Bank of America Corporation (NYSE: BAC) sees allocations to equities versus bonds falling. That’s amid recession fears. Per EPB, “the cyclical economy has just started to shed jobs today, and leading indicators signal the recession is likely underway.”
“To get advanced warning of recessions, you must look at the construction and manufacturing sectors, even though these two sectors are only 13% of the labor market,” EPB adds, noting traditional indicators’ weakening predictability is not so great to ignore the insight. “It’s clear that the composition of traditional leading indicators remains appropriate, and thus, the current resounding recessionary signal should not be ignored.”
BAC strategist Michael Hartnett said, though, that this “consensus lust for recession” must soon be satisfied. Otherwise, the “pain trade” would be even higher yields and stocks; the S&P 500 (INDEX: SPX) is enjoying an accelerated rally which Jefferies Financial Group (NYSE: JEF) strategists think portends a period of flatness, now, over the coming weeks …
Graphic: Retrieved from Jefferies Financial Group (NYSE: JEF) via The Market Ear.
… and through options expiration (OpEx), typically a poor performance period for the SPX.
Beyond the uninspiring fundamentals, the positioning contexts are supportive. Recall our letters published earlier this year. If the market consolidated and failed to break substantially, then falling implied volatility (IVOL) and time passing would bolster markets and, potentially, help build a platform for a rally into mid-year. A check of fixed-strike and top-line measures of IVOL like the Cboe Volatility Index or VIX confirms options activities are keeping markets intact.
Graphic: Retrieved from Danny Kirsch of Piper Sandler (NYSE: PIPR). “SPX May $4,150.00 call volatility, the lack of realized volatility weighing on the market. Volatility low, not cheap.”
Beyond the rotation into shorter-dated options, just one of the factors exacerbating the decimation of longer-dated volatility, traders’ consensus is that markets won’t move a lot and/or they don’t need to hedge over longer time horizons; traders want punchier exposure to realized volatility (RVOL), and that they can get through shorter-dated options that have more gamma (i.e., exposure to changes in movement), not vega (i.e., exposure to changes in implied volatility).
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via Bloomberg.
Consequently, counterparties may be less dangerous to accelerating movement in either direction; hence, the growing likelihood of a period of flatness.
“Despite the collapse in the 1-month realized volatility, we suspect most vol control funds have scaled into using their longer-term realized vols, which by design, lead to less aggressive rebalancing flows,” Tier1Alpha says. “For example, the 3-month rVol, which is currently driving our model, was essentially unchanged yesterday, which means volatility targets were maintained, and very little additional rebalancing had to occur. So even with the decline in the 1-month vol, overall risk exposure remained the same.”
With IVOL at a lower bound, the bullish impacts yielded by its compressing have largely played out. There may be more to be gained by movements higher in IVOL, in addition to the expiry of many call options this OpEx. By owning protection, particularly far from current prices, you are positioned to monetize on the market downside and non-linear repricings of volatility, as this letter has discussed in recent history. The caveat is that volatility can cluster and revert for longer; hence, your structure matters.
“I am concerned that VIX is underpricing the series of events that we know to expect over the coming weeks,” says Interactive Brokers Group Inc’s (NASDAQ: IBKR) Steve Sosnick. “While there is now an 88% implied likelihood of a 25 basis point hike, the likely path of any potential future hikes and assumed cuts should be more clarified at the meeting and in its aftermath. And oh, has anyone ever heard the expression “sell in May and go away?”
Graphic: Retrieved from Interactive Brokers Group Inc (NASDAQ: IBKR).
With call skews far up meaningfully steep in some products, still-present low- and zero-cost call structures this letter has talked about in the past remain attractive. If the market falls apart, your costs are low, and losses are minimal. If markets move higher into a “more combustible” position, wherein “volatility is sticky into a rally,” you may monetize your call structures and roll some of those profits into bear put spreads (i.e., buy put and sell another at a lower strike). An alternative option is neutral. Own something such as a T-bill or box spread (i.e., buy call and sell put at one strike and sell call and buy put at another higher strike). Some boxes are yielding upwards of 5.4% as of yesterday’s close.
To end, though the short-dated options activity may prompt cascading events in market downturns, the main issue is the reduced use of longer-dated options; a supply and demand imbalance likely resolves itself with an implied volatility repricing of a great size where longer-dated options outperform those that are shorter-dated.
Our locking in of rates or using the profits of call structures to position for a potential IVOL repricing, particularly in the back half of the year when dealer positioning is less clear, buybacks are to fall off of a cliff, rates may fall, and the boost from short-covering has played its course, is an attractive proposition given the context.
Graphic: Retrieved from Bloomberg. “The S&P 500 (white line) is well above its levels from early March, while the yield on the 3m-2y spread remains in a deep inversion, signifying meaningful expectations of cuts in the months ahead.”
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 5:40 AM ET. Sentiment Neutral if expected /MES open is inside of the prior day’s range. /MES levels are derived from the profile graphic at the bottom of this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. The lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility. UMBS prices via MND. Click here for the economic calendar.
Administrative
Morning, team. Still working on a bigger write-up for later this week. Here are some key things to know. Have a good day!
Positioning
After a boost bolstered by systematic-type investors acting on changes in trend and volatility, the market is at a pivot of sorts.
Graphic: Retrieved from Danny Kirsch of Piper Sandler Companies (NYSE: PIPR). The move in [Nasdaq 100] relative to [the Russell 2000], [S&P 500 versus Russell 2000] looks similar. Ties into re-grossing theme, adding longs (QQQ+SPY) and shorts (IWM). Also fits with recent bid for credit.”
After a test of key areas of confluence, measures of the market’s strength weakened heading into the late-day equity weakness, Monday.
Graphic: Key market internals retrieved from TradingView.
Further, lots of the bullishness of the trend change and falling volatility was spent. The market is in a precarious state heading into Jerome Powell’s testimony, today.
Following Powell’s testimony, ranges likely expand.
On one hand, FOMO-type demand for call options exposures, coupled with CTAs further “raising their equity exposure” on trend signals and lower volatility, may boost markets into a “more combustible” state the Daily Brief for February 17 explained.
Graphic: Retrieved from Deutsche Bank AG (NYSE: DB) via Bloomberg.
On the other hand, in the context of liquidity coming off of the table and the increased competition between equities and fixed income, should Powell disappoint, expansion of implied volatility (IVOL) on demands for protection, alone, could “draw markets lower” into the March 17 options expiration (OpEx), options data and insight provider SpotGamma says. For more on how to trade this precariousness and reduce portfolio downside, see the Daily Brief for March 3.
Technical
As of 5:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a positively skewed overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $4,059.25.
Key levels to the upside include $4,071.25, $4,082.75, and $4,095.25.
Key levels to the downside include $4,045.25, $4,032.75, and $4,019.00.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: Areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Volume-Weighted Average Prices (VWAPs): A metric highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!
Graphic updated 6:45 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Administrative
Slow start to the week with some color on statements made in last week’s detailed newsletters, like the one published on September 16, 2022.
As an aside, some updates are coming to this letter’s format and you will be in the loop on what those are and why, shortly.
Fundamental
This is the season for volatility. The S&P 500’s (INDEX: SPX) monthly realized volatility, over a period spanning 1928 to 2021, has historically been high during this part of the year.
Graphic: Retrieved from The Market Ear. Via Goldman Sachs Group Inc (NYSE: GS).
Adding to the volatility are uncertainties with respect to the macro environment. For example, last week we discussed the implementation of contractionary monetary policies for reducing inflation and growth.
Read the Daily Brief for September 16, 2022, for detail on rates, quantitative tightening (and its impact on lending and market liquidity), as well as positioning and beyond.
Given the lagging data policymakers input into their decision-making, versus what non-lagging indicators are showing the likes of Catherine Wood and Elon Musk, “deflation is in the pipeline,” and the Fed may hike into a “deep recession,” as BlackRock Inc (NYSE: BLK) strategists put.
Per Andreas Steno Larsen, in the latest Consumer Price Index (CPI) report, which had traders pricing increased odds of a 100 basis point hike to interest rates, shelter costs did much of the “heavy lifting.”
Graphic: Retrieved from Bloomberg via Michael J. Kramer. Based on where rates are at, the market may still be too expensive.
The MoM shelter costs were up in excess of 0.7%. Notwithstanding, the “[c]ost of shelter is the most lagging variable in the basket,” all the while the “shelter index in the CPI basket lags the housing price development by up to 18 months.”
As a result, this means drops in rents and home prices could “take more than a year for the CPI methodology to” account.
Graphic: Via Morgan Stanley (NYSE: MS) research.
These aforementioned comments, coupled with reports issued by the National Federation of Independent Business, boost the cases of those claiming inflation has peaked, such as Musk and Wood.
Steno Larsen puts forth that “most analysts and newsletter-sellers … missed the most important inflation print of the week, namely the NFIB price plan survey” which bolsters the case for prices reaching their “new highs in YoY terms.”
Pointing readers back to the September 16, 2022 letter for contexts on the positioning.
Further, it is essentially the case that “2022 is a put-weighted regime [and] returns are negative into options expiration (OPEX) and positive after,” explained SpotGamma on Sunday.
The impact of OPEX is so staggering that “flipping to cash” the week of expiry nets far better returns than holding S&P 500 without any adjustments.
As of 6:45 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,857.25 HVNode puts into play the $3,909.25 MCPOC. Initiative trade beyond the MCPOC could reach as high as the $3,935.00 VPOC and $3,964.75 HVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,857.25 HVNode puts into play the $3,826.25 HVNode. Initiative trade beyond the latter could reach as low as the $3,770.75 HVNode and $3,722.50 LVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: A feature of this 2022 down market was responsiveness near key-technical areas (that are discernable visually on a chart). This suggested to us that technically-driven traders with shorter time horizons were very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
That’s changing. The key levels, quoted above, are snapping far easier and are not as well respected. That means other time frame participants with wherewithal are initiating trades.
Those are the participants you should not fade.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!
Graphic updated 6:50 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Administrative
A longer note so stick with me!
Updates are pending for the above dashboard. Exciting! Beyond this, the newsletter is getting a revamp in other parts. If you have any feedback on what should be changed, please comment!
Also, I am going to refer everyone to a conversation between Joseph Wang and Andy Constan, as well as some updates Cem Karsan of Kai Volatility made (HERE and HERE). That is, in part, a primer for what we will be talking more about, soon.
Fundamental
Talked about yesterday was the prospects of contractionary monetary policy reducing inflation and growth. BlackRock Inc (NYSE: BLK) strategists, even, put forth that a “deep recession” is needed to stem inflation. In short, “there is no way around this,” they claim.
Graphic: Retrieved from The Market Ear. FedEx Corporation (NYSE: FDX) sold 20% on warning about the global economy.
From thereon, we talked about how rates rising would “bring private sector credit growth down,” as well as “private sector spending and, hence, the economy.”
Based on where rates are at, the market may still be too expensive.
Graphic: Retrieved from Bloomberg via Michael J. Kramer. “What is amazing is how expensive this market is relative to rates. The spread between the S&P 500 Earnings yield and the 10-Yr nominal rate is at multi-year lows.”
On the other hand, some argue inflation peaks are in. ARK Invest’s Cathie Wood suggests “deflation [is] in the pipeline, heading for the PPI, CPI, PCE Deflator.”
Tesla Inc’s (NASDAQ: TSLA) Elon Musk added that he thinks the Federal Reserve (Fed) may make a mistake noting “a major Fed rate hike risks deflation.” Musk suggested the Fed should drop 0.25%, basing his decision on non-lagging indicators, unlike the Fed.
That’s not in line with what CME Group Inc’s (NASDAQ: CME) FedWatch tool shows. Through this tool we see traders pricing an 80% chance of a 0.50-0.75% hike, all the while quantitative tightening (reducing Fed Treasuries and mortgage-backed securities holdings) accelerated on September 15.
UST and MBS will roll off (which could turn into “outright sales”) at a pace of $95 billion per month, now, increasing competition for funding among commercial banks, and bolstering borrowing costs, as explained, below.
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
According to Bank of America Corporation (NYSE: BAC), since 2010, nearly 50% of the moves in market price-to-earnings multiples were explained by quantitative easing (QE), the inverse of QT, through which the Fed (or central banks, in general) creates credit used to buy securities in open markets, MarketWatch explains.
Graphic: Retrieved from the Federal Reserve Bank of Richmond. “The Fed Is Shrinking Its Balance Sheet. What Does That Mean?”
The “purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risk assets as investors look elsewhere for higher returns. QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.”
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via MarketWatch.
The liability side of the Fed’s balance sheet is what “matters to financial markets.”
Thus far, “reductions in Fed liabilities have been concentrated in the Treasury General Account, or TGA, which effectively serves as the government’s checking account” to run the day-to-day business.
Given that we’re talking about balance sheets, here, Fed liabilities must match assets. Thus, a rise in the TGA must be accompanied by a decline in bank reserves (which are liabilities to the Fed). This, as a result, decreases the room banks have to “lend or to finance trading activity by hedge funds and other financial market participants, [which] further [cuts into] market liquidity.”
With the Treasury set to increase debt issuance, boosting TGA, it will effectively take “money out of the economy and put[] it into the government’s checking account.” The linked reduction in bank deposits and reserves bolsters “repurchase agreement rates and borrowing benchmarks linked to them, like the Secured Overnight Financing Rate,” per Bloomberg.
Graphic: Retrieved from the Federal Reserve Bank of New York. “The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.”
Adding, this may play into “an additional tightening of overall financial conditions, in addition to the increase in the main fed funds rate target that the central bank intends to continue boosting.”
This will “put more pressure on the private sector to absorb those Treasurys, which means less money to put into other assets” that may be riskier, like equities, said Aidan Garrib, the head of global macro strategy and research at Montreal-based PGM Global.
Positioning
As of 6:50 AM ET, Friday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.44%. Net gamma exposures decreasing may promote generally more expansive ranges.
Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics.
Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of options structures.
This is as there’s been a lot of speculation, particularly on the downside (put options), setting the stage for a more volatile and fragile market environment, says Kai Volatility’s Cem Karsan.
“On the index level, people are not well hedged,” a departure from what the case was heading into and through much of 2022. It’s the case that heading into 2022, traders were well hedged. Into and through the decline, traders’ monetization of existing hedges, as well as counterparty reactions, “compressed volatility” realized across US equities, as explained on July 15, 2022.
This made for some attractive trade opportunities seen here.
Graphic: Retrieved from The Market Ear. “VIX has decoupled from cross-asset volatilities.”
Now, given that the go-to trade is to sell stock and puts, short interest has grown, as have other risks, associated with this activity; essentially people are “los[ing] faith in convexity and risk premia’s ability to work,” as a result of “poor performance of vol,” and, the reaction to their “pain and financial loss,” is setting the stage for tail risks heading into the Q1 and Q2 2023.
The sale (purchase) of the front (back) expirations will bolster market pinning; as SpotGamma puts forth, “the positive impact of put closers and rolls, as well as decay,” is easing the market drop. However, this “positioning likely compounds drops and adds to volatility,” in the future.
To quote: “Though the removal of put-heavy exposures can boost markets higher, too add, the positive impacts are dulled via the demand for put exposures at much lower prices.”
Graphic: Retrieved from SpotGamma.
These particular options, which are at much lower prices, “are far more sensitive to changes in direction and IVOL,” as I explained in a SpotGamma note. These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly.
Graphic: Via Mohamed Bouzoubaa et al’s Exotic Options and Hybrids.
“If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”
Graphic: Via Banco Santander SA (NYSE: SAN) research.
Technical
As of 6:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,909.25 MCPOC puts into play the $3,935.00 VPOC. Initiative trade beyond the latter could reach as high as the $3,964.75 HVNode and $4,001.00 VPOC, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,909.25 MCPOC puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as low as the $3,826.25 and $3,770.75 HVNodes, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: A feature of this 2022 down market was responsiveness near key-technical areas (that are discernable visually on a chart). This suggested to us that technically-driven traders with shorter time horizons were very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
That’s changing. The key levels, quoted above, are snapping far easier and are not as well respected. That means other time frame participants with wherewithal are initiating trades.
Those are the participants you should not fade.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
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.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 850+ that read this report daily, below!
Graphic updated 8:00 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. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
As much as it may be a so-called chart crime to overlap past market environments and project or forecast what may happen, it’s quite eerie that today’s path of returns appears similar to that of 1394-1937, 2005-2008, and 1997-2001, for example.
Graphic: Retrieved from Deutsche Bank AG (NYSE: DB).
Moreover, this time around, it’s the case that markets have fallen on participants’ pricing of higher interest rates and quantitative tightening (QT).
Graphic: Retrieved from The Market Ear. Via Guggenheim Partners.
Some argue there is more to go on the pricing of a potential economic slowing happening here, in the U.S., abroad in China, and beyond.
Graphic: Retrieved from Bloomberg. “Earnings are related to the economic cycle, but not tightly, and expectations for next year are intertwined with macroeconomic concerns.”
Notwithstanding, and we will end the fundamental section with this, today, Credit Suisse Group AG’s (NYSE: CS) Jonathan Golub puts forth the following:
“Although revisions are negative, projected EPS growth rates remain positive for the remainder of 2022-23. While 3Q growth has fallen to 4.7%, EPS should expand 9-10%, assuming similar beats as experienced in 2Q. Historically, earnings hold up best when inflation is elevated. Many investors are interpreting the recent decline in estimates as a harbinger to recession. Our work shows that in high inflationary periods (1973, 1980, 1981) earnings peak just 2 months prior to a recession’s onset. With EPS growth projections still positive, revisions would have to fall much more to signal an economic contraction.”
Positioning
Referring traders to a recent case study (HERE) on how to play this market environment, as well as the impacts of implied volatility (IVOL) compression September 8 (HERE).
After a period of sideways-to-lower, markets are rebounding, boosted by IVOL compression and traders’ re-positioning ahead of potential including inflation and monetary policy updates.
Notwithstanding, as Kai Volatility’s Cem Karsan well explained to Charles Schwab Corporation’s (NYSE: SCHW) TD Ameritrade Network, traders must look out for the “window of real risk.”
The energy for a downside move “is significant” after this year’s decimation of “skew and volatility,” he said. “Hedging for convexity is in the 5th percentile.”
This is because participants hedged heading into the decline, and sold skew as the markets explored lower. After the current period of volatility supply passes, Karsan added, and markets were to trade lower, there is the risk of a reach for protection and a fatter tail.
Graphic: Merrill Lynch Options Volatility Estimate (INDEX: MOVE), a measure of volatility for the US Treasury market, versus the Cboe Volatility Index (INDEX: VIX), a measure of volatility for the equity market, diverged this year. This is, in part, due to the supply of volatility in equities.
Should nothing happen, then the unwind of the recent speculation amongst “family offices and institutions front-running the speculative hedges that are more than 50 units,” will add support.
Graphic: Retrieved from SentimenTrader on September 7, 2022.
Technical
As of 6:40 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the upper part of a 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.
Any activity above the $4,069.25 HVNode puts into play the $4,107.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,136.75 MCPOC and $4,189.25 LVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $4,069.25 HVNode puts into play the $4,018.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,991.00 VPOC and $3,952.75 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: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Graphic: Updated 9/8/2022. The daily chart of the SPDR S&P 500 ETF Trust (NYSE: SPY).
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
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.
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.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 850+ that read this report daily, below!
Graphic updated 7:15 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
Please pardon the light letter, team.
The Federal Reserve (Fed) Chair Jerome Powell will speak on monetary policy today at 9:10 AM ET. He is likely to embolden the tone set forth yesterday by the Fed’s Lael Brainard who said that higher rates for far longer seem necessary at this juncture.
The base case calls for a 75 basis point hike to interest rates this month, followed by 50 basis points in November, according to Goldman Sachs Group Inc (NYSE: GS) forecasts.
A quick check of the Eurodollar – which reflects the interest offered on U.S. dollar-denominated deposits held at banks outside of the U.S. (i.e., participants’ outlook on interest rates) – shows a peak in the overnight rate at 4.155% in February of 2023. From thereon, rate cuts are implied.
Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim.
It’s the case that monetary policies implemented resulted in too many dollars (still) chasing too few goods. We spoke on supply side dislocations last week and put forth that, from a monetary perspective, the Fed, among its peers like the ECB, can only and will tighten to stem inflationary pressures that are (to remain) structural.
Graphic: Retrieved from Bloomberg. “The number of references to the word ‘shortage’ in the Fed’s latest Beige Book report edged higher after declining for three straight reports, according to a Bloomberg tally. Job markets remained tight and labor shortages weighed on several sectors. That plus continued supply-chain snarls hampered manufacturing, the Fed said.”
It is the case that the economy is on a path that is “L”-shaped (i.e., vertical drop in activity via recession, and flatline for a period of time as rates remain higher for longer to prevent a sharp rise in inflation, again).
Zoltan Pozsar of Credit Suisse Group AG (NYSE: CS) puts forth that policymakers now have to “generate a round of negative wealth effects to lower demand such that it becomes more in line with the new realities of supply.”
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
Technical
Implied volatility (IVOL) is wound and markets are in an environment characterized by two-way ranges that are larger. Yesterday, we unpacked one way traders could have played the entry into this environment.
Further, as SpotGamma puts it well, a positive response to Powell’s remarks, into and through events such as the next update on consumer prices and the Federal Open Market Committee (FOMC) meeting, opens the door to IVOL compression and this would be “a boost for equities.”
That’s because the Delta risk counterparties are exposed to by holding short put options, for instance, reduces with falling IVOL. Accordingly, since the short puts carry less positive Delta, the counterparty reduces its negative Delta exposure via the underlying future or stock, which can support markets.
Graphic: Retrieved via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator. S&P 500 volatility selling coincides with a drop in IVOL and a price rise in the underlying.
Technical
As of 7:15 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,988.25 HVNode puts into play the $4,018.75 HVNode. Initiative trade beyond the latter could reach as high as the $4,064.00 RTH High and $4,107.00 VPOC, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,988.25 HVNode puts into play the $3,952.75 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,925.00 VPOC and $3,884.25 LVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Graphic: Daily chart of the SPDR S&P 500 ETF Trust (NYSE: SPY).
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
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.
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.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!
Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
To start, thank you to the many new subscribers who joined in the past weeks. I’m honored.
Further, today we start broad (fundamental) and hone into specifics on how to act in the current trade environment (positioning), as well as potential inflection (technical) points.
I encourage you to read through to the technicals part, if possible. Have a great week!
Seasonally speaking, the markets are in the midst of one of the most bullish periods of the year.
With bonds and equity products now off their swing lows and commodities off their highs (as inflation has, potentially, peaked), we have to question how much more?
Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS).
Well, thus far, and this is something we’ve talked about in the past, markets have suffered through compression in multiples. Does it stop or is there a looming earnings compression?
Graphic: Retrieved from Credit Suisse Group AG (NYSE: CS).
The earnings season shall shed clarity on the answer all the while – what is known – a strong dollar is sure to translate into a headwind for S&P 500 earnings growth.
Graphic: Retrieved from The Market Ear. Via Morgan Stanley (NYSE: MS) research. “The simple math on S&P 500 earnings from currency is that for every percentage point increase on a year-on-year basis it’s approximately a 0.5xhit to EPS growth. At today’s 16% year-on-year level, that translates into an 8% headwind for S&P 500 EPS growth, all else equal”
“The main point for equity investors is that this dollar strength is just another reason to think earnings revisions are coming down,” Morgan Stanley’s Mike Wilson explains.
“[T]he recent rally in stocks is likely to fizzle out before too long.”
Moreover, with the impulse in credit falling, labor market showing preliminary signs of weakness, a drawdown in commodities (which is consistent with sharply lower economic growth), and bond market pricing rate cuts in early 2023, immediately following the hiking cycle, portfolios can “stay away from highly speculative assets, own USD cash and start allocating towards 5-10y+ government bonds,” as Alfonso Peccatiello explains well in his letter, The Macro Compass.
Graphic: Retrieved from The Macro Compass published by Alfonso Peccatiello.
Positioning
Calmer trade alongside easing volatility and generally rising gamma exposures. Trade, at times, was responsive. Participants would add positive (negative) delta bets into weakness (strength).
Graphic: Updated 7/8/2022. SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator registers the sale of put (blue line) and call (orange) options.
Noteworthy is the continued sale of volatility, particularly across shorter time horizons, as well as increased demand for call options, especially in some of the larger index weights. Volatility sale, on the part of customers, leaves liquidity providers warehousing long volatility (which is kind of a naive thing to say as we’re discounting customer trades being paired off with each other).
Nonetheless, these liquidity providers’ positions, all else equal, will maintain or increase in value if underlying(s) realize volatility (especially that far in excess of implied). To hedge, rips (dips) will be sold (bought) to offset the increasing positive (negative) delta.
Graphic: Updated 7/7/2022. SpotGamma’s HIRO indicator for Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL). Rising orange and blue lines point to call buying and put selling, both of which have bullish implications.
Moreover, this trend in volatility supply is in part on the loss of interest in “leveraged long S&P” trades, as well as “marginal demand for puts,” as SqueezeMetrics has stated, before.
Graphic: Retrieved from The Market Ear. Originally sourced via VIX Central. “Chart shows the VIX term structure ‘crash’ since June 13, which was the most recent VIX peak. The curve is now back to normal with the short end of the curve ‘much’ lower than longer-term maturities. Let’s see how far down they ‘press’ this.”
“Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”
Graphic: Retrieved from The Market Ear. “VIX has decoupled from cross-asset volatilities.”
Accordingly, the volatility markets have realized (RVOL) has crept (and exceeded, at times) the volatility implied (IVOL).
Graphic: Via S&P Global. As explained by SpotGamma, “30-day realized SPX volatility is now trading above the VIX, something that generally shows after major selloffs wherein IV “premium” needs to reset to calmer/higher equity markets.”
This, coupled with “a flattening in the downside fixed strike skew, while the upside wings [are] more smiley,” as described by JPMorgan Chase & Co (NYSE: JPM), has made for attractive low-cost spread opportunities, as talked about in the July 8, 2022 letter.
Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear.
For instance, as discussed Friday, ratio spreads continue to work well for low- or no-cost exposure to the upside.
Pursuant to those remarks, no-cost spreads this letter’s writer has structured in Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL) are pricing hundreds of dollars in credit to close.
Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim.
Obviously, there’s no mention, here, of the risk management (e.g., sizing and width) involved. Again, this is as I’m trying to give actionable info without providing explicit recommendations.
Similarly, if one thought volatility, though at a high starting point particularly at the money (ATM), was due for a repricing, they would look for exposure to the downside via something such as an inverse ratio (or back spread), as said last week.
This is as the ATMs, unlike those further out of the money (OTM), are less convex in vega.
Graphic: Via Mohamed Bouzoubaa et al’s Exotic Options and Hybrids.
Technical
As of 7:00 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle-to-lower part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,867.25 LVNode puts into play the $3,909.25 MCPOC. Initiative trade beyond the MCPOC could reach as high as the $3,943.25 HVNode and $3,982.75 LVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,867.25 LVNode puts into play the $3,831.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,800.25 LVNode and $3,755.00 VPOC, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Example: The below 65-minute S&P 500 chart with volume profiles was included in the July 8, 2022 edition of the newsletter. Prices were near an inflection (micro-composite point of control and two key volume-weighted average price levels). From thereon, selling surfaced.This is what is meant by responsiveness near key-technical areas.
Graphic: Updated 7/2/22. 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.
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.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!
Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
An incredibly busy past few months with what it seems are back-to-back historic developments.
For instance, just this week, crypto broker Voyager Digital (OTC: VYGVF) filed for bankruptcy. “Impaired” will be account holders who likely won’t be “getting back exactly what they’re owed,” as reported by Bloomberg.
This is on the heels of crypto market volatility affecting some of Voyager’s largest borrowers like Three Arrows Capital, an embattled hedge fund. Voyager lent deposits to these parties at rates of interest that were ultra-high. Customers were then, accordingly, paid high rates.
However, this was done under the impression that the customer holdings were liquid, easy to access, and not subject to counterparty risks. That didn’t happen. Voyager, like others, was “making a lot of unsecured or undersecured loans.”
What’s the takeaway, here? Bloomberg’s Matt Levine explains well.
“If supposedly safe crypto brokerages keep failing and customers keep losing money, that is bad for the whole ecosystem; if your money isn’t safe with any crypto brokerage then you might just not buy crypto.”
Others in the ecosystem have continued to lever on the supposed successes of crypto. The failure of Voyager, among others, may have knock-on effects to be felt much later in the cycle.
From Voyager's subreddit. Pretty messed up; we keep talking about these companies throwing around nine-figure sums and make fun of people like Su Zhu, but in the end, they're all still living lavish lives. That $650m wasn't theirs – it was hundreds of people's savings added up. pic.twitter.com/DGxl09lCQz
Another historic development was the London Metal Exchange’s (LME) cancellation of billions of dollars in trades. This made whole large bettors in that ecosystem, all the while dinging liquidity providers, badly.
Some, including algorithmic fund Transtrend, left the LME as they could no longer trust it with client funds.
The question is what now? What’s the next big thing and, more importantly, will it have an impact on the traditional markets we watch?
As talked about in past analyses, it is over the last four decades that monetary policies were a go-to for supporting the economy. From that, created was “a disinterest and unimportance to cash flows.”
The commitment to reducing liquidity and credit has consequences on the real economy and asset prices, accordingly, which rose and kept the deflationary pressures of policies at bay.
It is elevated volatility, persistent declines, slower tightening processes abroad, among other things, that are to prompt investors to lower their selling prices in risk(ier) assets (e.g., options bets, metals, cryptocurrency and stablecoins, equities, bonds) and compete for cash.
Graphic: Via TradingView. Retrieved by Physik Invest.
This all is to continue bolstering the dollar’s surge to some of its strongest levels in years.
As well as further douse inflation (which is likely to peak on inventories bloat and a “supply gut”) and, eventually, prompt the Federal Reserve to reverse its aggressive rate hike and quantitative tightening (QT) path.
Graphic: Posted by Joe Weisenthal. “Wheat has erased all of its gains for the year. Also, it looks like corn and soy are rolling over.”
“It is starting,” Nassim Nicholas Taleb said online. “I’ve seen gluts not followed by shortages, but I’ve never seen a shortage not followed by a glut.”
ARK Invest’s Catherine Wood, who was very early to call the peak inflation, puts forth that “If inventories and stock prices are leading indicators for employment and wages, … then fears of cost-push inflation a la 1970’s should disappear during the next six months.”
Positioning
Thus far, we’re far into a dot-com type collapse, albeit one that has happened “underneath the surface of the indices,” per Simplify Asset Management’s Mike Green, as those largest stocks still are recipients of strong passive flows.
Graphic: SqueezeMetrics’ Dark Pool Index shows a trend in heightened implicit buying support.
The upcoming earnings season is likely to shed clarity with respect to corporates’ ability to weather or pass on higher costs. It is possible, as some put forth, that there is a broad “earnings compression,” deepening the de-rate in the face of what has been a “multiple compression.”
From a positioning perspective, so awing is the absence of heightened demand for downside skew, all the while that, on the upside, is bid probably due to the reach for bets on a ferocious bear market rally.
Graphic: Posted by SpotGamma. “30-day ATM SPY IV vs the VIX and while this plot has a bit of noise it seems to very closely resemble @Nations_Indexes VIX/VOLI measurement. One interpretation here is that OTM options aren’t trading for much premium over ATM (flat skew).”
As explained yesterday, it makes sense to be a buyer of volatility, albeit via complex structures.
For instance, buying volatility on the upside that is closer to current prices and selling that which is farther out (if bullish). And (if bearish), opting for calendars (as it is volatility in the shortest of maturities being sold heavily), back spreads, and the like.
Graphic: Posted by SpotGamma. “TSLA open interest continues to decline, particularly on the put side as the stock trades near 1year lows. Interestingly at-the-money IV remains elevated to levels going back to the days of the $1200 call gamma squeeze.”
On a more granular level, after the release of the Federal Open Market Committee (FOMC) meeting minutes, participants added to their put sales and call buys, at the index level. The hedging of this does more to take from potential realized volatility.
Graphic: Pictured is SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator.
At its core, though, the market is at a pivot and losing the $3,800.00 S&P 500 area likely does more to bolster the creep in realized (RVOL) volatility, versus that which is implied (IVOL), all else equal.
Graphic: SPDR S&P 500 ETF Trust (NYSE: SPY) historical (orange) and implied (white) volatility via Interactive Brokers Group Inc’s (NASDAQ: IBKR) Trader Workstation.
Technical
As of 6:45 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,859.00 overnight POC puts into play the $3,883.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $3,909.25 MCPOC and $3,943.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,859.00 overnight POC puts into play the $3,831.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $3,800.25 LVNode and $3,774.75 HVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
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.
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.
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!
Overnight, equity index futures were sideways to lower. Commodities and bonds were mixed. Implied volatility measures fell. The dollar rose.
A volatile quarter-end ahead of a long weekend. Noteworthy is the market’s responsiveness to visual levels. For instance, the S&P 500’s (FUTURE: /ES) high of the day printed at $3,821.50 or so, a key level in yesterday’s morning letter.
This points to heightened activity by technically-driven traders with short time horizons. Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Moreover, on an annual basis, core inflation was the lowest since November while consumers’ spending cooled suggesting the economy is on a weaker footing. In Europe, inflation hit a record, boosting calls for more aggressive monetary policy action.
Adding, Goldman Sachs Group Inc (NYSE: GS) strategists see equity valuations falling further “[u]nless bond yields start to decline and buffer rising equity risk premiums.” Michael Burry, the Founder of Scion Asset Management, too, sees declines lasting on “earnings compression.”
Ahead is data on S&P Global Inc’s (NYSE: SPGI) manufacturing PMI (9:45 AM ET), as well as the ISM manufacturing index and construction spending (10:00 AM ET).
Graphic updated 6:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: A bit philosophical here, today, as a difficult half-year has passed and I’m low on the time I have to commit to analysis this morning.
Markets are substantially lower from the end of 2021, all the while there are now, in greater quantity and frequency, calls being made that equities have more room to the downside.
That very well may be the case, and the upcoming earnings season is likely to provide investors clarity with respect to corporates’ ability to weather or pass on higher costs, among other things.
Regardless, everything we discuss on a daily basis – fundamental and technical market drivers – will do little for us if we do not have a framework for assessing risk and opportunity.
Before ever taking a position, I ask myself the following: What is it that I have to lose? For me, the answer depends.
At times, it is dependent on a position’s payoff profile. At others, it’s the max pain I’m willing to subject myself to during adverse market conditions or when I have limited mental capital.
As Dennis Gartman of the Gartman Letter said:
“Capital comes in two varieties: Mental and that which is in your pocket or account.”
“[T]he mental is the more important and expensive of the two. Holding to losing position costs measurable sums of actual capital, but costs immeasurable sums of mental capital.”
And, with that, the other key is that the money is made in not losing it. Fortunately, this law was impressed on me, early. Returning 100%, only to suffer a 50% loss, sets you back to where you were, initially.
These comments are pursuant to traders I’ve had the honor of connecting with over the past year or so. Many made a killing to only have given most, if not all of it, back.
This has an immeasurable effect on one’s mental capital.
Though I’ve not participated in the most recent weaknesses, my mental capital has suffered. I’ve, subsequently, reduced the size of my positions and opted to define my losses, buying into volatility while it is cheap, as I view it, and waiting for the relationship to flip to sell in size.
Returning to the comment on whether the market’s de-rate has played out. I do not know. Can it go further? Probably. There are a host of references converging below current market prices, as pointed to in the Technicals section, below, that probably are taken at some point in the year.
That said, whether long or short, ask what it is that you have to lose?
If it’s a number, define your loss and take the trade. Take (or provide) liquidity when others don’t want to. Buy (or sell) volatility when it is cheap (or expensive). Let the trade work.
It’s a coinflip, probably, at the end of the day. If we know what we have to gain and lose, we’ve moved the expected outcome that much further our way. Have a good long weekend, team.
Technical: As of 6:30 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,770.25 HVNode puts in play the $3,793.75 HVNode. Initiative trade beyond the latter HVNode could reach as high as the $3,821.50 LVNode and $3,840.75 ONH, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,770.25 HVNode puts in play the $3,727.75 HVNode. Initiative trade beyond the latter HVNode could reach as low as the $3,688.75 HVNode and $3,639.00 RTH Low, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: At $3,500.00 in the S&P 500 (INDEX: SPX), or $350.00 in the SPDR S&P 500 ETF Trust (NYSE: SPY) is the convergence of multiple visual references.
The 50.00% retracement (COVID-19 low through to 2021 peak), the 200-week moving average, and the volume-weighted average price anchored from the 2018 market bottom all converge at this $3,500.00 ($350.00) high open interest strike.
Graphic: Via TradingView. Taken by Physik Invest. SPDR S&P 500 ETF Trust (NYSE: SPY).
Definitions
Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
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Overnight, equity index futures resolved a multi-day consolidation and auctioned higher, far beyond the prior day’s range. Commodities were mixed while bonds were lower.
The break from consolidation is one of the most bullish happenings in weeks. We’re monitoring whether participants add to their recent short volatility bets against direction, or whether there is repositioning and this bolsters the initiative probe.
Ahead is data on University of Michigan consumer sentiment, inflation expectations, and new home sales (10:00 AM ET), as well as some Fed speak (7:30 AM and 4:00 PM ET).
Graphic updated 6:40 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: To start, I want to apologize for any confusion, yesterday, with respect to the /GE Eurodollar quote. This newsletter said the peak of the Fed-rate-hike cycle – terminal rate – sat near December 2023.
That’s wrong. It’s December 2022.
Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around DEC 20[22].
Okay, moving on, now!
New data is pointing to a “remarkable” drop in demand for goods and services during June, compared to months prior.
“US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” S&P Global (NYSE: SPGI) Market Intelligence’s Chris Williamson explained.
“The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”
Graphic: Via S&P Global Inc. “This is a sizeable miss and evidence of a quick slowdown in demand, though it’s still in positive territory (above 50). This report is consistent with a shifting narrative away from inflation worries and towards growth worries.”
Businesses (particularly in retail) are way “more concerned about the outlook” of costs and demand, as well as the path in monetary policies and deterioration in financial conditions.
Graphic: Via Bloomberg. “Supply constraints, exacerbated by Russia’s war in Ukraine this year, account for about half of the surge in US inflation, with demand currently making up a third of the increase, according to new research from the Federal Reserve Bank of San Francisco.”
That’s validated by Tesla Inc’s (NASDAQ: TSLA) CEO Elon Musk speaking about the carmaker’s losses from new plants, supply chain problems, and the like.
Graphic: Via Bloomberg. “Long-term ocean freight rates between China and the US West Coast are higher than spot prices for the first time since April 2020.”
“The past two years have been an absolute nightmare of supply chain interruptions, one thing after another,” Musk said.
“We’re not out of it yet. That’s overwhelmingly our concern is how do we keep the factories operating so we can pay people and not go bankrupt.”
Graphic: Via Bloomberg. “Supply chains in Asia look to be on the mend,” though it will “ take a while for supply and demand to rebalance.”
It’s a global move into recession all at once, as Jeffrey Snider of Alhambra Investments says.
“Combine the potential for break in repo collateral with economy heading toward recession, no wonder the Euro[dollar] curve inversion is spreading as rapidly as it has. Possibility of something big going wrong, therefore ending rate hikes, is huge now.”
“Euro[dollar] squeeze, collateral shortage, deflationary potential in money, and now demand destruction in global real economy.”
Graphic: Via Alhambra Investments.
Over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted innovation and, by that token, deflation, ultimately creating “unimportance to cash flows,” as well put by Kai Volatility’s Cem Karsan.
Now, there’s a strong commitment to reducing liquidity and credit, all the while there are chokepoints monetary policymakers have little control over.
This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay. A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s poor sentiments and economic data reflects this.
At the same time, “bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang puts it.
Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”
Retail buyers, who, according to Michael Wang of Prometheus Alternative Investments, “were a significant driver of the inflated valuations we saw in tech and crypto,” are capitulating in stocks, all the while froth in housing markets is soon to abate, likewise.
Notwithstanding, Mark Zandi of Moody’s Corporation (NYSE: MCO) does not see “the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values,” just as prices of raw materials are retreating as inventories are bloating.
As put forth, partially, earlier this week, one has to wonder about the likelihood that inflation is near its high and whether the de-rates have played their course.
Let’s keep an open mind and follow up on this, in detail, next week.
Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”
Positioning: Keeping this section short.
As stated yesterday, a feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL) given that participants are hedged and volatility remains in strong supply.
Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.
“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”
As I said in SpotGamma’s note, last night, given “the high starting point in IVOL, as well as its place in relation to [RVOL], it makes sense to own structures that benefit either from sharp changes in underlying price or an abrupt repricing in volatility.”
Cutting into the realization of a sharp change in underlying price or a far-reaching rally, however, are short-volatility bets across shorter maturity periods (and the associated hedging), as well as big (and popularized) positions set to roll off at the quarter-end.
Liquidity providers, per SpotGamma, all else equal, will have to sell to re-hedge, and we will talk about this further, next week.
Graphic: Taken 6/22/2022. SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator points to selling of put and call options in the S&P 500 (INDEX: SPX) and S&P 500 ETF (SPY). Those liquidity providers, who are on the other side, are more exposed to long volatility, which they hedge by buying (selling) into weakness (strength) underlying.
Technical: As of 6:40 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,821.50 LVNode puts in play the $3,843.00 RTH High. Initiative trade beyond the RTH High could reach as high as the $3,911.00 VPOC and $3,943.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,821.50 LVNode puts in play the $3,793.25 ledge. Initiative trade beyond the ledge could reach as low as the $3,770.75 HVNode and $3,735.75 HVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Recent trade has been lackluster and the overnight break is the most bullish happening in weeks. The go-to trade this week was short volatility. Participants responded to tests of key visual areas, and sold options, particularly in shorter maturities.
In the coming session(s), some of those participants will respond to the break in a manner that bolsters the initiative drive. Notwithstanding, the key to watch for is whether participants will use the bump as an opportunity to add to their most recent short volatility bets against the direction.
Ultimately, the more time that is spent outside of the prior consolidation area, the likelihood that the breakout is a signal to look for dips to buy and play rotations to key areas up above.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.
Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area.
Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.
Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
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.
