Categories
Commentary

Daily Brief For May 17, 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 higher. The S&P 500, in particular, probed the high end of the low-volume (gap) area it broke into on May 9, 2022.

The key is to monitor whether the S&P 500 is able to sustain the prices it discovered overnight. If so, then the odds that participants are, indeed, hammering out a bottom are heightened.

Ahead is data on retail sales (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), the NAHB home builders’ index, and business inventories (10:00 AM ET).

Fed-speak is scattered. At 9:15 AM ET, the Philadelphia Fed’s Patrick Harker speaks on health care. At 2:00 PM ET, Fed Chair Jerome Powell is interviewed by the WSJ. At 2:30 PM ET, the Cleveland Fed’s Loretta Mester talks at an inflation conference. And, lastly, at 6:45 PM ET, the Chicago Fed’s Charles Evans speaks.

Graphic updated 6:50 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: Out of all the news, it was noteworthy when Elon Musk broke with the prevailing opinion to declare the U.S. was facing a tough recession that would last up to 18 months. 

This is on the heels of a large “misallocation of capital,” he says, caused by the government printing “a zillion amount of more money than it had.”

Musk cautioned companies to watch their costs and cash flows, the latter of which we talked on the importance of in cycles where monetary conditions are tighter and there is less money to be had for corporates who are taking “the long view” and “competing on eyeballs and growth,” per Kai Volatility’s Cem Karsan who this letter’s writer spoke with last summer.

As Karsan puts it, over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted deflation, ultimately creating “a disinterest and unimportance to cash flows.”

“Monetary policy has a velocity of almost zero, it goes directly to ‘Planet Palo Alto,’ and Palo Alto creates new technologies,” Moontower’s Kris Abdelmesih puts well in a summary of Karsan’s macro thesis.

“They’re sophisticated, futuristic people. They provide new self-driving cars and things getting delivered to your doorstep. They create supply … [and] does not increase demand. And so it is deflationary.”

Over the last years, in light of talk to address increasing inequality, money was sent to labor, so to speak, and that promoted inflation.

Moreover, today’s contractionary monetary policy is a blunt tool and is not equipped to “address the main problem which is a lack of supply to absorb the demand.”

Please read Moontower’s full write-up, here.

That’s sort of in accordance with comments we quoted Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar making, yesterday. Essentially, “the Fed is pursuing demand destruction through negative wealth effects,” as the “central banks can only deal with nominal” chokepoints.

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

With even President Biden endorsing the closure of the “wealth window,” Karsan believes corporations will have to worry about making money again.

“These cycles are a lot shorter than the monetary supply-side cycles but they tend to be very bad for multiples and great for economic growth.”

With that in mind, there is no escape. Even the traditional bond-stock relationship – the 60/40 framework – is at risk of being upended.

Graphic: Via Andy Constan of Damped Spring Advisors. “Zero rate hikes in 2023. Clearly, a recession is being priced in.” Per Bloomberg, a Bank of America Corporation (NYSE: BAC) survey puts the Fed put (a pivot) at $3,529.00 in the S&P 500.

Positioning: Measures of implied volatility came in. That’s significant since participants have a lot of exposure to put options.

Further, we see liquidity providers being short those puts. As volatility continues to come in, the exposure of those options to direction (delta) compresses. 

As a result, liquidity providers will taper some of their negative delta short stock and futures hedges to that positive delta put position.

Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”

Those delta hedging flows with respect to changes in volatility (vanna) are on top of what has historically been a front-running of the bullish flow associated with the delta decay of options, particularly with respect to time (charm), into options expirations (OPEX). 

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

Notwithstanding, though proxies for buying and this hedging of existing options positioning, at the surface, appear to point to positively (skewed) forward returns, we have concern over the level at which from implied volatility is dropping from, and the general divergence between the volatility realized and implied, talked about yesterday.

Basically, as SpotGamma says, there’s not as much “stored energy to catalyze a rally.” 

SqueezeMetrics adds

The Cboe Volatility Index (INDEX: VIX) compressing, while dealer gamma exposure is “more negative than it’s been in years is not how you get sustained rallies–it’s how you get energy for bigger downside moves.”

Therefore, we continue to focus on participating in upside with as little debit risk as possible, via the use of complex strategies, further validated by quoted research.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,083.75 overnight high (ONH) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,148.25 and $4,184.25 high volume nodes (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,083.75 ONH puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,013.25 micro composite point of control (MCPOC) and $3,978.50 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: A push-and-pull between the largest of S&P 500 weights.

For instance, Apple Inc (NASDAQ: AAPL) is clinging to its prior trend.

Graphic: Via Bloomberg.

All the while products like Amazon Inc (NASDAQ: AMZN), are trading into key supports.

Graphic: Via Bloomberg.

We continue to monitor our market internals and (large) changes in positioning (e.g., open interest builds at higher prices further out in time) that will provide further validation to this most recent S&P 500 reversal.

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Current reads of breadth (top charts), in particular, are uninspiring. An advance you do not short has an advance-decline line that’s pegged at +2,000, coupled with a Tick (bottom left) that has trouble closing below 0 for nearly the entirety of a session. Caution.

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.

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 16, 2022

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

What Happened

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

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

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

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

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

What To Expect

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

Graphic: Via Bloomberg

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

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

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

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

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

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

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

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 13, 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 indices probed higher, above Thursday’s trade, which established a new swing low. The Cboe Volatility Index (INDEX: VIX) fell while yields were bid and commodities mixed.

Today, we’ll get into some key narratives including crypto turmoil and financial conditions, as well as a validation of some of our trade theses.

Ahead is data on import prices (8:30 AM ET), University of Michigan consumer sentiment and inflation expectations (10:00 AM ET), as well as Fed-speak by Neel Kashkari (11:00 AM ET).

Take care and watch your risk.

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: In the news, panic in the cryptocurrency markets eased and Tether (CRYPTO: USDT-USD), the world’s largest stablecoin, backed by commercial paper and U.S. Treasuries, climbed back to par.

JPMorgan Chase & Co’s (NYSE: JPM) Teresa Ho said there would be little impact on traditional funding markets while, according to Barclays PLC’s (NYSE: BCS) Joseph Abate, redemptions in Tether, which has a market value just shy of $90-100 billion, would only “cause meaningful strains in money markets should they exceed half of the stablecoin’s total holdings.”

Graphic: Via Bloomberg.

Also in the news are rising interest rates (e.g., mortgage rates up to ~5.30%) and a weak equity market (e.g., S&P 500 lower ~20%), among other things, feeding into a tightening of financial conditions (which is how monetary policy impacts the economy).

Graphic: Via Bloomberg.

“Financial conditions for households and businesses wanting to borrow or raise capital tightened again last week and are the most restrictive since the first wave of the pandemic in 2020 and before that 2012,” Reuters’ John Kemp said.

Graphic: Via John Kemp.

This is as inflation has become “deeply embedded,” spreading from the energy and raw materials-intensive merchandise sector to services.

Graphic: Via John Kemp.

“Rapid service sector price increases usually signal the imminent arrival of a recession,” Kemp said, pointing to decisions by some public companies like Uber Inc (NYSE: UBER), Twitter Inc (NYSE: TWTR), and Amazon Inc (NASDAQ: AMZN) to slow growth and cut labor forces as a validation of slowing momentum.

Graphic: Via Bloomberg. “I think we’re primed for a big distressed supply surge,” said Phil Brendel, a distressed debt analyst for Bloomberg Intelligence. “Everyone gets comfortable and complacent on credit and then when it turns, you tend to see these massive spikes.”

The accelerated selling of equities (~$6.2 billion), bonds (~11.4 billion), cash (~$19.7 billion), and some commodities (~$1.8 billion in gold), over the last week, per Bank of America Corporation’s (NYSE: BAC) Michael Hartnett is capitulation. 

“The definition of true capitulation is investors selling what they love,” Hartnett said, gauging the prospects that stocks have hit a near-term bottom. “Fear and loathing suggest stocks are prone to an imminent bear market rally, but we do not think ultimate lows have been reached.”

Positioning: In past commentaries, we talked about ways to play a returns distribution that is skewed to the upside (albeit, with large negative outliers).

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics. A higher DIX/GEX ratio has historically been associated with S&P 500 outperformance in the subsequent month. A very low DIX/GEX ratio has historically been associated with positive S&P 500 performance in the subsequent month, though there are many more negative outliers.

The following Goldman Sachs Group Inc (NYSE: GS) remark is a validation of what we’ve discussed:

“Even though the VIX’s reaction to recent spot downside has been mild, its high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear.

Mainly, zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals. 

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

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.

As stated before, width and timing are everything. 

Too much time or too narrow may result in asymmetric losses when the demand for upside bets further out in price and time bids the skew that you’re short, relative to the at-the-money volatility you own.

Ten to fifteen days to expiration and 500-1000 points wide, in the Nasdaq 100 (INDEX: NDX), one of the hardest hit of the indexes, work well. 

An easy check is whether the spread prices for a debit or credit to close if the underlying moves to the long strike of the spread, all else equal.

Debits (which may run as low as $0.00, depending on trade location) can be offset with credits from put sales.

Graphic: Chart of the Nasdaq 100 (INDEX: NDX).

Technical: As of 6:45 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 higher potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume node (LVNode) puts into play the $4,011.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,069.25 high volume area (HVNode) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode puts into play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,899.00 VPOC and $3,862.75 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.

Considerations: Gap scenarios are in play.

Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

Definitions

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

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

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

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

About

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

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

Some of his works include conversations with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, FTX’s Sam Bankman-Fried, 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 12, 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 lower, mostly, alongside most commodities and crypto.

Notable is how orderly the selling has been, particularly in the equity space. That’s due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

The fundamental narrative has changed little. Chief among participants’ worries are growth and inflation, the monetary response to the two, as well as chokepoints not limited to supply chains.

Ahead is data on jobless claims and the producer price index (8:30 AM ET), as well as Fed-speak by Mary Daly (4:00 PM ET).

Graphic updated 7:15 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: In Wednesday’s morning letter, we talked about the expectations for annual inflation to have peaked and month-on-month inflation to have risen a small amount.

Per Bloomberg, “the broader CPI rose 0.3% from the prior month and 8.3% on an annual basis, a slight cooling but still among the highest readings in decades.”

Stocks were sold, after, on the limited change to the broader fundamental outlook. The hardest hit was growth and technology, including cryptocurrency. 

“Now that central banks are unwinding monetary support, growth stocks’ valuations have further to fall,” Citigroup Inc (NYSE: C) strategists including Robert Buckland said

Notwithstanding, “any stabilization in nominal yields should eventually help to stabilize real yields and hence equity valuations.” 

This is because higher rates play into bigger discounts on future profit.

Graphic: Via Bloomberg.

Positioning: Orderly selling continues.

Despite falling about the same distance (peak to present low) during the equity market rout of 2020, selling, this time around is steady and there is no panic, and that’s partly the result of there being “plenty of put-buyers, but nearly as many sellers,” according to SqueezeMetrics.

Accordingly, using off-exchange short sales as a proxy for buying activity, we see implicit buying support, and that’s due in part to “passive flows” which ultimately end up “supporting the largest stocks,” hence the index’s strength versus smaller (and much weaker) constituents.

Taken together, some metrics this letter often looks to for insight into the potential distribution of future returns, carry less weight; it’s odds and when the largest stocks succumb to fundamental weaknesses, for lack of a better way of expressing it, that likely takes the indexes with it.

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics. A higher DIX/GEX ratio has historically been associated with S&P 500 outperformance in the subsequent month. A very low DIX/GEX ratio has historically been associated with positive S&P 500 performance in the subsequent month, though there are many more negative outliers.

Moreover, with the S&P 500’s break of $4,000.00, an area around which there is a lot of open interest, particularly on the put side, “increases capitulation risk” in the case participants start reaching for protection and indirectly taking from market liquidity as liquidity providers sell into weakness to hedge.

Notwithstanding, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma. Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

Ways to participate in upside, while limiting downside, markedly, were discussed on May 10. Making money is one thing. Not losing money is another.

Lose less when wrong. Make more when right.
Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

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

In the best case, the S&P 500 trades higher; activity above the $3,907.75 micro composite point of control (MCPOC) puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 HVNode could reach as high as the $4,011.00 untested point of control (VPOC) and $4,069.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,907.75 MCPOC puts in play the $3,862.75 LVNode. Initiative trade beyond the $3,862.75 LVNode could reach as low as the $3,816.75 and $3,780.75 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

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 10, 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 auctioned sideways to higher, inside of the prior day’s range. Most other commodity and bond futures were bid while implied volatility metrics came in a bit.

Notable was the depth and breadth of Monday’s decline. Though the indexes were tame, some of which is attributable to suppressive hedging, single stocks expanded their ranges, greatly, to the downside, and this points to potential capitulation.

On the news front, a U.S. central bank report found that “the risk of a sudden significant deterioration [in liquidity] appears higher than normal” and stablecoin use to meet margin requirements in crypto trades makes them “vulnerable to runs.”

This is just as some algorithmic stablecoins have lost their peg (e.g., UST/USD ~$0.60).

Additionally, the report found elevated inflation, as well as the reaction to that “could negatively affect domestic economic activity, asset prices, credit quality, and financial conditions.”

Ahead is data on real household debt (11:00 AM ET).

Graphic updated 6:25 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

Context: We continue to build out the narrative.

A market-wide drop, Monday, pointed to signs of capitulation as “small-time investors offloaded a net of about $1 billion in equities, the most aggressive selling in 14 months,” per JPMorgan Chase & Co (NYSE: JPM).

Graphic: Via @TaviCosta. “Nasdaq has already declined almost as much as it did during the March 2020 crash. Back then, the Fed was all about saving the stock market and the economy. Today, it’s all about how much more they are going to hike rates.

Notwithstanding, the volatility divergences this letter has pointed to, in the face of pronounced realized volatility, continue.

Graphic: Via Topdown Charts. Wednesday (FOMC) price rise (right) versus Thursday (post-FOMC) liquidation.

As Pat Hennessy of IPS Strategic Capital explains, at-the-money implied volatility is high and term structure is in backwardation, which are reflections of uncertainty and demand for hedges.

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

“It’s just rare to see wingy short-dated puts like this so cheap relative to ATM.”

As explained in Monday’s letter (and in greater detail, Friday), a measure like the Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

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

To quote Benn Eifert of QVR Advisors: “Skew goes up if vol outperforms the skew curve a lot on  a selloff.”

Graphic: Updated May 9, 2022. The VVIX via Physik Invest.

What’s going on? 

There is really negative sentiment and emotion, both of which are playing into market weaknesses and realized volatility. However, that realized volatility is not priced in.

There are “plenty of put-buyers, but nearly as many sellers,” SqueezeMetrics explains

You “don’t have to protect what you don’t own. Some investors de-grossed. Short momo (e.g., CTA) wants to bet on a bleed (a la 2000), but not on a crash. Put underwriting! No carry trades elsewhere. Sell SPX vol!”

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, the SPDR S&P 500 ETF Trust (NYSE: SPY) was a recipient of heavy put selling and call buying on 5/9/22.

Why does this matter?

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (positive exposure to gamma) so that you may have gains that are potentially amplified in case of directional movement.

When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (positive exposure to volga) so that you may have gains that are potentially amplified in case of implied volatility repricing.

So, in all, it is a question of whether the reward is worth the risk (see below “How To Play”).

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

As The Ambrus Group’s Kris Sidial sums well: 

With an S&P 500 below $4,000.00, “I would expect more of an aggressive reach for hedges … that spot- vol correlation break (weakness) would not be as present.”

“Spot- vol correlation has sucked recently, but vol relative strength should kick in.”

How I’m Playing: Borrowing from May 3’s letter, here.

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

This letter’s author is concentrated on zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals.

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

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

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

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk, and, as explained, the risk has yet to meet the reward.

Read more about these strategies, here. The above is NOT a trade recommendation or advice.

Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the 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 $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode/gap boundary puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 could reach as low as the $3,907.75 HVNode and $3,862.75 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

Cave-Fill Process: Widened the area deemed favorable to transact at by an increased share of participants. This is a good development.

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

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

Gamma: Gamma is the sensitivity of an option to changes in the underlying price.

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

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

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

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

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.

Options Expiration (OPEX): Reduction of dealer gamma exposure.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 6, 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 auctioned weak, inside of the prior day’s large trading range.

Yesterday, the equity indexes, bonds, and crypto (which many saw as a hedge against equities) were sold, aggressively. The selling came one day after the Federal Reserve hiked 0.50 basis points and outlined its balance sheet reduction timeline.

Notable was ten-year Treasury yields breaking the 3.00% barrier.

Despite a more dovish tone (i.e., Fed assuaging participants of a 0.75 basis point hike in the coming meetings), the near-vertical price rise (which we discussed was a function of “structural buyback” in yesterday’s morning letter) was taken back in a fire sale across all sectors.

Today is data on nonfarm payrolls, unemployment rates, average hourly earnings, and labor force participation (8:30 AM ET). Later, consumer credit data is released (3:00 PM ET).

Speaking today is the Fed’s John Williams (9:15 AM ET), Raphael Bostic (3:20 PM ET), James Bullard and Chris Waller (7:15 PM ET), as well as Mary Daly (8:00 PM 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

Positioning: In yesterday’s detailed letter, we talked about the implications of participants’ hedging heading into and after the Federal Open Market Committee (FOMC) event.

Mainly, markets were stretched and participants were demanding protection in size. As said:

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

After that “structural buyback,” as Kai Volatility’s Cem Karsan explained clearly, it was highly likely the bear trend would hold. Participants not shifting their bets on direction (via options) to higher prices, further out in time, further suggested very little change in sentiment.

Toggle, which is an AI and machine learning research firm tracking 35,000 securities globally, sent us, yesterday, their post-Fed analysis. According to them, “during the first week after the Fed’s 50 bps hike markets broadly headed lower.”

“In fact, 1 in 5 times the drop reached more than 5%.”

Graphic: Via Toggle.

The firm’s CEO and founder – Jan Szilagyi – said, in response to the market action that “market bulls should root for stocks to go down first.”

That’s actually a powerful statement. For markets to break (rally), they sometimes need to rally (break). Said another way, at times the market is stretched. Sellers (buyers) are either too short (or too long), if we will.

In order to trade lower, for instance, that short inventory (which in and of itself is a support mechanism as it is a bunch of buy orders sitting at lower prices) must be cleared (i.e., covered).

After that support is removed, the market can succumb to whatever fundamental weaknesses it was trying to price in. 

In this case, “the incremental effects on liquidity (QE/QT),” as Karsan says.

Moreover, what’s interesting, and this is something others have picked up on, is the difference between the level of volatility that is realized and implied by activity in the derivatives market.

Another time we saw such divergences was during the 2020 Coronacrisis sell-off.

Graphic: Via @HalfersPower. On March 2, 2020, “VIX-30 day realized vol go from 99 percentile yesterday to inverted and 9 percentile today lol. (left vs. right).

Let’s unpack. So, the Cboe Volatility Index (INDEX: VIX), as described by Cboe Global Markets Inc (BATS: CBOE), is a “constant, 30-day expected volatility of the U.S. stock market, derived from real-time, mid-quote prices of S&P 500 Index (INDEX: SPX) call and put options.”

Essentially, to make it simple, VIX is the equity market’s pricing of risk or insurance and it has a strong inverse relationship with the SPX. If SPX is lower, the VIX higher, basically.

Then, just as we have metrics to measure the change in an option’s sensitivity to the underlying direction (delta) or gamma, we have the sensitivity of an option to changes in volatility (vega) or volga.

Volga has different names. Vomma. The convexity of vega (i.e., change in vega based on change in volatility implied by market participants’ activity). The volatility of volatility. And so on.

The volatility of volatility can naively be measured through the Cboe VVIX Index (INDEX: VVIX) which, according to Cboe, “represents a volatility of volatility in the sense that it measures the expected volatility of the 30-day forward price of VIX.”

Historically, the gauge has a mean somewhere beneath 100 and a high correlation with the VIX at times of heightened stress (e.g., Coronacrisis).

Graphic: The VVIX via Physik Invest.

What’s going on is there is really negative sentiment and emotion, both of which are playing into market weaknesses and realized volatility. However, that realized volatility is not priced in.

In other words, the volatility of volatility – VVIX – is low relative to the volatility realized (and implied) and that, as I take it, essentially means that the market is not pricing up protection.

Graphic: Via The Ambrus Group’s Kris Sidial. “Trotting out the good old VVIX/VIX (trader heuristic) to compare SPX skew to VIX Vol. Negative sentiment but lack of fear continues.”

Why does this matter? Well, when you think there is to be an outsized move, relative to what is priced, you buy options (positive exposure to gamma) so that you may have gains that are potentially amplified in case of directional movement.

You also buy can buy options for positive exposure to volga. This is so that you may have gains that are potentially amplified in case of movement (repricing) in implied volatility.

Graphic: Via @Alpha_Ex_LLC. “Here’s 10-day realized vs VVIX on a scatter. The ‘white star’ is 40 realized but only 117 VVIX. When realized this high, VVIX typically closer to 150.”

With back-to-back daily price changes sometimes in excess of 2%, this essentially suggests to us the potential for the pricing of equity market risk to “catch up.”

Graphic: Via Bloomberg. The realized volatility for the SPX versus the VIX.

Per SpotGamma, much of this has to do with market participants being “well-hedged.”

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

The Ambrus Group’s Kris Sidial, who felt that the liquidation was likely large desks de-risking their book, explains, well, too: 

“Vol is mainly used as a source of hedging. We are coming off of a big FOMC meeting where vol was slightly elevated. Think about this for a second, although SPX had a nasty day today, we are still right where we were at Tuesday… what does that tell you?”

“That means there wasn’t really a NEED to rehedge that same exposure. Volatility didn’t compress much after FOMC and when the market gave it all back it brought us right back to where we started. Put yourself in the shoes of an institution.”

Graphic: SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO) for SPY shows light put selling and call buying. Participants are (likely) hedged and are not demanding protection in size amid lower prices.

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

So, what do you do with this information? The idea is that volatility implied may reprice to reflect what is realized. In such a case, you’d want positive exposure to volga (i.e., don’t sell volatility).

This is more of a view on volatility rather than direction, at this juncture.

Directionally speaking, the returns distribution is skewed positive. This is from an overlay of proxies for buying and naive gamma exposure.

Here’s one model using similar data we often look at in this letter.

Graphic: Via nextSignals. “When SPX and [gamma exposure] nosedive after an extended selloff while dark pools’ buying sharply diverges to the upside … buy the S&P 500.”

Technical: As of 6:45 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 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 $4,148.25 high volume area (HVNode) puts in play the $4,184.25 HVNode. Initiative trade beyond the $4,184.25 HVNode could reach as high as the $4,212.25 micro composite point of control (MCPOC) and $4,303.00 weak high (obvious breakout level), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,148.25 HVNode puts in play the $4,099.25 regular trade low (RTH Low). Initiative trade beyond the RTH Low could reach as low as the $4,055.75 low volume area (LVNode) and $3,978.50 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.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 3, 2022

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

What Happened

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

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

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

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

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

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

What To Expect

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

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

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

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

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

Graphic: Via Crossborder Capital Ltd. Taken from Bloomberg.

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

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

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

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

“We find these fears overblown.”

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 2, 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 auctioned off of Friday’s regular trade lows. Yields, the dollar, and implied volatility metrics were bid.

There were no changes in the newsflow’s tone this weekend; investors remain concerned over the implications of monetary policy shifts and inflation, as well as war, COVID, and the supply pressures associated.

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

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

What To Expect

Fundamental: The indexes continue to hold well in the context of severe weaknesses under the hood, so to speak, especially in the high-flying technology and growth of 2020-2021.

Stocks like Zoom Video Communications (NASDAQ: ZM) and Netflix Inc (NASDAQ: NFLX), the beneficiaries of the work-from-home trends, have de-rated substantially since the start of 2022.

Graphic: Via Bloomberg.

In spite of earnings growth (~10% for S&P 500 companies that have reported, per Bloomberg), “the reaction to earnings surprises in April was asymmetric,” and a display of “the outsized role played by outliers.” 

For context, “Mega-cap growth (MCG) & Tech earnings are missing by -6.0% at the aggregate level [while] the median company [is] beating by 5.7%.”

This is as inflation, among other factors, continues to bite into the “over-optimistic multiples driven by the assumption that pandemic-era performance could continue in perpetuity.”

Per Bank of America Corporation (NYSE: BAC), the S&P’s current P/E is way too high, given the current CPI.

Graphic: Via Bank of America Corporation. Taken from Bloomberg. “It’s straightforward common sense that higher inflation would lead to paying a lower multiple of earnings because you expect future earnings to be eaten into by inflation. And common sense is borne out empirically; all else equal, higher inflation does indeed tend to mean lower earnings multiples.”

Notwithstanding, trimming outliers, inflation may have peaked and that is a positive for those equity investors who think “inflation is high, but they’re confident that it’s transitory,” therefore current valuations are just.

Graphic: Via Bloomberg.

Per @ConvexityMaven, recession chatter is unwarranted. The economy is expanding and the only worry investors should have is “if the Fed cannot chill nominal GDP.”

That means “rates are going north” and, according to Bank of America Corporation’s Michael Hartnett, “asset prices must reset lower.”

Some investors, like the Japanese, have heeded this message and are offloading billions in Treasuries in anticipation of more attractive levels and “stabilization in long-dated yields.”

Perspectives: Some, including Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, believe market participants are in for a world of [much more] hurt as “central banks can only deal with nominal, not real chokepoints.”

“Banks’ stock buybacks are lowering SLRs as we speak, and the Fed is about to embark on QT, and these nominal balance sheet and liquidity trends, will at some point clash with the realities of a garden variety of supply chain issues,” as a result of geopolitical chokepoints.

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

Given Pozsar’s findings, “The Fed will do QE again by summer 2023.”

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

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

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

This liquidity supply, apart from passive flows, stems from index-level hedging pressures, also.

Here’s why, as borrowed from our April 27, 2022 commentary.

Participants are well-hedged and use weakness as an opportunity to buy into a less highly valued broader market.

Well-hedged means that customers (i.e., you and I) own protection against long equity exposure. So, that could mean customers own puts and/or are short calls. One of the most dominant flows is the long put, short call.

Such trade offers customers positive, yet asymmetric (gamma), exposure to direction (delta). In other words, negative delta and positive gamma. 

The counterparty has exposure to positive delta and negative gamma. If the underlyings trade lower and volatility rises, all else equal, the position will lose. To hedge against these losses, the counterparties will sell underlying into weakness.

If prices reverse and move higher, these counterparties will re-hedge and buy underlying.

Normally, as seen over the bull run of 2020 and 2021, markets are in an uptrend and there’s a strong supply of volatility. Often, customers sell more calls than puts and, in an uptrend, those calls solicit more active hedging than the put options.

Recall that the customer is short the call. That means the counterparty is long the call (a positive delta and gamma trade) and will make money if prices rise, all else equal. 

The hedging of this particular exposure (i.e., sell strength, buy weakness), in an uptrend, occurs slower (i.e., counterparts will allow their profits to run), and that’s what can help the market sustain lower volatility trends for longer periods.

When prices reverse and underlyings trade lower, put options solicit increased hedging activity. Given the nature of counterparty exposure to those puts, that hedging happens quickly and can take from market liquidity as to volatility (i.e., buy strength, sell weakness).

Graphic: Via SqueezeMetrics. Equity move lower solicits increased hedging activity of put options. Counterparties have negative gamma exposure to these puts. Therefore, to hedge, they buy strength and sell weakness, adding to realized volatility. This trend is ongoing.

So, what now?

Participants are most concerned (and hedging against) unforeseen monetary policy action and economic chokepoints like a potential Russian default. 

Investors will get clarity on some of these issues in the coming sessions.

Graphic: Via SpotGamma, the estimated gamma for calls by strike as a positive number and puts as a negative number on the S&P 500 ETF, the SPY. Notice the weight on the put side.

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

Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”

Whether those price rises kick off a sustained reversal depends on what the fundamental situation is, then.

Presently, the largest index constituents are starting to succumb to worsening fundamentals and that will, ultimately, feed into the indexes which are pinned due to passive and hedging flows.

In other words, fundamentals will trump this talk of positioning (i.e., it is only in the short-term does this positioning we’ve talked about have greater implications).

Consideration: The returns distribution, based on implied volatility metrics alone, is skewed positive (though there are some large negative outliers pursuant to The Ambrus Group’s Kris Sidial recent explanation that despite negative sentiment, “nobody is truly scared” and “Fixed strike vols continue to underperform, along with the lack of concern in the VX term structure”).

Caution.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,118.75 regular trade low (RTH Low) puts in play the $4,158.25 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 untested point of control (VPOC) and $4,279.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,118.75 RTH Low puts in play the $4,101.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,055.75 low volume area (LVNode) and $3,978.50 low volume area (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: Terribly weak price action, last week, with the S&P 500, Nasdaq 100, and Russell 2000 all flirting with early 2022 lows.

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

That indicator denotes the level at which the average buyer/seller is in.

In other words, it is the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called demand zone, the level ought to be looked at as overhead supply on tests, higher. Caution.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 28, 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 auctioned sideways-to-higher alongside some upbeat earnings announcements.

Meta Platforms Inc (NASDAQ: FB) surged post-market, yesterday, after its main social network Facebook added more users than expected. 

PayPal Holdings Inc (NYSE: PYPL) vowed to rein in costs and boost profits while Qualcomm Inc (NASDAQ: QCOM) rose on an upbeat forecast.

There’s a strong push-and-pull between what’s good and bad. File Deutsche Bank’s (NYSE: DB) recent comments on a pending recession under what’s bad.

The bank sees the Fed Target Rate reaching up to 6% which “will push the economy into a significant recession by late next year.”

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

What To Expect

Fundamental: Divergences across different assets and markets continue.

For instance, the equity market’s pricing of risk which we can take as being reflected by the CBOE Volatility Index [INDEX: VIX]) is not moving lock-step with that of measures elsewhere.

Graphic: Via Bloomberg.

The fear in one market tends to spread to others. Regardless of the cause, it seems that equity and bond market participants are not on the same page.

Is that really true, though? Not necessarily. 

If we look at some single stocks, Netflix Inc (NASDAQ: NFLX), among others (all the while S&P 500 earnings have been revised up) has suffered through a substantial de-rate and volatility as participants priced the implications of policy evolution, slower economic growth, and beyond.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear.

That has us returning to pinning at the index level, relative to what the constituents are doing.

As well explained in Physik Invest’s March 3, 2022 commentary, this is more so a function of positioning and structural flows, or supply of liquidity.

Absent some exogenous event, participants are well-hedged for what is known (e.g., rate hikes and quantitative tightening (QT), COVID resurgences, Russia and Ukraine, among other things).

The caveat is that the Federal Reserve is far more aggressive than expected, ramping up QT, “a direct flow of capital to capital markets or flow out of,” per Kai Volatility’s Cem Karsan. 

For context, it is the intention to take from the max liquidity (which pushed participants out of the risk curve and promoted a divergence from fundamentals) markets were supplied with, and this has the effect of removing market excesses, some of which have fed into volatility markets.

In part, some of the QT has been reflected in bond prices, JPMorgan Chase & Co (NYSE: JPM) explains. However, should there be far more aggressive monetary action, as Deutsche research suggests, coupled with a worsening of the geopolitical and/or economic situation abroad (e.g., Russian default), markets are likely to succumb.

“Using the balance sheet as a tightening tool represents a large change in the Fed’s attitude, and IS NOT priced into the market,” MacroTourist’s Kevin Muir adds.

“An increase in the pace of tightening of QT should mean lower stocks, wider credit spreads, and a slight reduction in the need for front-end hikes.”

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. The “Nasdaq has underperformed the S&P 500 but by less than what the move in real yields would suggest.”

Positioning: Volatility to continue as markets have traded lower and participants have priced up the cost of insurance – particularly at the short-end – on underlying equity exposure.

Graphic: SPX volatility term structure via Refinitiv. Taken from The Market Ear.

This is due to options delta (exposure to direction) being far more sensitive (gamma) across shorter time horizons (i.e., the range across which options deltas shift from “near-zero to near-100% becomes very narrow.”)

Yesterday, markets were pinned after exploring lower in the days prior. The activity was concentrated in short-dated bets at those levels, and that’s in part a result of some of the hedging that went on.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options Indicator.

If markets do not perform to the downside (i.e., do not trade lower), those short-dated bets on direction will quickly decay, and hedging flows with respect to time (charm) and volatility (vanna) may bolster sharp rallies.

Whether those price rises have legs depends on what the fundamental situation is, then. Regardless, the returns distribution, based on implied volatility metrics alone, is skewed positive, albeit there are some large negative outliers.

Graphic: Via @HalfersPower. “In backwardation via $VIX: $VIX3M next month [realized volatility] is highest amongst the deciles (d10 >1) ~43% subsequent realized volatility.”

Technical: As of 7:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, 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 $4,236.25 regular trade high (RTH High) puts in play the $4,267.75 RTH High. Initiative trade beyond the $4,267.75 RTH High could reach as high as the $4,303.75 overnight high (ONH) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,236.25 RTH High puts in play the $4,191.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,136.00 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), 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: Markets are higher after testing some key levels outlined in prior letters.

The Invesco QQQ Trust Series 1 (NASDAQ: QQQ), one of the weakest products this letter monitors, just tested a major VWAP, yesterday, anchored from the lows of March 2020. 

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

The Nasdaq has led the market down. It may lead the market higher on reversals. We’ll continue to monitor market breadth, among other metrics, for signs of strength.

Definitions

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

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

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

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

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

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

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

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 April 27, 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 probed higher, essentially negating Tuesday’s end-of-day, knee-jerk liquidation.

Tuesday’s selling came alongside Russia cutting gas to Poland and Bulgaria, Vice President Kamala Harris testing positive for COVID-19, and heavy selling in growth and tech stocks, amid doubts corporate profits can withstand the Federal Reserve’s bid to tame inflation.

As Jerome Schneider of Pacific Investment Management Co says, QT will “have a profound effect on the cost of liquidity and more importantly the cost of transacting business and reallocating assets from one avenue to another avenue.” 

“There might not necessarily be a rapid deceleration or decline in the stock market or other risk assets, but there’s going to be a changing cost of capital that this balance sheet is going to be part of.”

After the close, weakness continued. Alphabet Inc (NASDAQ: GOOGL) (NASDAQ: GOOG) missed on slowing sales growth and digital-ad spending. One of the biggest losers was Tesla Inc (NASDAQ: TSLA) which shed 12% or so on news that Elon Musk would use his fortune, much of which is tied up in Tesla, to buy Twitter Inc (NYSE: TWTR).

Germany’s passage of a bigger borrowing budget, coupled with China’s pledge to boost infrastructure bolstered an overnight advance that fed into price action at home. The S&P 500, in particular, for a brief moment, took back a key level, negating much of yesterday’s liquidation.

Ahead is data on international trade in goods (8:30 AM ET), as well as pending home sales and the rental vacancy rate (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

Positioning: Markets are positioned for continued volatility. 

Based on a reading of market gamma exposure (GEX) and buying support (DIX), the returns distribution is skewed positive. There’s buying in the context of an environment in which the hedging of options positioning implies selling into weakness and buying of strength.

Graphic: Via Barclays PLC (NYSE: BCS) research.

In the most simple way that I can explain: when positioning is stretched one way, that often tends to mark a turning point – the returns distribution is either skewed positive or negative.

Graphic: Via Physik Invest. Data via SqueezeMetrics. Updated March of 2022. A high DIX/GEX ratio often portends positive 1-month returns.

An updated read, after Tuesday’s weak close, tells us that we can (1) definitely expect larger ranges to continue and (2) potential for short-term bounces

Based on overnight activity, one of those is happening, now.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

This is as participants are both well-hedged and using weakness as an opportunity to buy into a less highly valued market.

Well-hedged means that customers (i.e., you and I) own protection against long equity exposure. So, that could mean customers own puts and/or are short calls. One of the most dominant flows is the long put, short call.

Such trade offers customers positive, yet asymmetric (gamma), exposure to direction (delta). In other words, negative delta and positive gamma. 

The counterparty has exposure to positive delta and negative gamma. If the underlyings trade lower and volatility rises, all else equal, the position will lose. To hedge against these losses, the counterparties will sell underlying into weakness.

If prices reverse and move higher, these counterparties will re-hedge and buy underlying.

Normally, as seen over the bull run of 2020 and 2021, markets are in an uptrend and there’s a strong supply of volatility. Often, customers sell more calls than puts and, in an uptrend, those calls solicit more active hedging than the put options.

Recall that the customer is short the call. That means the counterparty is long the call (a positive delta and gamma trade) and will make money if prices rise, all else equal. 

The hedging of this particular exposure (i.e., sell strength, buy weakness), in an uptrend, occurs slower (i.e., counterparts will allow their profits to run), and that’s what can help the market sustain lower volatility trends for longer periods.

When prices reverse and underlyings trade lower, put options solicit increased hedging activity. Given the nature of counterparty exposure to those puts, that hedging happens quickly and can take from market liquidity as to volatility (i.e., buy strength, sell weakness).

See, below, E-mini S&P 500 book depth, a proxy for market liquidity, and how much it has declined since the end of last year when markets became more volatile and noise around the Federal Reserve’s intent to taper bond-buying and raise rates grew louder.

Graphic: Via CME Group Inc (NASDAQ: CME) Liquidity Tool. Note how in late March, book depth rose as markets rose and customer call activity solicited increased hedging of counterparty long-gamma exposure (i.e., buy weakness, sell strength), adding to market liquidity.

In the above environment, counterparty hedging matters; the market is more sensitive to the flow, so to speak. That sensitivity is expected to continue.

SpotGamma, an options data and analysis service, sees the early May period as pivotal. Then is the Federal Open Market Committee (FOMC) meeting and the potential Russian default, per Moody’s Corporation (NYSE: MCO).

As quoted: “Russia ‘may be considered in default’ if it does not pay two bonds in US dollars by end of a grace period on May 4.”

Graphic: Via Bloomberg.

Until those events are resolved, participants will likely continue to (remain) hedge(d). Upon resolve, customers likely monetize their protection to offset losses on underlying equity exposure. 

That means selling volatility which reduces counterparty exposure to short puts (negative gamma and positive delta). To re-hedge, underlying is bought back and that may support a price rise.

Graphic: VIX term structure via VIX Central. Expansion (higher) solicits counterparty selling which pressures the market lower. Compression (lower) solicits counterparty buying which bolsters attempts higher.

Whether that price rise has legs depends on what the fundamental situation is, then. See the below section titled Considerations for a full technical picture and the most likely turning points.

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 middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,217.25 overnight high (ONH) puts in play the $4,267.75 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,303.75 ONH and $4,337.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,217.25 ONH puts in play the $4,193.25 spike base. Initiative trade beyond the spike base could reach as low as the $4,136.50 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), or lower.

Considerations: Spikes mark the beginning of a break from value. Spikes higher (lower) are validated by trade at or above (below) the spike base (i.e., the origin of the spike).

Additionally, the indexes continue to trade below their 20-, 50-, and 200-day simple moving averages, confirming the trend change and bearish tone (further validated by poor breadth).

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).

All indexes remain, as stated, yesterday, below their volume-weighted average prices (VWAPs) anchored from the start of this year (or their respective peaks). 

VWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Liquidity algorithms, too, are benchmarked and programmed to buy and sell around VWAPs.

The Invesco QQQ Trust Series 1 (NASDAQ: QQQ) just tested a major VWAP, yesterday, anchored from the lows of March 2020. That’s a fair price to pay for Nasdaq 100 exposure.

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

Notwithstanding, notice the flat-to-declining AVWAP that’s black in color. So long as prices remain below this level, the index is likely a sell. 

Should that level flatten (and begin to rise), and if the QQQ was able to trade above it for a sustained period, there is potential for sustained upside.

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

Definitions

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

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

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

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

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.