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Overnight, the equity index and commodity futures were bid, all the while bonds and the dollar edged lower. This is after a week-long or so de-rate on tougher monetary policies.
Big headlines include the White House’s mulling of a U.S. gas tax suspension, Russia’s status as a top exporter of crude to China, Goldman Sachs Group Inc’s (NYSE: GS) recession warning, Elon Musk’s intent to cut Tesla Inc’s (NASDAQ: TSLA) workforce, and falling Iron ore prices on China’s building downturn.
Interesting reads from over the weekend include Dr. Pippa Malmgren’s letter on the market’s “nosedive” which is likely to be “followed by a newfound understanding of what is possible,” and how that plays into economic strength and military superiority.
Adding, timely was a Sohn 2022 conversation with Stanley Druckenmiller on his experiences and the current market environment.
Ahead is data on the Chicago Fed National Activity Index (8:30 AM ET), existing-home sales (10:00 AM ET), as well as Fed-speak by Loretta Mester (12:00 PM ET) and Tom Barkin (3:30 PM ET).
Graphic updated 6:30 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: Keeping this letter brief, today.
The sale of both bonds and equities worsened in part due to the implications of inflation and the Federal Reserve’s (Fed) response to that inflation.
Graphic: Via Nordea Bank’s (OTC: NRDBY) research. “We suspect that the real economy will be less sensitive to a rise in interest rates this time, which means that the Fed could have to move rates more-than-expected before policy gets restrictive. The strongest argument is that the household balance sheets are in a much better shape to sustain their level of spending as the massive injections of money and credit through both monetary and fiscal stimulus have changed household balance sheets dramatically.”
Essentially, as Joseph Wang, who was a trader at the Fed, puts it, “[b]onds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol.”
“Investors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.”
Ultimately, an increase in the RRP (reverse repo) and QT (which is a direct flow of capital to capital markets) “would drain the pool of bank deposits by ~$1t by year-end,” and this may prompt investors to “continue to lower their selling prices to compete for the cash they want.”
Positioning: Detailed was Friday, June 17’s commentary that honed in on some of the implications of pre- and post-Federal Reserve meeting positioning.
Essentially, with the June monthly options expiration (OPEX), there was a roll-off of a large amount of customer negative delta exposure (via put options they owned).
Graphic: Via SpotGamma’s S&P 500 Index (INDEX: SPX) Gamma Model. Updated June 17, 2022.
With expiration, liquidity providers (who were short these put options, as well as underlying to hedge) re-hedged (bought back some of their static short-delta), and this removes pressure.
“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, who we quoted last week.
“Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”
Accordingly, markets are off their lows. However, in the above text, we made little mention of participants’ rolling forward of their options bets to lower strikes, further out in time, as well as the impact of customers still maintaining a “sizable short put position,” a dynamic we’ve talked about before.
Graphic: Via SpotGamma. “Options flow, last week, was unsurprisingly dominated by index puts (red lines). Most interesting was index puts bought to cover (third chart) indicating there was a fairly sizable short put position heading into last week.”
Taken together, coupled with what SpotGamma observes is “anemic” call buying (viewed as the blue line in the top chart above), participants are hedged and volatility remains well-supplied.
Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from The Market Ear. “The ‘muted’ VIX narrative goes on. The VIX vs SPX gap remains rather wide here. The second chart shows just how ‘depressed’ VIX remains vs the underlying px action. Most people have been stopped out/de-grossed risk, so there isn’t much demand to hedge exposure.”
Despite being stretched from a technical perspective, positioning-wise, lower prices are sticky and the context for a far-reaching bounce, all else equal, is not there.
We shall provide updates to this, later in the week. Read the Daily Brief for June 17, 2022, for more on how to position in light of the above information.
Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,735.75 HVNode puts in play the $3,749.00 ONH. Initiative trade beyond the ONH could reach as high as the $3,773.25 HVNode and $3,821.50 LVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,735.75 HVNode puts in play the $3,722.50 LVNode. Initiative trade beyond the $3,722.50 LVNode could reach as low as the $3,690.25 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.
Definitions
Volume Areas: 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.
Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.
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!
Update: Technicals section now reflects the proper overnight inventory stat.
After a week-long or so de-rate to reflect the impact of higher inflation and harsher monetary policies, equity index futures are trading in a responsive fashion.
The S&P 500, in particular, lies pinned against the $3,700.00 high options open interest strike. The large June monthly options expiration has implications on the expansion of the range, as noted in prior letters.
The newsflow remains depressing. Taken alone, you’d think the Federal Reserve (Fed) would be “soft[ly] landing” us into a depression, just in time for WWIII to help us get out of it.
Kidding. The utmost sympathy for those negatively affected by war and economic hardship.
The distinction between the economy and the market is blurred and the drop is the recession. The equity markets are a mechanism pricing the implications of all the points we talk about, in real-time, months (6-12) in advance.
Given that, there are better measures to assess whether a de-rate has played out, fully. In the last session, information, generated by the market – internals, volatility measures, and the like – suggested to us that more selling was in store, all the while there was a definite change in tone in the non-linear strength of volatility and skew with respect to linear changes in price of assets.
Should you care for the narratives in news, then here it is:
The Bank of England (BOE) pointed to the potential for a more aggressive rate hike schedule if data were to reflect a wage spiral. The Swiss National Bank (SNB) upped rates an unexpected 50 basis points. The White House weighed fuel-export limits. Both residential permitting and housing starts plummeted with the 30-year fixed-rate breaching 6.00%.
Adding, U.S. junk bond spreads topped 500 basis points for the first time since 2020, and China, also, launched its third most modern aircraft carrier.
Ahead, Fed Chair Jerome Powell speaks at 8:45 AM ET. Then updates on industrial production and capacity utilization (9:15 AM ET), as well as leading economic indicators (10:00 AM ET).
Graphic updated 6:30 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Team. We’re going to have to keep it a bit shorter, today, and leave out the fundamentals section. Sorry!
In a nutshell, and this is borrowing from a past post-Federal Open Market Committee (FOMC) event letter, as well put forth by Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event.”
Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator alluded to counterparty buyback of static short delta hedges to positive delta options exposures.
“The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”
Essentially, the baseline bear trend held because, essentially, the Fed is, indeed, expected to continue raising rates and withdrawing liquidity. This will prompt a continued de-rate with QT being “a direct flow of capital to capital markets.”
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 March 2023.
Great, moving on. What’s next?
Essentially, with the June monthly options expiration (OPEX), expected is a roll-off of a large amount of customer negative delta exposure (via put options they own). Taken in a vacuum, with expiration, liquidity providers (who are short put options and short underlying to hedge) will re-hedge (buyback static short-delta, among other things), and this is taken as bullish.
Graphic: Via SpotGamma. “While many of these put positions could be paired off with other offsetting positions (i.e. netting out some of this delta), we remain of the opinion that a lot of these put positions are investor short hedges which will be rolled out and down on OPEX. This means that large ITM puts will be exchanged for OTM puts, which creates a short delta hedge imbalance for dealers (i.e. they need to cover short futures). This is what may drive the OPEX-related rally.
However, this is definitely discounting the impact on delta from participants rolling forward their bets on direction.
Graphic: Via Shift Search. Participants, mainly sell to close their short-dated bets on the downside while buying to open those that are further out in time and lower in price.
As talked about yesterday, we were to gauge the delta impact by how far below the high open interest strikes the equity indexes were to travel. As stated, these options, have little time to expiry and, thus, their gamma (the sensitivity of the option to change indirection) grows rather large, at near-the-money strikes.
Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading.
As the time to expiry narrows, above the strike in question delta decays, and counterparts buy back their static delta hedges.
As the time to expiry narrows, below the strike in question delta expands and counterparts sell more static delta to hedge.
Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading.
This means that if far below these high-interest strikes, associated hedging, less any new reach for protection would keep markets pressured. If above, hedging, less new sales of protection, would bolster markets higher.
Graphic: Via SpotGamma. “SPX prices X-axis. Option delta Y-axis. When the factors of implied volatility and time change, hedging ratios change. For instance, if SPX is at $4,700.00 and IV jumps 15% (all else equal), the dealer may sell an additional 0.2 deltas to hedge their exposure to the addition of a positive 0.2 delta. The graphic is for illustrational purposes, only.”
Ultimately, if lower, all else equal, the June 17 OPEX will coincide with the removal of the in-the-money options exposures in question. Negating the rollover of exposures and leaving the door open to some delta imbalance (need to buy to re-hedge exposure) suggests that after this expiration, markets may have less pressure to rally against.
“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, wrote in a note. “Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”
What do you do with this information?
Well, recall that we’ve talked ad nauseam about the supply and demand of volatility, as well as how that impacted the volatility realized (RVOL) and implied (IVOL) by the market.
Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR). The divergence in volatility implied (IVOL) by participants’ options activity, versus that which the market realizes (RVOL) resurfaced on June 15, 2022, in the Nasdaq 100 (INDEX: NDX).
Essentially there was an “absolute slamming” (i.e., sale of options), particularly in shorter-dated tenors and this played into the generally poor performance in skew, hence our comments on the benefit to buying into implied skew convexity should volatility reprice.
Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), was very depressed, too, in comparison to the VIX, itself.
Basically, participants are hedged and volatility remains well-supplied.
To hedge or capitalize on a potential reach for protection, amid forced selling or demand for protection by a greater share of the market in ways not recently seen, then the repricing in those structures would be a boon to those that own them.
Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR).
To quote Benn Eifert of QVR Advisors: “Skew goes up if vol outperforms the skew curve a lot on a selloff.”
Graphic: Via Banco Santander SA (NYSE: SAN) research.
And, as touched on in this morning’s introduction, there was a definite change in tone in the non-linear strength of volatility and skew with respect to linear changes in the price of assets.
Personally, I, along with a partner who I trade closely with, saw increases in the prices of ratio structures (long or short one option near-the-money, short or long two or more further out-of-the-money) by hundreds of percent for only a few basis points of change in the indexes.
As Karsan explained online, there was “a spike in short-dated -sticky skew, [the] first we’ve seen since [the] secular decline began and it hints [at] a potentially critical change in dealer positioning [and] the distribution of underlying outcomes.”
“We’re transitioning to a fat left tail, right-based distribution.”
Graphic: Via English Stack Exchange. Visualizing the transition to a fat left tail and right-based distribution that is skewed negative (i.e., the green distribution).
So why does any of this matter?
This is a validation of our perspectives on how one should position, given what the supply and demand of volatility looked like prior.
Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” as Mohamed Bouzoubaa et al explain well in the book Exotic Options and Hybrids.
“ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.”
In other words, by owning that protection, you are positioned to monetize on a continued non-linear repricing of volatility. However, doing this in a manner that cuts decay (when nothing happens) is the difficult part.
Graphic: Sourced via Towards AI. Skewness and kurtosis cheat sheet.
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 lower part of a positively skewed overnight inventory, inside 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 $3,688.75 HVNode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as high as the $3,773.25 HVNode and $3,808.50 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,688.75 HVNode puts in play the $3,664.25 HVNode. Initiative trade beyond the $3,664.25 HVNode could reach as low as the $3,610.75 HVNode and $3,587.25 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.
Definitions
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.
