returns over the past 25 years.”

“To maintain a risk-on (rally) environment, traders would need to position themselves into call options, now, further up in price, farther out in time, which they seem to be doing, albeit in not overly significant quantities.”

Notwithstanding, as SpotGamma adds, “with participants getting rid of commodity inflation and long volatility hedges that performed poorly, [this] (1) leaves equity markets more susceptible to the whims of potentially negative underlying macro forces and (2) leaves volatility markets more prone to jumps.”

Thus far, it’s the case that we’re far more than halfway through a dot-com type collapse that’s happened “underneath the surface of the indices,” per Simplify Asset Management’s Mike Green. Should those strong passive flows falter, that likely takes from some of the support in the largest of index constituents.

Graphic: Retrieved from The Market Ear. Via Barclays PLC (NYSE: BCS).

Were the latter to happen, you’d want protection in the form of structures that would enable you to monetize on some sort-of non-linear repricing in volatility (e.g., butterflies and back spreads), should participants seek protection in a way they haven’t this year.

If nothing were to happen, the bid in skew would, at least, assist those structures in maintaining their value better, essentially.

Technical

As of 7:00 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 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.

Any activity above the $4,153.25 HVNode puts into play the $4,189.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,227.75 HVNode and $4,259.75 LVNode, or higher.

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

Any activity below the $4,153.25 HVNode puts into play the $4,117.75 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $4,073.00 VPOC and $4,040.75 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.

Considerations: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are 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.

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, 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 July 15, 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!

Graphic updated 6:35 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

Note: A really interesting discussion in the below positioning section which tidies up some of the past analyses we’ve made. Read on for more!

Ahead are updates on retail sales, import prices, Empire State Manufacturing (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), as well as University of Michigan consumer sentiment and inflation expectations, and business inventories (10:00 AM ET).

This week, markets repriced after data on inflation came in hot. Participants have bet on tough action from the Federal Reserve (Fed). Now, there is a near-50% chance of a 100 basis point hike later in July.

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

Per The Macro Compass, published by Alfonso Peccatiello, companies have downgraded their outlooks and job creation “is much less impressive” amid labor force shrinkage.

“[T]he number of total employed people in the US divided by its total population in the 25-54y age bracket dropped below 80%,” he explains. “Over the last 30 years, at the peak of each economic cycle, this ratio was over 80%.”

Accordingly, earnings “are nowhere near pricing the economic slowdown, … [and there still remains] way too much optimism.”

Graphic: Retrieved from The Market Ear. Via Barclays Plc (NYCE: BCS).

Additionally, commodities (even more so those that are industrial and “are the cleanest expression of global demand”) have endured selling pressure with a near 30% copper drawdown likely to precede positive total returns for long bonds, Peccatiello explains.

Graphic: Retrieved from Callum Thomas. With “[r]ecessions see[ing] oil prices fall by 20% to 70%, … being bullish on oil at this point is either betting against history or [] recession.”

Positioning

The drawdown in commodities is significant as that was, arguably, the last place that offered participants a hedge against their poorly performing bond and equity exposures. 

“A lot of people allocated to commodity trend following and that did a good job in the first two quarters,” The Ambrus Group’s Kris Sidial explained

“CTAs were performing and you had a lot of people who did not need to buy [equity] volatility because their portfolios were covered from the inflation hedges.”

Graphic: Shared by Benn Eifert of QVR Advisors.

That, coupled with the sale of ultra-short-dated volatility, particularly in some of the single names to capture “rich” volatility, as well as hedging of structured products issuances, continues to play into suppressed index volatility.

For context: Rising rates and a drive for yield have been a boon for exotic derivatives. 

Participants often seek exposure to products that are essentially short volatility a year or so out. The counterparty, here, is long volatility on these notes. To hedge risk – since “you can’t just be long volatility, … [otherwise] you’ll bleed money for long periods of time” – the bank will hedge risk in the listed market. 

However, on a one-year auto-callable, for which it would be appropriate to sell one-year volatility in the listed market, “some of these banks … create this synthetic calendar profile where they’re … sell[ing] a little bit of one-month vol because they can take in that theta a whole lot faster, or two- and three-month vol,” spreading exposure in buckets.

See, here, for a sample presentation on what is an Auto-Callable Yield Note.

This suppresses “vol in the front of the term structure, and … opens up the door to … that other move where if everybody is selling vol in the front of the term structure,” it may blow out on a large increase in demand.

“If you look back during COVID, there are articles about banks that lost a lot of money because of the[ir] hedges. This has happened previously and you’re seeing little blips of it start to” return.
Graphic: Retrieved from The Ambrus Group’s Kris Sidial. “[S]ome dealers will opportunistically look to sell vol in some buckets in the front of the term structure.”

Basically, “the macro landscape … opened up another area to hedge” which resulted in the increased movement of realized equity (RVOL) volatility, relative to that which is implied (IVOL).

Graphic: Via S&P Global Inc (NYSE: SPGI). As explained by SpotGamma, “30-day realized SPX volatility is now trading above the VIX, something that generally shows after major selloffs wherein IV “premium” needs to reset to calmer/higher equity markets.”

Now, with commodities not offering protection, one has to be concerned if “the flock move[s].”

“If commodities are not performing, they’re not going to work as a hedge for your portfolio. That opens the door … [to] markets sliding lower and [people] need[ing] to get hedges on,” which is likely to bid equity volatility where some single names “are only trading three to four vol points above where they were trading in January of 2020,” the complete dismissal of a crash.

Therefore, “if you wanted to go out and hedge, the opportunity is still there in the equity space.”

Technical

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

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

Any activity above the $3,807.00 VPOC puts into play the $3,830.75 MCPOC. Initiative trade beyond the MCPOC could reach as high as the $3,867.25 LVNode and $3,909.25 MCPOC, or higher.

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

Any activity below the $3,807.00 VPOC puts into play the $3,770.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,751.00 VPOC and $3,722.50 LVNode, 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: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are 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.

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, former 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 July 8, 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!

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

A light few letters after what it seems were like weeks of heavy content to discuss.

Further, prices at the pump are falling on an “unseasonal” drop in consumption, all the while the biggest bulls have tempered their outlooks on the market citing inflation and the implications of geopolitical tensions.

Graphic: National average gas prices posted by AAA.

An overseas slowdown affecting China likely solicits stimulus. Reported was China’s Ministry of Finance considering the sale of special bonds with proceeds used to pay for infrastructure and boost a slowed economy increasingly in the clear from Covid.

Graphic: Shared by Alfonso Peccatiello. “the pace of real-economy money printing (not bank reserves…) going on in the 5 largest economies in the world. It’s a good leading indicator for economic growth & the performance of several asset classes. It just printed below the GFC lows.”

Moreover, as talked about yesterday, inflation may have peaked. Inventories are pointing to a looming supply gut.

Graphic: Via Bloomberg.

Accordingly, the Federal Reserve (Fed), just as it was slow to end stimulus late last year and early this year, maybe slow in moderating its efforts to de-stimulate.

Graphic: Retrieved from Axios. “The glut of cash being parked at the Fed is reflective of policies that have already run their course, especially with quantitative tightening underway.” But, “it’s a representation of how much too far the Fed went in easing,” says Thomas Simon, an economist at Jefferies Financial Group (NYSE: JEF).

Minutes from the last Federal Open Market Committee (FOMC) meeting revealed a rate hike up to 75 basis points in July would be appropriate, per Moody’s Corporation (NYSE: MCO).

A strong jobs report would likely prompt the Fed “to raise rates even more aggressively as they pursue their goal to raise the unemployment rate,” explains Bryce Doty of Sit Fixed Income.

“As [the Fed] seek[s] to destroy demand, they are also destroying supply. As a result, inflation will persist longer and the economy will be even worse.”

This is pursuant to calls by the Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar who put forth, earlier this year, that the “Fed is pursuing demand destruction through negative wealth effects,” as the “central banks can only deal with nominal [and] not real 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).”

Ultimately, the “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.”

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

Graphic: Via Bloomberg.

Positioning

Data shows net gamma exposure increasing which may increasingly feed into smaller ranges and a positive drift amid shorter-dated volatility sales and a pick up in call demand, particularly in some of the larger index weights.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL). Rising orange and blue lines point to call buying and put selling, both of which have bullish implications.

The creep in volatility realized (RVOL), versus that which is implied (IVOL), coupled with “a flattening in the downside fixed strike skew, while the upside wings [are] more smiley,” per JPMorgan Chase & Co (NYSE: JPM), makes it so we can put on more complex structures.

Graphic: Via S&P Global Inc (NYSE: SPGI). As explained by SpotGamma, “30-day realized SPX volatility is now trading above the VIX, something that generally shows after major selloffs wherein IV “premium” needs to reset to calmer/higher equity markets.”

For instance, ratio spreads continue to work well for low- or no-cost exposure to the upside. 

Graphic: Via Option Alpha.

Likewise, if one thought volatility, though at a high starting point particularly at the money (ATM), was due for a repricing, they would look for exposure to the downside via something such as an inverse ratio (or backspread). 

This is as the ATMs, unlike those further out of the money (OTM), are less convex in vega.

Graphic: Via Option Alpha.

Technical

As of 6:30 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper 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 $3,909.25 MCPOC puts into play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as high as the $3,982.75 LVNode and $4,016.25 HVNode, or higher.

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

Any activity below the $3,909.25 MCPOC puts into play the $3,867.25 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,831.00 VPOC and $3,800.25 LVNode, 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: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are 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.

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, former 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 July 1, 2022

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

What Happened

Overnight, equity index futures were sideways to lower. Commodities and bonds were mixed. Implied volatility measures fell. The dollar rose.

A volatile quarter-end ahead of a long weekend. Noteworthy is the market’s responsiveness to visual levels. For instance, the S&P 500’s (FUTURE: /ES) high of the day printed at $3,821.50 or so, a key level in yesterday’s morning letter. 

This points to heightened activity by technically-driven traders with short time horizons. 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.

Moreover, on an annual basis, core inflation was the lowest since November while consumers’ spending cooled suggesting the economy is on a weaker footing. In Europe, inflation hit a record, boosting calls for more aggressive monetary policy action.

Adding, Goldman Sachs Group Inc (NYSE: GS) strategists see equity valuations falling further “[u]nless bond yields start to decline and buffer rising equity risk premiums.” Michael Burry, the Founder of Scion Asset Management, too, sees declines lasting on “earnings compression.”

Ahead is data on S&P Global Inc’s (NYSE: SPGI) manufacturing PMI (9:45 AM ET), as well as the ISM manufacturing index and construction spending (10:00 AM ET).

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

What To Expect

Fundamental: A bit philosophical here, today, as a difficult half-year has passed and I’m low on the time I have to commit to analysis this morning.

Markets are substantially lower from the end of 2021, all the while there are now, in greater quantity and frequency, calls being made that equities have more room to the downside.

That very well may be the case, and the upcoming earnings season is likely to provide investors clarity with respect to corporates’ ability to weather or pass on higher costs, among other things.

Read: Former Bridgewater Associate Talks Recession Odds, Capturing A Macro Edge.

Regardless, everything we discuss on a daily basis – fundamental and technical market drivers – will do little for us if we do not have a framework for assessing risk and opportunity

Before ever taking a position, I ask myself the following: What is it that I have to lose? For me, the answer depends. 

At times, it is dependent on a position’s payoff profile. At others, it’s the max pain I’m willing to subject myself to during adverse market conditions or when I have limited mental capital. 

As Dennis Gartman of the Gartman Letter said:

“Capital comes in two varieties: Mental and that which is in your pocket or account.”

“[T]he mental is the more important and expensive of the two. Holding to losing position costs measurable sums of actual capital, but costs immeasurable sums of mental capital.”

Graphic: Retrieved from Twitter. Dennis Gartman’s Rules of Trading.

And, with that, the other key is that the money is made in not losing it. Fortunately, this law was impressed on me, early. Returning 100%, only to suffer a 50% loss, sets you back to where you were, initially.

These comments are pursuant to traders I’ve had the honor of connecting with over the past year or so. Many made a killing to only have given most, if not all of it, back.

This has an immeasurable effect on one’s mental capital.

Though I’ve not participated in the most recent weaknesses, my mental capital has suffered. I’ve, subsequently, reduced the size of my positions and opted to define my losses, buying into volatility while it is cheap, as I view it, and waiting for the relationship to flip to sell in size.

Returning to the comment on whether the market’s de-rate has played out. I do not know. Can it go further? Probably. There are a host of references converging below current market prices, as pointed to in the Technicals section, below, that probably are taken at some point in the year.

That said, whether long or short, ask what it is that you have to lose? 

If it’s a number, define your loss and take the trade. Take (or provide) liquidity when others don’t want to. Buy (or sell) volatility when it is cheap (or expensive). Let the trade work.

It’s a coinflip, probably, at the end of the day. If we know what we have to gain and lose, we’ve moved the expected outcome that much further our way. Have a good long weekend, team.

Read: A guide to making money for individual traders retrieved from SqueezeMetrics.

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 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 $3,770.25 HVNode puts in play the $3,793.75 HVNode. Initiative trade beyond the latter HVNode could reach as high as the $3,821.50 LVNode and $3,840.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,770.25 HVNode puts in play the $3,727.75 HVNode. Initiative trade beyond the latter HVNode could reach as low as the $3,688.75 HVNode and $3,639.00 RTH Low, or lower.

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

Considerations: At $3,500.00 in the S&P 500 (INDEX: SPX), or $350.00 in the SPDR S&P 500 ETF Trust (NYSE: SPY) is the convergence of multiple visual references.

The 50.00% retracement (COVID-19 low through to 2021 peak), the 200-week moving average, and the volume-weighted average price anchored from the 2018 market bottom all converge at this $3,500.00 ($350.00) high open interest strike.

Graphic: Via TradingView. Taken by Physik Invest. SPDR S&P 500 ETF Trust (NYSE: SPY).

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.

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 June 24, 2022

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

What Happened

Overnight, equity index futures resolved a multi-day consolidation and auctioned higher, far beyond the prior day’s range. Commodities were mixed while bonds were lower.

The break from consolidation is one of the most bullish happenings in weeks. We’re monitoring whether participants add to their recent short volatility bets against direction, or whether there is repositioning and this bolsters the initiative probe.

Ahead is data on University of Michigan consumer sentiment, inflation expectations, and new home sales (10:00 AM ET), as well as some Fed speak (7:30 AM and 4:00 PM ET).

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

What To Expect

Fundamental: To start, I want to apologize for any confusion, yesterday, with respect to the /GE Eurodollar quote. This newsletter said the peak of the Fed-rate-hike cycle – terminal rate – sat near December 2023. 

That’s wrong. It’s December 2022.

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around DEC 20[22].

Okay, moving on, now!

New data is pointing to a “remarkable” drop in demand for goods and services during June, compared to months prior. 

“US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” S&P Global (NYSE: SPGI) Market Intelligence’s Chris Williamson explained.

“The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”

Graphic: Via S&P Global Inc. “This is a sizeable miss and evidence of a quick slowdown in demand, though it’s still in positive territory (above 50). This report is consistent with a shifting narrative away from inflation worries and towards growth worries.”

Businesses (particularly in retail) are way “more concerned about the outlook” of costs and demand, as well as the path in monetary policies and deterioration in financial conditions. 

Graphic: Via Bloomberg. “Supply constraints, exacerbated by Russia’s war in Ukraine this year, account for about half of the surge in US inflation, with demand currently making up a third of the increase, according to new research from the Federal Reserve Bank of San Francisco.”

That’s validated by Tesla Inc’s (NASDAQ: TSLA) CEO Elon Musk speaking about the carmaker’s losses from new plants, supply chain problems, and the like. 

Graphic: Via Bloomberg. “Long-term ocean freight rates between China and the US West Coast are higher than spot prices for the first time since April 2020.”

“The past two years have been an absolute nightmare of supply chain interruptions, one thing after another,” Musk said.

“We’re not out of it yet. That’s overwhelmingly our concern is how do we keep the factories operating so we can pay people and not go bankrupt.”

Graphic: Via Bloomberg. “Supply chains in Asia look to be on the mend,” though it will “ take a while for supply and demand to rebalance.”

It’s a global move into recession all at once, as Jeffrey Snider of Alhambra Investments says

Read: Daily Brief for May 18, 2022

“​​Combine the potential for break in repo collateral with economy heading toward recession, no wonder the Euro[dollar] curve inversion is spreading as rapidly as it has. Possibility of something big going wrong, therefore ending rate hikes, is huge now.”

“Euro[dollar] squeeze, collateral shortage, deflationary potential in money, and now demand destruction in global real economy.”

Graphic: Via Alhambra Investments.

Over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted innovation and, by that token, deflation, ultimately creating “unimportance to cash flows,” as well put by Kai Volatility’s Cem Karsan. 

Now, there’s a strong commitment to reducing liquidity and credit, all the while there are chokepoints monetary policymakers have little control over. 

This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay. A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s poor sentiments and economic data reflects this.

At the same time, “bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang puts it. 

Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”

Retail buyers, who, according to Michael Wang of Prometheus Alternative Investments, “were a significant driver of the inflated valuations we saw in tech and crypto,” are capitulating in stocks, all the while froth in housing markets is soon to abate, likewise.

Notwithstanding, Mark Zandi of Moody’s Corporation (NYSE: MCO) does not see “the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values,” just as prices of raw materials are retreating as inventories are bloating.

As put forth, partially, earlier this week, one has to wonder about the likelihood that inflation is near its high and whether the de-rates have played their course.

Let’s keep an open mind and follow up on this, in detail, next week.

Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”

Positioning: Keeping this section short. 

As stated yesterday, a feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL) given that participants are hedged and volatility remains in strong supply. 

Read: Daily Brief for June 23, 2022.

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

Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

As I said in SpotGamma’s note, last night, given “the high starting point in IVOL, as well as its place in relation to [RVOL], it makes sense to own structures that benefit either from sharp changes in underlying price or an abrupt repricing in volatility.”

Cutting into the realization of a sharp change in underlying price or a far-reaching rally, however, are short-volatility bets across shorter maturity periods (and the associated hedging), as well as big (and popularized) positions set to roll off at the quarter-end.

Liquidity providers, per SpotGamma, all else equal, will have to sell to re-hedge, and we will talk about this further, next week.

Graphic: Taken 6/22/2022. SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator points to selling of put and call options in the S&P 500 (INDEX: SPX) and S&P 500 ETF (SPY). Those liquidity providers, who are on the other side, are more exposed to long volatility, which they hedge by buying (selling) into weakness (strength) underlying.

Technical: As of 6:40 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, 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 $3,821.50 LVNode puts in play the $3,843.00 RTH High. Initiative trade beyond the RTH High could reach as high as the $3,911.00 VPOC and $3,943.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,821.50 LVNode puts in play the $3,793.25 ledge. Initiative trade beyond the ledge could reach as low as the $3,770.75 HVNode and $3,735.75 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.

Considerations: Recent trade has been lackluster and the overnight break is the most bullish happening in weeks. The go-to trade this week was short volatility. Participants responded to tests of key visual areas, and sold options, particularly in shorter maturities.

In the coming session(s), some of those participants will respond to the break in a manner that bolsters the initiative drive. Notwithstanding, the key to watch for is whether participants will use the bump as an opportunity to add to their most recent short volatility bets against the direction. 

Ultimately, the more time that is spent outside of the prior consolidation area, the likelihood that the breakout is a signal to look for dips to buy and play rotations to key areas up above.

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.

Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. 

Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator. 

Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

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 June 23, 2022

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

What Happened

Overnight, equity index futures auctioned higher, inside of the prior range, with bonds. Commodities were mixed and implied volatility measures were bid.

Yields fell after comments by Federal Reserve (Fed) Chair Jerome Powell and growth updates in Europe stoked fears of a global downturn, per Bloomberg, as the prospects of a soft-landing look “very challenging.” 

“Financial conditions have tightened and priced in a string of rate increases and that’s appropriate,” Powell said. “We need to go ahead and have them.”

Today we’ll dive into positioning – what’s promoting responsive trade – and how to think about the market, accordingly.

Ahead is data on jobless claims and current account (8:30 AM ET), as well as S&P Global Inc (NYSE: SPGI) manufacturing and services PMI (9:45 AM ET), followed by the Federal Reserve (Fed) Chair Jerome Powell’s testimony (10:00 AM ET).

Graphic updated 7:50 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Positioning: Fed Chair Powell added clarity to the central bank’s stance on policy, and its intent to tighten without pushing the economy into a recession, which we’ve argued we’re already in. 

Graphic: Via Morgan Stanley (NYSE: MS).

“The other risk, though, is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy,” Powell said. “We can’t fail on that task. We have to get back to 2% inflation.”

The peak of the Fed-rate-hike cycle – terminal rate – now sits at December 2022.

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around DEC 2022.

A feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL).

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). The divergence in IVOL by participants’ options activity, versus RVOL, continues to resurface in the S&P 500 via the SPDR S&P 500 ETF Trust (NYSE: SPY).

As talked about before, participants are hedged and volatility remains in strong supply. Options data and insights platform SqueezeMetrics explains that this is due in part to lower leverage.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator points to selling of put and call options in the S&P 500 (INDEX: SPX) and S&P 500 ETF (SPY). Those liquidity providers, who are on the other side, are more exposed to long volatility, which they hedge by buying (selling) into weakness (strength) underlying.

“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”

Graphic: Via SqueezeMetrics.

Accordingly, it remains profitable to own options structures.

“This is the opposite of 2017 where the VIX was at 10% and the realized was 7%,” a trade that leverage poured into and resulted in the spectacular short-volatility ‘Volmageddon’ blow-up in February of 2018,” Dennis Davitt of Millbank Dartmoor Portsmouth explains.

Read: Daily Brief for May 24, 2022.

Graphic: Via Millbank Dartmoor Portsmouth.

How to play?

IVOL is bid and at a “higher starting point,” as I described in a SpotGamma note. Noteworthy, too, was the change in tone with respect to the non-linearity and strength of volatility with respect to linear changes in asset prices.

Read: Daily Brief for June 16, 2022.

In the current environment, we have to ask ourselves what would hurt participants the most?

It’d likely be forced selling or demand for protection by a greater share of the market in ways not seen. The associated repricing of IVOL would be a boon for those who own options, particularly in strikes further from current prices where there is a ton more convexity in volatility.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). SPDR S&P 500 ETF Trust (NYSE: SPY) implied volatility skew, or the difference in IVOL – an estimate of potential price changes given the fear of movement – between options strikes that are close and far from the underlying’s current price. Notice the sensitivity of this curve farther out.

Still, with volatility at that higher starting point, many have exposure to positive delta (options that increase in value if the market goes up, all else equal) and gamma (the amplification of profits as the underlying continues to trade higher). 

That (insignificant) demand in the right tail still makes it so we may position, for cheap, in spread structures that still offer attractive and asymmetric payouts (e.g., 500 to 1000 point wide Nasdaq 100 butterflies and ratio spreads maturing up to 20 or 30 days out).

Read: Trading Volatility, Correlation, Term Structure and Skew by Colin Bennett et al. Originally sourced via Academia.edu.

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 (the inverse of a back spread).

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

In the best case, the S&P 500 trades higher; activity above the $3,787.00 VPOC puts in play the $3,821.50 LVNode. Initiative trade beyond the LVNode could reach as high as the $3,843.00 RTH High and $3,911.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,787.00 VPOC puts in play the $3,735.75 HVNode. Initiative trade beyond the $3,735.75 HVNode could reach as low as the $3,696.00 LVNode and $3,639.00 RTH Low, or lower.

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

Considerations: The SPDR S&P 500 ETF Trust (NYSE: SPY) is above the convergence of a key anchored volume-weighted average price level and retracement.

In the case of a continued downside, that is an area where participants may see a response.

Graphic: Via TradingView. Taken by Physik Invest. SPDR S&P 500 ETF Trust (NYSE: SPY).

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.

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

Modus operandi is responsive trade (i.e., fade the edges), rather than initiative trade (i.e., play the break).

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 June 8, 2022

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

What Happened

Overnight, equity index futures took back some of Tuesday’s sharp advance which happened against the trend of prevailing options activity (discussed further below).

This is as narratives remain unchanged. Investors are pricing the implications of the actions to address heightened inflation, as well as how that may play into (further) economic slowing.

Ahead is data on wholesale inventories (10:00 AM ET). Below is a light commentary to rebuild our narrative after the week-long pause.

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: On Friday, participants will receive an update on inflation when consumer price data is released.

Graphic: Taken from Morningstar Inc (NASDAQ: MORN). Forecasts for this week’s remaining U.S. data from a survey compiled by The Wall Street Journal.

It is one of the Federal Reserve’s commitments to promote stable prices; the institution is aiming for a soft landing just as supply chains, higher prices, and borrowing costs, among other things, are cutting into growth. 

Graphic: Via the New York Federal Reserve. Taken from Bloomberg. “The gauge brings together 27 variables that take the temperature of everything from cross-border transportation costs to country-level manufacturing data in the euro area, China, Japan, South Korea, Taiwan, the UK and the US.”

“The Fed is in a major jam,” said Oren Klachkin of Oxford Economics. “They don’t want to let inflation spiral but they also don’t want to kill the expansion. Finding the middle ground between those is hard, and their tools are blunt, so the task before them is monumental.”

Graphic: Via Bloomberg analysis of the World Bank Group’s Flagship Report – Global Economic Prospects – for 2022. “Against the challenging backdrop of higher inflation, weaker growth, tighter financial conditions, and limited fiscal policy space, governments will need to reprioritize spending toward targeted relief for vulnerable populations.”

Last Wednesday marked the start of quantitative tightening (QT), a practice used to shrink the Fed’s balance sheet and amplify the effect of rate hikes, further cutting into financial conditions, “the mechanism through which the Fed [impacts] the real economy,” explains Dennis DeBusschere of 22V Research.

“If the data doesn’t slow, financial conditions will need to tighten more,” and this will play into less demand for goods and services, many of which (are continuing to) remain in short supply.

Graphic: Taken from S&P Global Inc (NYSE: SPGI). 

Accordingly, Joseph Wang, who was a trader at the Fed, explains well that cash, which has been spared from the market rout, is set to become scarcer.

“Bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” he said. “Investors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.”

Graphic: Via the Investment Company Institute. Taken from Joseph Wang. “Investors are selling everything for cash.”

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

Graphic: Via the St. Louis Fed’s (FRED) Federal Reserve Economic Data. Taken from Joseph Wang. “The overall level of bank deposits is declining even as demand for bank deposits from investors is increasing.”

Positioning: Responsive trade is the status quo, as validated by SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator.

Graphic: Via SpotGamma. “Delta hedging flows with respect to changes in volatility (vanna) likely helped dampen some of the negativity of options buys and sells.”

Accordingly, measures of implied volatility, based on supply and demand dynamics talked about in the past, are falling from already low levels, and thus, the marginal impact of further volatility compression does less to bolster equity market upside.

To note the Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX or the volatility of volatility (a naive but useful measure of skew), dropped off largely, too, in comparison to the VIX, itself.

Graphic: Updated June 3, 2022. Via Tier1Alpha. “Several commentators have noticed that the price of volatility on the VIX, VVIX, has retreated sharply versus the past two years. If we look over a longer time horizon, this seems less so with a structural bid VIX tails driving higher implied hedging costs at each level of the VIX.  The current sub-100 VVIX level, while certainly lower than the past two years, is far from cheap historically.”

Given this all, SpotGamma suggests ultra-short-dated volatility, before the Federal Open Market Committee (FOMC) meeting, is likely to be sold, further depressing the front-end of the term structure while the “proceeds of that trade are funneled into farther-dated post-FOMC volatility.”

In other words, participants could sell short-dated volatility for exposure to that which is farther dated and, even, non-linear with respect to changes in delta (gamma) and vega (volga). 

Ultimately, such a structure would assist participants in lowering the cost of directional exposure.

Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading. In a long calendar spread, the trader sells shorter-dated implied volatility and uses the proceeds of that sale to fund, in part, longer-dated implied volatility exposure at the same strike.

More to come in future commentaries.

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

In the best case, the S&P 500 trades higher; activity above the $4,133.00 VPOC puts in play the $4,164.25 RTH High. Initiative trade beyond the RTH High could reach as high as the $4,189.25 LVNode and $4,227.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,133.00 VPOC puts in play the $4,101.25 LVNode. Initiative trade beyond the LVNode could reach as low as the $4,073.25 Weak H/L and $4,055.75 LVNode, 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, 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 24, 2022

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

What Happened

Overnight, equity index futures softened after what appeared to be continued covering of shorts into Monday’s close. Commodities were mixed, bonds higher, and implied volatility higher.

In the news the amount of money parked at major Federal Reserve facilities climbed to another all-time high, passing $2 trillion. JPMorgan Chase & Co’s (NYSE: JPM) CEO Jamie Dimon said recently that the Fed must do quantitative tightening since there’s too much liquidity in the pipes.

Adding, the Fed’s Raphael Bostic said policymakers may hike rates by 0.50 basis points after their next two meetings before pausing in September to allow for observation. This is as banks UBS Group AG (NYSE: UBS) and JPMorgan Chase & Co cut their expectations for growth here and abroad.

Ahead is data on S&P Global Inc (NYSE: SPGI) manufacturing and services (9:45 AM ET). Later, participants get updates on new home sales (10:00 AM ET) and Fed-speak by Chair Jerome Powell. Later this week, on Wednesday, participants will receive minutes of the Fed’s most recent meeting which may provide further insight into the central bank’s intent to tighten.

Graphic updated 6:15 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: So long as market participants are using JPEG images of rocks as collateral for debt, it is likely we have not reached a more permanent bottom in the broad market. 

Kidding – just trying to lighten the mood, haha! Sorry to my crypto friends! 

For real, though, maybe the destruction of that market is what we’re to watch for.
Graphic: Via Corey Hoffstein. “You call it ‘tulip mania,’ but I’m gonna need to see evidence that the Dutch set up lending markets where they used paintings of rocks as collateral.”

Support of market excesses was liquidity in the financial system, a lot of which is now piling into the Fed’s overnight reverse repurchase agreement facility (RRPs).

Graphic: Via Bloomberg. Per the Federal Reserve Bank of New York: “A reverse repurchase agreement conducted by the Desk, also called a “reverse repo” or “RRP,” is a transaction in which the Desk sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the transaction.”

Since the start of the year, however, the anticipation and pricing in of the removal of some of this liquidity have fed into market weaknesses.

Per the Damped Spring Advisors’ Andy Constan, the “Fed will reduce their balance sheet by choosing not to reinvest the proceeds of maturity payments of existing holdings back into the market. The U.S. Treasury will need to find new buyers for the bonds it issues.”

Please read our Daily Brief For May 5, 2022, here, for more on the Federal Reserve’s updates.

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

Constan adds: “In June, that supply those markets will need to absorb will be $50 billion USD and will grow to $95 billion (of which some will be outright sales of mortgages by the Fed).”

Accordingly, “[j]ust as USD strength occurred as global investors chased U.S. assets, as the U.S. economy led the global economy out of the Covid chasm, the next leg of asset returns is more likely in countries that remain relatively easy and where the economy is still lagging.”

Goldman Sachs Group Inc’s (NYSE: GS) Vickie Chang notes: “Using history as a guide, in order for equities to come off their recent lows (and stop declining), this kind of monetary-tightening induced contraction is most likely to end when the Fed itself shifts.” 

“It may be that the market needs to see signs of the inflation deceleration that our US economists expect in the second half of the year in order to see sustained relief.”

Positioning: Pursuant to comments established last week, Dennis Davitt of Millbank Dartmoor Portsmouth explains that the “realized volatility of the underlying S&P 500 is above 27% … with implied volatility of options trading between 24%-27%,” which translates to a VIX at 30%.

“It is profitable to own options with such an active and volatile cash market. This is the opposite of 2017 where the VIX was at 10% and the realized was 7%,” a trade that leverage poured into and resulted in the spectacular short-volatility ‘Volmageddon’ blow-up in February of 2018.

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

What does this mean?

Davitt concludes that “18 months” out there are “elevated option prices which may foretell an increase in the volatility of the equity market through this time next year.”

Though the Cboe Volatility Index (INDEX: VIX) may print higher, it is likely that it does not spike and point to an immediate market bottom, all else equal, like it has in the very near past.

Graphic: Via Millbank Dartmoor Portsmouth.

How to play?

It makes more sense to have exposure to underlying markets, synthetically (i.e., own options). This is based on the current relationship between realized and implied volatility.

Graphic: Via Robson Chow, founder at Tradewell. “The spread between IV and RV remains quite low relative to the past 50 trading days and 1st decile in the historical data.  It is printing where, historically, the most forward realized volatility and the weakest relative mean returns over the next 60 days can be expected.”

This is in contrast to the thesis that “long volatility is a poor equity hedge” because, on average, it’s overpriced and has less than a 100% negative correlation with the equity market.

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

Given fundamental contexts, many foresee continued weaknesses. Notwithstanding, markets are stretched to the downside and the path of least resistance, based on prior comments, is up.

This is with the caveat that traders should look at the current window of time as a period during which markets have less pressure to rally against. Per SpotGamma, this is due to the put-heavy options expiration (OPEX), Friday. 

Still, the rally into Monday “pulled forward some of the energy from [those] options that were to roll off,” and now, participants are “much less hedged than they were.” Should demand return, that will bid options prices and likely solicit liquidity provider pressures which, all else equal, start to cool into the $3,700.00 S&P 500 area.

Graphic: Via SpotGamma.

Technical: As of 6:15 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 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 $3,943.25 HVNode puts in play the $3,969.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, 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 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,862.75 LVNode and $3,831.00 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.

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 very 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.

Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 4, 2022

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

What Happened

Overnight, equity index futures were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

A check on some naive measures suggests we’re in for an expansion of range (i.e., heightened realized volatility) in the coming session(s). Key, today, are Federal Open Market Committee (FOMC) updates (2:00 PM ET) and a news conference (2:30 PM ET). 

The expectation is a 50 basis point hike and balance sheet contraction with run-off caps of $95 billion. If the action is in line with expectations (priced in), the reaction is likely to be positive.

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (10:00 AM ET). 

Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: Expected is front-loaded tightening, by the Federal Reserve (Fed), today.

The consensus is anchored around a 50 basis-point hike in May and no adjustments to the Reverse Repo Rate (RRP) or Interest on Reserve Balances (IORB), says Nordea Bank (OTC: NRDBY) research. The Fed may opt, also, to initiate a 75 basis-point hike in June.

“We believe that after the FOMC hikes by a half-point in May and presents a detailed plan to reduce the Fed balance sheet,” imminently, says Anna Wong, Yelena Shulyatyeva, Andrew Husby, and Eliza Winger of Bloomberg. 

“Powell will avoid definitive guidance about the size of future hikes, as policymakers assess how the runoff is affecting the economy in coming months.”

Graphic: Via Nordea research. Heightened inflation, exacerbated by sticky supply pressures and the conflict in Ukraine, and trends in demand have played into a tough talk on monetary policies.

As noted before, the key (risk) is the statements on the Fed’s balance sheet and the (imminent) process to shrink it through quantitative tightening (QT).

Graphic: Via Mish Talk. “The Fed expanded QE aggressively for years. But nearly all of that expansion was longer-dated securities as the [] chart shows. If the Fed had short-term securities it could reduce its balance sheet simply by runoff. Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

Per Nordea, QT is likely to consist of a 3-month phase-in period and run-off caps of $95 billion (i.e., $60 billion on U.S. Treasuries [USTs] and $35 billion in mortgage-backed securities [MBSs]), effectively lowering the Fed’s balance sheet by $670 billion by year-end.

Graphic: Via Bloomberg and Mitsubishi UFJ Financial Group Inc (NYSE: MUFG) U.S. Macro Strategy.

This is alongside the realization that “1Q may be the last good quarter of earnings as higher costs and increased recession risks weigh on future growth,” Morgan Stanley’s (NYSE: MS) Mike Wilson explains.

Graphic: Via Royal Bank of Canada (NYSE: RY) U.S. Equity Strategy and Bloomberg.

Market weakness in the past weeks was the result of “growing evidence that growth is slowing faster than most investors believe,” Wilson adds, and “the market is currently so oversold, any good news [such as Fed action being as expected] could lead to a vicious bear market rally.”

“We can’t rule anything out in the short term but we want to make it clear this bear market is far from complete.”

Positioning: Borrowing from yesterday’s letter, as little has changed, bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and highly sensitive to changes in implied volatility and direction.

Graphic: SqueezeMetrics on “how IV, direction, and moneyness cause option dealers to buy or sell the underlying.”

This exposure’s roll-off and compression in volatility ought to coincide with liquidity provider support to markets (i.e., relief of pressure from hedges to concentrated options positioning).

Per Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Validation of the latter (move) ought to be confirmed by participants’ new concentration of bets. In other words, if participants start to concentrate their bets at higher prices, further out in time, that confirms (changing sentiment) and (improves) the odds of sustained follow-through.

If not, it’s likely that prices, after a short-term relief, will succumb to fundamental weaknesses.

Technical: As of 7:00 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced overnight inventory, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,157.00 VPOC puts in play the $4,123.00 VPOC. Initiative trade beyond the $4,123.00 VPOC could reach as low as the $4,055.75 and $3,978.50 low volume areas (LVNodes), or lower.

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

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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