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Commentary

Market Commentary For The Week Ahead: ‘Should I Stay Or Should I Go’

Notice: Physik Invest’s daily market commentaries will be suspended for the next five regular trading sessions or February 22-26.

Please accept our apologies for the inconvenience and thank you for the support!

Key Takeaways:

  • Debt, inflation threatening low-rate regime.
  • Markets most complacent in two decades.
  • Sentiment turns hot from hotter amid slide.
  • Global equity fund net inflows decelerated.
  • Markets fret about economic performance.
  • Retail sales and industrial production gain.

What Happened: U.S. stock index futures auctioned lower last week.

What Does It Mean: Market participants witnessed a rapid de-risking event, as a result of individual stock volatility, and a subsequent v-pattern recovery, that was later taken back as Friday’s large February monthly options expiration (OPEX) neared.

More On The V-Pattern: A pattern that forms after a market establishes a high, retests some support, and then breaks above said high. In most cases, this pattern portends continuation.

At the same time, bond and equity market volatility diverged, materially. 

In other words, a rapid move up in rates — as investors become increasingly concerned over the value of their bonds due to rising debt levels and inflation — has yet to be priced in as an equity market risk.

Graphic 1: The Market Ear unpacks divergence in volatility across different markets.

Adding, the risk of inflation comes alongside a potential for slowing in economic growth, which may have knock-on effects, such as savers protecting their capital by investing in non-productive assets, thus helping form speculative asset bubbles.

Risk Of Monetary Support: The increased moneyness of financial markets; investors look to exchange-traded products (e.g., S&P 500) as savings vehicles, thereby forcing participants, like the Federal Reserve, to backstop market liquidity, and promote market and economic stability in times of turmoil.
A great paper on the impact of central bank intervention, passive index investing, and asymmetric liquidity provisioning.

Still, as Bloomberg suggests, reasons to not panic include an overreaction by market participants, premature Fed tightening, and a risk asset rout (i.e., rising rates may eventually increase demand for safety assets).

“Typically it’s a good environment for risk assets. Neither the pace nor the extent of the move so far has been unusual relative to other historical moves coming out of a recession,” said Pimco’s Erin Browne. “It would take a significant move in real yields in order to disrupt risk markets broadly.”

Graphic 2: Benchmark 10-year real rate in solidly negative territory.

Moving on, given OPEX, participants have a clue as to why the market failed to resolve directionally over the past week: option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure.

Aside from OPEX, we must talk more about the v-pattern recovery and a prior week’s spike exit from balance, as well as low broad market volatility.

In light of the v-pattern, balance, and spike, the S&P 500’s long-term uptrend remains intact. In support of this uptrend, systematic and hedge fund participants are increasing their long-exposure, given the economic recovery, and a drop in volatility.

Beyond that, speculative activity in the options market and measures of market liquidity fail in offering much information.

Graphic 3: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust (NYSE: SPY), for the week ending February 19, 2021. Activity in the options market was primarily concentrated in short- and long-dated tenors, near the $390, a strike that corresponds with $3,900.00 in the cash-settled S&P 500 Index (INDEX: SPX).

What To Expect: U.S. stock indexes are positioned for directional resolve.

This comes alongside the acceptance of higher prices (inside a prominent high-volume area, or HVNode) and an overnight rally-high at $3,959.25.

More On Overnight Rally Highs: Typically, there is a low historical probability associated with overnight rally-highs ending the upside discovery process.

More On Volume Areas: A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). 

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

What To Do: In the coming sessions, participants will want to pay attention to the VWAP anchored from the $3,959.25 peak and $3,909.25 HVNode.

Volume-Weighted Average Prices (VWAPs): Metrics 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.

In the best case, the S&P 500 opens and remains above the $3,909.25 volume area.

Additionally, auctioning above the $3,915.00 VWAP would suggest buyers, on average, are in control and winning, since the February 15 rally high.

Auctioning beneath $3,909.25 turns the HVNode, nearby, into an area of supply, offering initiative sellers favorable entry and responsive buyers favorable exit. 

The situation would drastically deteriorate with trade beneath the $3,880.00 HVNode, the last reference before participants find acceptance in an area of low-volume.

In such scenario, future discovery ought to be volatile and quick as participants repair some of the poor structures left in the wake of a prior advance, and look to the next area of high-volume (i.e., $3,830.75) for favorable entry and exit.

Graphic 4: Profile overlays on a 65-minute and 4-hour chart of the Micro E-mini S&P 500 Futures. See all decision levels of /ES and /NQ here, also.

Conclusions: The go/no-go level for next week’s trade is $3,909.25. 

Any activity at this level suggests market participants are looking for more information to base their next move. Anything above (below) this level increases the potential for higher (lower).

Levels Of Interest: $3,909.25 HVNode.

Photo by Charles Parker from Pexels.

Categories
Commentary

Market Commentary For The Week Ahead: ‘To The Moon’

Key Takeaways:

  • Positive earnings revisions nearing records
  • Equity mutual funds attract strong inflows.
  • Multi-asset funds raising equity allocations.

What Happened: U.S. stock indexes resolved a week-long trading range, Friday.

What Does It Mean: As the new administration looked to advance the status of coronavirus relief, U.S. stock index futures established record highs.

This comes as stock indexes, particularly the S&P 500, traded sideways after a rapid de-risking event associated with the GameStop Corporation (NYSE: GME) crisis, and subsequent v-pattern recovery.

More On The V-Pattern: A pattern that forms after a market establishes a high, retests some support, and then breaks above said high. In most cases, this pattern portends continuation.

As stated on Friday, the tight trading range is most likely attributable to the large February monthly options expiration (OPEX), after which, the interest at the $3,900.00 S&P 500 option strike will roll-off. 

Graphic 1: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust (NYSE: SPY), for the week ending February 12, 2021. Activity in the option market was primarily concentrated in short-dated tenors near $390, a strike that corresponds with $3,900.00 in the cash-settled S&P 500 Index (INDEX: SPX).

Why’s this? Most funds are committed to holding long positions. In the interest of lower volatility returns, these funds will collar off their positions, selling calls to finance the purchase of downside put protection.

As a result of this activity, option dealers are long upside and short downside protection.

This exposure must be hedged; dealers will sell into strength as their call (put) positions gain (lose) value and buy into weakness as their call (put) positions lose (gain) value.

Now, unlike theory suggests, dealers will hedge call losses (gains) quicker (slower). This leads to “long-gamma,” a dynamic that crushes volatility and promotes momentum, observed by lengthy sprints, followed by rapid de-risking events as the market transitions into “short-gamma.”

If the interest near $3,900.00 S&P 500 is not rolled up in price and out in time, then option hedging requirements will change.

However, it is important to note that, in recent days, some exposure has been rolled up in price and out in time. This suggests an inclination by participants to maintain long exposure through OPEX, a day that would mark an end to pinning (which we’ve seen over the past weeks).

One such example can be seen below.

Graphic 4: Purchase of call positions higher in price and farther out in time in the cash-settled S&P 500 Index

What To Do: In coming sessions, participants will want to pay attention to the $3,919.75 spike base and $3,928.25 balance-area high.

More On Spikes: Spike’s 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).

Balance-areas make it easy to spot change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).

Given the spike out of balance, the following frameworks ought to be applied. 

In the best case, the S&P 500 opens and remains above the $3,919.75 spike base, confirming last week’s higher prices. In the worst case, the S&P 500 auctions below the $3,919.75 spike base.

Trade below the spike base would be the most negative outcome and may trigger a new wave of downside discovery, repairing some of the poor structures left in the wake of the aforementioned advance.

Graphic 5: Profile overlays on a 30-minute candlestick chart of the Micro E-mini S&P 500 Futures.

Conclusions: The go/no-go level for next week’s shortened holiday trade is $3,919.75. Trade below this level suggests markets are not yet ready to rally.

Levels Of Interest: $3,919.75 spike base.

Cover photo by Pixabay, from Pexels.

Categories
Commentary

Market Commentary For 2/4/2021

Notice: To view this week’s big picture outlook, click here.

What Happened: U.S. stock index futures balanced in prior-range, as evidenced by a lack of directional resolve.

What Does It Mean: After a rapid de-grossing and v-pattern recovery, stock indexes are nearing an important hurdle.

In particular, the S&P 500 has to contend with a transition into long-gamma.

Gamma is the sensitivity of an option to changes in underlying price. Dealers that take the other side of option 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.

Adding: Here’s a good explanation I wrote regarding the derivative market’s impact on the equity market.

Graphic 1: SpotGamma suggests S&P 500 nearing “Long-Gamma” territory.

Further, given the aforementioned v-pattern recovery, a price sequence that ought to be followed by further price discovery, as high as the 100% price projection, which happens to be near $4,000.00 in the S&P 500, market participants ought to also pay attention to divergences popping up across different indices.

To be more specific, Wednesday’s regular trade in the Nasdaq-100 showed weakness relative to the S&P 500. In the end, participants established a neutral-center day on S&P 500 and neutral-extreme down day in the Nasdaq-100.

On a neutral-center day, participants test both extremes before closing an index in range, suggesting minimal confidence and balance. On a neutral-extreme day, participants test both extremes before closing at on extreme, suggesting increased confidence and imbalance.

The profile shape in the S&P 500 confirms balance while in the Nasdaq-100 it’s likely that participants were “too” long and had poor location.

What To Expect: Thursday’s regular session (9:30 AM – 4:00 PM ET) will likely open inside of prior-balance and -range, suggesting limited directional opportunity and high volatility.

Currently, the S&P 500 is rotating at the $3,842.00 high-volume area (HVNode).

As stated, HVNodes can be thought of as building blocks — they also denote areas of supply and demand. In this case, $3,842.00 can be thought of as an area of supply. The primary strategy is to respond to probes into these supply (i.e., selling responsively) and demand (i.e., buying responsively) areas as they offer favorable entry and exit.

In the coming session, participants will want to pay attention to Tuesday’s overnight high ($3,483.50) and Monday’s regular-trade low ($3,799.00). The reason being, between those two references is a developing balance area. Balance-areas make it easy to spot change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend).

Added Note: There is a low historical probability that overnight rally-highs end the upside discovery process.

From an order flow perspective, the absence of aggressive buying suggests more of the same — balance or downside to repair poor structures left in the wake of short-covering and initiative buying in the day’s prior.

In the simplest way, high-volume areas can be thought of as building blocks. A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure. If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.

For today, the following frameworks ought to be applied.

In the best case, the market will initiate above, or find acceptance at (in the form of rotational trade) the $3,842.00 HVNode. In the worst case, responsive sellers appear and restart the downside discovery process. Any break that finds increased involvement below the $3,799.00 regular-trade low, would favor continuation as low as the $3,727.75 HVNode.

The go/no-go for upside is the $3,843.50 overnight-trade high (ONH). The go/no-go for downside is $3,799.00 regular-trade low (RTH Low). Anything in-between portends responsive, non-directional trade.

A break above the ONH, participants may see discovery as high as $3,880.00, a balance-area projection (i.e., typical balance-break target). A break below the RTH Low, participants may see prices as low as $3,750.00, another balance-area projection.

Levels Of Interest: $3,843.50 ONH, $3,799.00 RTH Low.

Categories
Commentary

Market Commentary For The Week Ahead: ‘The Flow Won’

Key Takeaways:

What Happened: Amid a volatile, news-heavy week, after a slew of earnings reports by heavily weighted index constituents, and an FOMC meeting that made no change to existing monetary policy, financial markets experienced a rapid de-risking, similar to what transpired prior to the sell-off in February 2020.

What Does It Mean: After extending the S&P 500’s rally, as well as establishing acceptance near the $3,850.00 price extension, an upside target, and excess (i.e., a proper end to price discovery), participants auctioned back into range, repairing poor structures left in the wake of initiative buying.

The action found acceptance below the $3,824.00 – $3,763.75 balance-area, invalidating the prior week’s break-out to new highs.

Since then, market participants were witness to violent two-sided trade, a result of the market transitioning into a short-gamma environment (Graphic 1).

In such case dealers hedge derivatives exposure by buying into strength and selling into weakness. This, will exacerbate volatility.

Graphic 1: SpotGamma data suggests S&P 500 has entered short-gamma environment

In a conversation for a Benzinga article to be released this coming week, I spoke with Kris Sidial, co-chief investment officer at The Ambrus Group, a volatility arbitrage fund, regarding GameStop Corporation (NYSE: GME) share price volatility, market microstructure, and regulation.

According to Sidial, the dynamics that transpired in GameStop can be traced back to factors like Federal Reserve stabilization efforts, and low rates, which incentivize risk taking (see Graphic 2).

“The growth of structured products, passive investing, the regulatory standpoint that’s been implemented with Dodd-Frank and dealers needing to hedge off their risk more frequently, than not,” are all part of a regime change that’s affected the stability of markets, Sidial notes. 

“These dislocations happen quite frequently in small windows, and it offers the potential for large outlier events,” like the equity bust and boom during 2020. “Strength and fragility are two completely different components. The market could be strong, but fragile.”

The aforementioned regime change is one in which dealer exposure to direction and volatility promotes crash up and down dynamics. Last February, the market was heavily one-sided with participants, like target date funds (e.g., mutual funds), selling far out-of-the-money puts on the S&P 500 for passive yield, and investors buying-to-open put options in an increasing amount for downside exposure, thus exacerbating volatility. 

Graphic 2: Newfound Research unpacks market drivers, implications of liquidity.
Graphic 3: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

Last week, per Graphic 4, the SPDR S&P 500 ETF Trust, the largest ETF that tracks the S&P 500, saw a rise in purchases of downside protection with time, which will likely lead to an increase in implied volatility and sensitivity of options to changes in underlying price.

These risks will be hedged off by dealers selling into weakness (see Graphic 3), thereby exacerbating downside volatility.

Graphic 4: Physik Invest maps out the purchase of call and put options in the SPDR S&P 500 ETF Trust, for the week ending January 30, 2021.

The activity was most concentrated in put options with a strike price of $361, corresponding with $3,610 in the cash-settled S&P 500 Index (INDEX: SPX). This, alongside the market’s entry into short gamma, and an inversion of the VIX futures term structure (see Graphic 5), in which longer-dated VIX expiries are less expensive, is a warning of elevated near-term risks for equity market stability.

Graphic 5: VIX Futures Term Structure per vixcentral.com.

What’s more? Aside from breaking technical trend (Graphic 6) is DIX, a proxy for buying derived from short sales (i.e., liquidity provision on the market making side) declining, and the presence of divergent speculative flows and delta (e.g., non-committed buying as measured by volume delta).

Graphic 6: Cash-settled S&P 500 Index experiences technical breakdown.
Graphic 7: DIX by SqueezeMetrics suggests large divergence between price and buying on January 27.
Graphic 8: Divergent Delta in the SPDR S&P 500 ETF (NYSE: SPY), the largest ETF that tracks the S&P 500.

What To Expect: In light of the technical breakdown U.S. stock indexes are best positioned for downside discovery.

As a result, participants ought to zoom out, and look for valuable areas to transact.

Graphic 9: 4-hour profile chart of the Micro E-mini S&P 500 Futures.

In Graphic 9, the highlighted zones denote high-volume areas (HVNodes), which can be thought of as building blocks.

A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test). 

If participants were to auction and find acceptance into areas of prior low-volume, as they have in the week prior, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.

Additionally, it’s important to remember what the market’s long-term trajectory is: up.

Late last year, JPMorgan Chase & Co. (NYSE: JPM) strategist Marko Kolanovic suggested equities would rally short-term with the S&P 500 auctioning as high as $4,000 on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. Since then, Kolanovic has downgraded growth and suggested the limited potential for further upside despite odds of a sustained economic recovery.

Note, Kolanovic has not called for an implosion in equity markets. Instead, the market is due for some downside discovery given a moderation in the recovery.

Given the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 takes back Friday’s liquidation and auctions above the $3,727.75 HVNode. Expectations thereafter include continued balance.

In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below the $3,689.50 HVNode, would favor continuation as low as the $3,611.50 and $3,556.00 HVNodes. Note that the second to last HVNode corresponds with the $361 SPY put concentration, which may serve as a near-term target, or bottom, for this sell-off, given last week’s activity at that strike.

Graphic 10: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures.

Conclusions: Participants ought to look for favorable areas to transact, such as those highlighted areas in the S&P 500, featured in Graphic 9.

Big picture, the sell-off ought to be bought, just not yet. Per Graphic 11, euphoria is still too high.

Graphic 11: Bank of America Corporation (NYSE: BAC) sentiment indicators.

Levels Of Interest: $3,727.75, $3,689.50, $3,611.50 and $3,556.00 HVNodes.

Cover photo by Pixabay from Pexels.

Categories
Commentary

Market Commentary For The Week Ahead: ‘Follow The Flow’

Key Takeaways:

What Happened: After prices were advertised below balance in the week prior, responsive buyers in the S&P 500 began a rally that found acceptance back inside a larger balance-area, near the $3,800 high-open interest strike.

Thereafter, initiative buyers extended the S&P 500’s rally, breaking the index above its $3,824.25 balance-area high (BAH), before establishing acceptance near the $3,850.00 price extension, an upside target, and auctioning back into range, repairing poor structures left in the wake of discovery.

What Does It Mean: In light of a failed breakdown in the week prior, U.S. stock indexes were best positioned for further downside discovery. However, after what appears to be aggressive buying in response to prices below value, it was clear that was not the case.

This leads to the following question: why did selling stop on January 15? One answer, aside from a positive start to the earnings season and prospects for further stimulus, may be OPEX, the January 15 option expiry. On expiration days, delta and gamma exposures change — depending on how derivatives exposure is removed or rolled — which causes dealers to adjust hedges.

According to SpotGamma, the January 15 expiry “resulted in a ~50% reduction in single stock gamma … [which] creates volatility because, as large options positions expire[], are closed and/or rolled, dealers have large hedges they need to adjust. There is a trove of data to suggest that the bulk of single stock call activity is long calls, and based on that we believe dealers (who are short calls vs long stock) therefore have long stock positions to sell.”

Put more simply, the price action may have been attributable to the sale of long stock that hedged expiring short derivatives exposure above the market (i.e., call side).

Per the SpotGamma S&P 500 dealer hedging graphic for the January 15 expiry below, “The black line was the mark on Thursday evening, with the red line being the forecasted position on Tuesday. This red line being substantially lower than the black suggests that dealers had to reduce delta exposure as a result of expiration. Note there is a larger shift at overhead prices suggesting this was a ‘call heavy’ expiration.”

Graphic 1: SpotGamma S&P 500 dealer hedging graphic for the January 15 options expiry

After the VIX (i.e., CBOE’s Volatility Index) expiry on January 20, alongside the inauguration of President Joe Biden, the prospects for a rally improved as “event premium in IV dries up … [and] put values drop, which allows dealers (who are short puts) to buy back short hedges … [fueling] a quick rally up to the 3850SPX/385SPY level (green arrow).”

Graphic 2: SpotGamma S&P 500 Gamma Levels

Adding, the number of put options sold to open exceeded the number bought to open, per SpotGamma, suggesting increased confidence in higher prices as market participants look to options for income, and not insurance.

Historically, the returns after such developments are mixed — more often the appearance of strong initiative buying surfaces (e.g., August and January 2020) before a liquidation helps correct excess inventory, and bring sense back into the market.

Graphic 3: SpotGamma plots opening option positions.

What To Expect: During Friday’s session in the S&P 500, responsive buying surfaced after a test of the $3,818.25 High-Volume Node (HVNode), above the $3,813.50 ledge (below which is a pocket of low-volume).

In the simplest way, high-volume areas can be thought of as building blocks. A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test).

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

After the S&P 500 found acceptance above the $3,813.50 ledge and $3,824.25 BAH, it encountered responsive selling near the $3,840.75 HVNode, the site of a downtrend line. Since the selling transpired at a visual level, market participants know that technically-driven, short-term traders in control. In other words, institutions (e.g, funds) tend not to transact at exact technical levels.

Given the aforementioned dynamics, participants will come into Monday’s session knowing the following:

  1. The S&P 500’s higher-time frame breakout remains intact, per graphics 7, 8, and 9.
  2. Late last year, JPMorgan Chase & Co. (NYSE: JPM) strategist Marko Kolanovic suggested equities would rally with the S&P 500 auctioning as high as $4,000 on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. Since then, Kolanovic downgraded growth and expressed the limited potential for further upside.
  3. The earnings of heavily weighted index constituents suggests participants discount improved speculative flows and delta (e.g., presence of committed buying or selling as measured by volume delta). Please see graphics 4, 5, and 6.
Graphic 4: Supportive order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500, on January 20 trend day.
Graphic 5: Supportive order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500, on January 22.
Graphic 6: Speculative derivatives activity for the week ending January 23, 2021.
Graphic 7: Daily candlestick chart of the cash S&P 500 Index

Given the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 takes back Friday’s liquidation and auctions above the $3,840.75 HVNode. Expectations thereafter include continued balance or initiative buying to take out the $3,859.75 overnight all-time high (there is a low probability that overnight all-time highs end the upside discovery process). Thereafter buying continues as high as the $3,884.75 price projection, or double the width of the balance-area, the typical target on a balance-area breakout.

In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below $3,824.25 BAH, would favor continuation as low as the $3,763.75 BAL.

Graphic 8: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures

Conclusions: Despite broad-market indices being in a longer-term uptrend, the odds of substantial upside resolve are low. Participants ought to look for favorable areas to transact, such as those high-volume areas in the S&P 500 featured in graphic 8.

All in all, the risk and reward dynamics, at these price levels, are poor.

Graphic 9: 4-hour profile chart of the Micro E-mini S&P 500 Futures

Levels Of Interest: $3,884.75, $3,859.75, $3,840.75 HVNode, $3,824.25 BAH, $3,763.75 BAL.

Cover photo by Jayant Kulkarni from Pexels.

Categories
Commentary

Market Commentary For The Week Ahead: ‘Rally On Pause’

Key Takeaways:

What Happened:

Alongside mixed economic releases, plans for added fiscal stimulus, as well as a start to the Q4 earnings season, U.S. index futures broke balance and auctioned lower.

Given that Friday’s worst case scenario was realized, U.S. stock indexes are positioned for further downside discovery.

Graphic 1: Profile overlays on a 30-minute candlestick chart of the Micro E-mini S&P 500 Futures

What To Expect: Friday’s session in the S&P 500 found responsive buying surface after a test of the $3,741.25 Virgin Point of Control, or VPOC (i.e., the fairest price to do business in a prior session).

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

In the simplest way, high-volume areas can be thought of as building blocks. A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure. If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.

Thereafter, buying pressure quickly disappeared, and the S&P 500 confirmed the balance-break. Now, in light of the market’s search for an area to establish balanced, two-sided trade, participants will come into Tuesday’s session knowing the following:

  1. Prior to a multi-session consolidation, profile structures denoted the presence of short-covering. This was the result of old, weak-handed business emotionally buying to cover short positions, causing swift movement, followed by a stalled advance, or two-sided trade.
  2. Unsupportive speculative flows and delta (e.g., non-presence of committed buying or selling) in some instances, as can be viewed by the order flow graphics 2 and 3 below.
  3. The multi-month upside breakout targeting S&P 500 prices as high as $4,000.00 remains intact, per graphic 4.
  4. After a v-pattern recovery, the S&P 500 consolidated near the $3,800 high-open interest strike, forming a balance-area. This structure was resolved with Friday’s balance-break. A break-out from balance is usually the start of a short-term auction. Therefore, placing trades in the direction of the break is the normal course of action. Trading back into the consolidation (above $3,763.75), thereby invalidating the break-out, may portend a move to the other end of balance ($3,824.25).
Graphic 2: Divergent delta in the iShares Russell 2000 ETF (NYSE: IWM), one of the largest ETFs that track the Russell 2000
Graphic 3: Order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500
Graphic 4: Daily candlestick chart of the cash S&P 500 Index

Given the above dynamics, the following frameworks apply for next week’s shortened holiday trade.

In the best case, the S&P 500 remains above its $3,763.75 balance-area low (BAL). Expectations thereafter include continued balance or initiative buying to take out the $3,824.25 balance-area high (BAH).

In the worst case, the S&P 500 remains below its $3,763.75 BAL. Expectations thereafter include a test of the low-volume node (LVNode) near $3,732.75. A break of the LVNode would portend a response near the $3,703.25 balance-break projection.

Conclusions: For now, despite a negative balance-break jeopardizing the bullish thesis, broad-market indices are in a longer-term uptrend. Participants ought to look for favorable areas to transact, such as those big-picture high-volume areas featured in graphic 5.

Graphic 5: 4-hour profile chart of the Micro E-mini S&P 500 Futures

Levels Of Interest: $3,763.75 BAL, $3,824.25 BAH, $3,732.75 LVNode, $3,703.25 balance-break projection.

Cover photo by Oleg Magni from Pexels.

Categories
Commentary

Market Commentary For The Week Ahead: ‘Euphoria Is The Status Quo’

Key Takeaways:

  • Higher-time frame breakouts remain intact.
  • Volatility rises; markets are a tad euphoric
  • Equity funds went all in at the top, literally
  • Corporate credit outlook enhanced greatly. 
  • Earnings could rise faster than anticipated. 
  • Blue wave implies more stimulus, spending.
  • The bull market broadens as sectors rotate
  • M2 and yields break out; the Fed could act.

What Happened: As investors looked beyond a weak jobs report and political uncertainty, to added economic stimulus and the coming earnings season, U.S. index futures hit new highs.

Graphic 1: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures

What To Expect: Friday’s session in the S&P 500 found initiative buying surface after a test of $3,774.75, the lower boundary of the low-volume area left in the wake of Thursday’s opening drive.

The long-liquidation and subsequent recovery left the market with minimal excess (i.e., a proper end to discovery) at the highs, and a strong close, taking out the overnight stat at $3,817.75 (which had low odds of remaining, given that overnight all-time highs rarely end the upside discovery process).

Noting: Excess forms after an auction has traveled too far in a particular direction and portends a sustained reversal. The absence of excess, in the case of a high, suggests not enough conviction; in such case participants will liquidate (i.e., back off the high) and strengthen the market, before following through.

In light of the market’s search for an area to establish balanced, two-sided trade, participants will come into Monday’s session knowing the following: 

  1. The multi-month upside breakout targeting S&P 500 prices as high as $4,000.00 remains intact.
  2. Prices are above all major moving averages, including the year-to-date volume-weighted average price (VWAP). 
  3. After the resolution of last Monday’s long-liquidation, the market shifted into price discovery mode, evidenced by higher prices and value migration.
  4. For numerous sessions, profile structures denoted the presence of short-covering, the result of old, weak-handed business emotionally buying to cover short positions, causing swift movement followed by a stalled advance, or two-sided intraday trade.
  5. The week ending January 8 established a v-pattern recovery, a price sequence that ought to be followed by further price discovery, as high as the 100% price projection, which happens to be near the multi-month upside breakout target at $4,000.
  6. Unsupportive speculative flows and delta (e.g., commitment of buying or selling) in some instances, as can be viewed by order flow graphics 2 and 3 below. 
  7. Alongside the long gamma narrative, in which dealers buy dips and sell rips to hedge their exposure, record options activity, among other dynamics, the S&P 500 closed near $3,800, a high open interest strike. For sustained upside directional resolve, participants would look for this exposure to roll up. 
Pictured: Divergent delta in the iShares Russell 2000 ETF (NYSE: IWM), one of the largest ETFs that track the Russell 2000
Pictured: Order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500
Graphic 4: S&P 500 tests the $3,800 high open interest strike, per SpotGamma

Given the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 remains above its $3,762.25 high-volume node (HVNode). Expectations thereafter include continued balance or a response followed by initiative buying to take out the price extension at $3,847.75. 

Noting: Any structure that denotes meaningful buying continuation, not short-covering, would feature elongated, upside range expansion on committed volumes, as well as the migration of value. 

In the worst case, the S&P 500 initiates below its $3,762.25 HVNode. Expectations thereafter include a test of the minimal excess low near $3,732.75 (a LVNode). A break of Monday’s regular session (9:30 AM – 4:00 PM ET) low would jeopardize the bullish thesis. 

Two go, no-go levels exist; trade that finds increased involvement above $3,824.25 and below $3,775.25 would suggest a change in conviction. Anything in-between favors responsive trade.

Conclusions: In a GMO article, Jeremy Grantham expressed his opinion on recent market activity.

I am long retired from the job of portfolio management but I am happy to give my opinion here: it is highly probable that we are in a major bubble event in the U.S. market, of the type we typically have every several decades and last had in the late 1990s. It will very probably end badly, although nothing is certain. I will also tell you my definition of success for a bear market call. It is simply that sooner or later there will come a time when an investor is pleased to have been out of the market. That is to say, he will have saved money by being out, and also have reduced risk or volatility on the round trip. This definition of success absolutely does not include precise timing. (Predicting when a bubble breaks is not about valuation. All prior bubble markets have been extremely overvalued, as is this one. Overvaluation is a necessary but not sufficient condition for their bursting.) Calling the week, month, or quarter of the top is all but impossible.

Continuing, in addition to market participants reckoning with the uneven recovery, stimulus, trade, inflation, among other risks, they must also worry about something that’s arguably more important: price and value.

As of now, all broad-market indices are in an uptrend, evidenced by higher prices and value. A break below $3,600.00 in the S&P 500 would denote a substantial change in tone.

Levels Of Interest: $3,762.25 HVNode, $3,732.75 LVNode, $3,824.25 rally high, as well as the $3,847.75 price extension.

Bonus: Some opportunities unfolding in the week ahead.

Photo by Valdemaras D. from Pexels.

Categories
Commentary

Market Commentary For 1/5/2021

Notice: To view this week’s big picture outlook, click here.

What Happened: Alongside uncertainty surrounding Senate runoffs and new COVID lockdowns, U.S. index futures balanced overnight after Monday’s rapid sell-off.

What Does It Mean: During last Thursday’s session, initiative buying, in the S&P 500, diverged prices from value. This dynamic resolved itself in Monday’s regular trade.

Overnight, prices recovered off their lows, but encountered responsive selling at the $3,705.00 low-volume node (LVNode).

What To Expect: Tuesday’s regular session (9:30 AM – 4:00 PM ET) will open inside of prior-balance and -range.

Adding, participants will come into today’s session knowing the following: (1) short-term, technically-driven market traders were not able to defend last week’s advance on tapering, holiday volumes, (2) weekend trade established a new all-time high (i.e., historically, there is a low probability that overnight all-time highs end the upside discovery process), (3) increased capital was not committed into the lows, evidenced by a divergent delta (i.e., the difference between buying and selling pressure), (4) the auction is resisting the low-volume area above $3,705.00, leaving a ledge, (5) a proxy for buying derived from short sales (i.e., liquidity provision on the market making side) rose, (6) bearish activity was concentrated in shorter-dated options.

Pictured: Speculative derivatives activity on Monday, January 4, 2021.
Pictured: DIX by Squeeze Metrics suggests divergence between price and buying.
Pictured: Divergent delta in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500.

Given the above dynamics, the following framework applies:

The S&P 500 will likely open within prior-balance and -range, so volatility will likely be high. The go/no-go level for upside is the $3,705.00 ledge which has repeatedly attracted responsive selling. Should prices auction off the ledge, into the low-volume area, the likelihood of continuation increases substantially. In such case, participants would then monitor for a response at the $3,727.25 high-volume node (HVNode), which also corresponds with a 61.80% fibonacci retracement.

Noting: High-volume areas represent value and have the tendency to attract price. Should the market auction into the high-volume area, then prices should slow as balanced, two-sided trade takes over (i.e., the region offers attractive entry and exit). Auctioning through the high-volume area would be the most positive outcome.

Breaking below Monday’s regular-trade low would be the most negative outcome. In that case, participants would monitor for responses at the high-volume node near $3,610.00 and the $3,597.50 anchored, volume-weighted average price.

Levels Of Interest: $3,705.00 LVNode.

Overall: The higher-time frame breakout in the S&P 500 remains intact. Caution warranted.

Pictured: Daily candlestick chart of the cash S&P 500 Index.
Categories
Commentary

Market Commentary For The Week Ahead: ‘Hello, Goodbye’

Key Takeaways:

What Happened: Coming into the extended holiday weekend, on tapering volumes, U.S. index futures balanced for four regular trading sessions (9:30 AM – 4:00 PM ET), before breaking out.

Pictured: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures

What To Expect: Thursday’s session found initiative buying surface above the $3,731.00 high-volume node (HVNode), the market’s most recent perception of value.

Given four-sessions worth of unchanged value, and the failure to fill the gap beneath a weak low (i.e., a visual level that attracts the business of short-term, technically-driven market participants) at $3,714.50, participants will come into Monday’s session knowing the following:

  1. Amid Thursday’s late-day buying, price diverged from value.
  2. The overnight rally high at $3,747.75 was recovered (i.e., based on historical trade, there were low odds that the overnight all-time high would end the upside discovery process).
  3. The multi-month upside breakout targeting S&P 500 prices as high as $4,000.00 remains intact.

In light of the above dynamics, the following frameworks apply for next week’s trade.

In the best case, the S&P 500 remains above its $3,731.00 HVNode. Expectations thereafter include continued balance, or a response followed by initiative buying to take out the price extension at $3,756.75.

In the worst case, the S&P 500 initiates below its $3,731.00 HVNode. Expectations thereafter include a test of the weak, minimal excess low at $3,714.50, and subsequent follow-through as low as the $3,691.00 break-point. 

Noting: Excess forms after an auction has traveled too far in a particular direction and portends a sustained reversal. Absence of excess, in the case of a low, suggests minimal conviction; participants will cover (i.e., back off the low) and weaken the market, before following through.

Two go, no-go levels exist; trade that finds increased involvement above $3,752.75 and below $3,714.50 would suggest a change in conviction. Anything in-between favors responsive trade.

Conclusion: From an uneven recovery, stimulus, elections, trade, and the like, it helps to boil it down to what actually matters: price and value. 

Though risks remain, markets are pricing in the odds of a continued rebound. All broad-market indices are in an uptrend. A break below $3,600.00 in the S&P 500 would denote a substantial change in tone.

Pictured: Retest of the upside breakpoint on a weekly candlestick chart of the cash S&P 500 Index

Levels Of Interest: $3,752.75 rally-high, $3,714.50 weak low, $3,731.00 HVNode, $3,756.75 price extension, $3,691.00 break-point.

Bonus: Here is a look at some of the opportunities unfolding.

Photo by Max Walter from Pexels.

Categories
Results

Case Study: Trading Tesla’s S&P 500 Inclusion

What Happened: On November 17, 2020, shares of Tesla Inc (NASDAQ: TSLA) surged on news that S&P Dow Jones Indices would include the stock in the S&P 500, the most liquid index in the world.

Since markets are most influenced by credit and positioning, news of the inclusion was impactful. Funds tied to the S&P 500 would purchase Tesla shares from a dealer by the addition date. This means that dealers would look to purchase shares of the stock heading into the event, to later supply funds at the close of Friday, December 18, the last session before the inclusion.

In the simplest of terms, the event was a positive since it meant that (1) speculative derivatives activity and associated hedging, (2) short-term traders, as well as (3) dealers and index funds would now support the stock.

The following sequence analysis unpacks how Physik Invest traded equity and derivatives tied to the carmaker’s stock leading up to the December 21, 2020 index inclusion.

Note: Click here to view all transactions.

Sequence 1: On news of the inclusion, market participants initiated shares of Tesla out of balance, beyond trend resistance. Thereafter, in accordance with a typical give and go scenario, the stock faded, filling 50% of the low-volume area left after the initial move higher, before aggressive buying resurfaced to continue the new trend.

Through November 19, the following positions were added for a $61.00 debit, in total. At this point if all legs were to remain out of the money (i.e., expire worthless) by November 20, the maximum loss would be $61.00, approximately 1/10 of a standard risk unit, or the capital risked in a typical position.

  • 500+1/530-2 call ratio spread
  • 490+2/505-3 call ratio spread
  • 525+1/550-2 call ratio spread
  • 510+1/525-2 call ratio spread
  • 445-1 put
  • 460-1 put

By November 20, all aforementioned positions were closed for an $827.00 credit, a 1,255.74% return on initial investment.

All the above call-side structures were initiated against the $500 high open interest strike. Reason being, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure.

On November 20, nearly 40% of Tesla’s gamma was to roll off. 

Pictured: November options gamma by Spot Gamma
Pictured: Speculative call-side options activity after the index inclusion announcement 

Moreover, since derivatives exposure was rolled into farther dated expiries, the stock would now be supported by dealers buying to hedge their derivatives exposure and facilitate the index inclusion.

Noting, at a simplistic level, prices often encounter resistance at prior highs due to the supply of old business. These areas take time to resolve. Breaking and establishing value (i.e., trading more than 15-minutes above this level) portends continuation.

Sequence 2: On November 20, the following structures expiring on December 4 were initiated for a $644.00 credit.

  • 450-1 put
  • 520+1/550-1 call ratio spread
  • 570+1/600-2 call ratio spread
  • 490-1/475+1 put ratio spread

Through November 24, the above structures were removed for a $876.00 credit.

Sequence 3: On November 24, the cost basis from November 19 ($61.00 debit) was reduced via an intraday long stock delta hedge that bought 10 shares at an average of $539.50.

The initial cost basis, after this particular trade, was brought down to a $0.20 debit.

Sequence 4: On November 25 the following positions were opened and closed the same day for a $179.30 credit.

  • Bought stock at $550.14 average
  • 480+1/500-2 call ratio spread

Sequence 5: On November 27, the following positions were initiated and closed by December 3 for a $117.10 debit.

  • Bought stock at $595.55 average
  • 475+1/437.5-2 put ratio spread

Sequence 6: On December 1 through December 3, the following positions were initiated, and then exited from by December 7 for a $1.77 debit.

  • Bought stock at $589.20 average
  • Bought stock at $563.77 average
  • 740+1/780C-2 call ratio spread

Sequence 7: Through December 17, the following positions were initiated and closed for a total $452.30 credit.

  • 720+1/820-2 call ratio spread
  • 740+1/830-2 call ratio spread
  • Bought stock at $632.17 average
  • 720+1/820-2 call ratio spread
  • Bought stock at $606.88 average
  • 800+1/860-2 call ratio spread
  • 500+1/480-2 put ratio spread

Sequence 8: From December 17 through December 23 the following positions were entered and exited from for a $322.00 credit.

  • 500+2/450-4 put ratio spread
  • 800+2/850-4 call ratio spread
  • 670+1/685-2 call ratio spread

Summary: In total, the above sequence of trades net a $3,098.29 credit after commissions and fees.

The strategies employed were in accordance with Physik Invest’s methodology: the trade of ratioed, multi-leg strategies that combine short and long positions to reduce risk and increase returns. 

Yes, in hindsight, one could have opted for something as simple as risk-reversals (e.g., buying calls and selling puts). However, the risks tied to such strategies are immense. By leveraging the dynamics of time and volatility, through complex spreads, risk was reduced.

Note: There were many times, during these sequences, that positions were structured in a way that would net no loss had the security moved sideways or lower into expiry.

Adding, per Fibonacci principles, one core aspect of Physik Invest’s market structure analysis, an upside target of $675.10 was established early on in the process. Tesla spent the majority of its December 18 session at this level.

Disclaimer: There is a $0.11 discrepancy between the transaction sheet and numbers provided in this case study. This is attributable to differences in rounding.