Categories
Commentary

Daily Brief For July 6, 2022

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

Graphic updated 6:25 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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: Impressive was the strength of the Nasdaq 100 (INDEX: NDX), relative to the S&P 500 (INDEX: SPX), yesterday. 

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. Retrieved by Physik Invest.

This is as traders are now paring back their bets on monetary tightening, given the deterioration in the U.S. economic outlook. The NDX, which has been most sensitive to changes in monetary policies, accordingly, responded best as that index is comprised of assets that have the most to lose in a high-rate, aggressive quantitative tightening (QT) environment.

Graphic: Via Bloomberg. “In less than two weeks, the market has dropped its prediction for a peak rate brought forward the moment of the first cut, and forecasts a far more aggressive cutting program that will start next spring.”

For context, QT is the central banking authorities’ removal of balance sheet assets via sales or the non-reinvestment of the principal sum of maturing securities. Accordingly, if bonds are sold, their values fall and yields rise. This pushes yield-hungry investors into less risky categories.

Graphic: Retrieved from @patrick_saner. “A 60/40 portfolio is now worth less than before the pandemic.”

“As you look at where to park your cash for the next six months, you could do worse than to look at a mix of oversold treasuries and stocks – offering both compelling yield and a good degree of value protection,” explains Toggle CEO Jan Szilagyi in a note.

Graphic: Via Toggle.

These are comments, however, in the face of what has been a “multiple compression,” as we talked about last week. The upcoming earnings season is likely to shed clarity with respect to corporates’ ability to weather or pass on higher costs, among other things.

In the case of a so-called “earnings compression,” some commentators suggest the market is not priced correctly and another leg lower may be initiated.

Adding, expected are the Federal Open Market Committee (FOMC) meeting minutes, today. 

They are likely to “indicate that policymakers were worried about the un-anchoring of inflation expectations, … justifying the Fed’s shift in placing more focus on headline inflation measures rather than just core measures,” according to Bloomberg’s chief U.S. economist Anna Wong.

Graphic: Via Bloomberg. “After surging consistently to hit an all-time high in the two years after the March 2020 shutdown, the [Commodity Research Bureau Raw Industrials index] turned sharply southward.”

Positioning: Data shows net gamma exposure increasing which may increasingly feed into smaller ranges if prices continue to rise.

Further, continued are gaps between volatility measures for the rates and equity markets. This is, in part, due to the supply of volatility, as we’ve talked about in past commentaries.

The Ambrus Group’s Kris Sidial adds: “Another reason why equity vol on the index level has been so well offered is due to the structured products market continuing its dominance.”

“Investors are turning to alternatives in this market & these solutions continue to gain attention which leads to index level vol selling.”

Graphic: Via The Ambrus Group’s Kris Sidial. “[S]ome dealers will opportunistically look to sell vol in some buckets in the front of the term structure.”

Given this, the relationship between realized volatility (RVOL) has crept and, at times, exceeded that which the market has implied (IVOL). This, coupled with naive metrics for skew, suggests to us that it still makes sense to be a buyer of volatility, albeit via more complex structures.

Graphic: Via Pat Hennessy. “Tomorrow’s SPX expo (Jul1) is wildin… 26 vol for any strike with a 37 or 38 handle with a ridiculous curvature in the tails. God speed to all the 1dte theta gang. Selling OTM puts/calls for the same vol as ATM seems… umm… not good.”

Technical: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the mid-to-upper part of a balanced 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.

Any activity above the $3,821.50 LVNode puts into play the $3,857.25 ONH. Initiative trade beyond the ONH could reach as high as the $3,883.25 LVNode and $3,909.25 MCPOC, or higher.

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

Any activity below the $3,821.50 LVNode puts into play the $3,793.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,755.00 VPOC and $3,727.75 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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 13, 2022

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

What Happened

Overnight, futures for commodities, the equity indexes, and bonds were weak. There was no salvation in different assets. Instead, the realized correlation, across markets, tightened.

This is on the heels of inflation data updates that have traders pricing a 50-50 odds for a 75 basis point interest rate hike in July, after a 50 basis point hike this month.

That said, Ben Bernanke, who is a former Federal Reserve (Fed) Chair, said monetary policy leaders may be able to sidestep a big recession, expressing hopes that improvements in supply chains, among other things, would help rein inflation.

In other news, Chinese military officials warned their U.S. counterparts to avoid the Taiwan Strait and dismissed the need for the United Nations to review labor standards in the Xinjiang region.

This is as Britain’s economy unexpectedly shrank and Russia claims it has destroyed U.S. and European weapons stores in Ukraine. Additionally, despite OPEC+’s modest output gains, the average price of a gallon of gas rose to over $5 per gallon in the U.S. 

This output shock is likely to last into 2023 with gas potentially reaching as high as $6-$7.

Interestingly, as an aside, power grid operators in the Midwest are suggesting rolling blackouts in the coming years. This is just as power use in the South hit all-time records.

Ahead is data on inflation expectations (11:00 AM ET). This week’s focus is on the Federal Open Market Committee’s (FOMC) monetary policy decisions and large derivative expirations.

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

What To Expect

Fundamental: The CPI report was released Friday. 

Expected was an 8.2% rise year-over-year (YoY) and 0.7% month-over-month (MoM). Core CPI (which excludes food and energy) was to rise by 5.9% YoY and 0.5% MoM, respectively.

Officially, the headline number rose to 8.6%, and, the same day, consumer sentiment dropped to record lows while expectations for inflation (5-10 years from now) jumped 0.3%.

Graphic: Via All-Star Charts. Taken from the Weekly S&P 500 ChartStorm.

As Bloomberg’s John Authers put it well, the report’s details “were if anything even more alarming. There’s no way around it; this was a bad report.”

Graphic: Via Schroders plc (OTC: SHNWF). Taken from the Weekly S&P 500 ChartStorm. “Everyone’s (current) favorite economic data report was out this week and it showed annual CPI inflation running at an 8.6% clip. On this chart that would imply a P/E ~11x (Current P/E is ~20x).

Subsequently, a key part of the U.S. yield curve turned upside down while traders priced more tightening by September (i.e., two 50 basis point hikes and one that is potentially 75 basis points), selling nearly everything but the U.S. dollar.

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

Early last week, after commentaries resumed, we talked about the reach for cash amid poor safety in fixed income and stock price declines.

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

Graphic: Via McClellan Financial Publications. “These bonds move a lot more like the stock market than like T-Bonds. What makes them even more interesting is that they tend to be terribly sensitive to liquidity, both good and bad.”

“Inflation is eating margins, eating consumer demand, and causing the dramatic monetary tightening we are witnessing. None of this is good for stocks,” said James Athey of Abrdn. 

“There is still much downside to come.” 

Positioning: In short, prior-mentioned supply and demand dynamics resulted in divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL).

Graphic: Via Robson Chow, founder at Tradewell. The SPDR S&P 500 ETF Trust (NYSE: SPY) “is off ~5% in two trading sessions and implied volatility is still below realized volatility.”

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

Consequently, the market’s descent has been orderly and not exacerbated by the demand for hedges and associated repricings of volatility.

This was expected, per Kai Volatility Cem Karsan’s commentary published in December 2021.

Graphic: Commentary published by Kai Volatility.

Accordingly, for “divergences in RVOL and IVOL to resolve, it would likely take forced selling,” as I explained in a recent SpotGamma commentary.

This is similar to the happenings of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).”

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

In light of this, on June 8, we talked about long volatility structures (that, one, either sold very short-dated pre-FOMC and OPEX volatility to fund that which is farther-dated or, two, buy into implied skew convexity, non-linear with respect to delta [gamma] and vega [volga] changes).

Why would you do that?

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

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

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

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

More on these dynamics later this week.

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

In the best case, the S&P 500 trades higher; activity above the $3,808.50 HVNode puts in play the $3,836.25 LVNode. Initiative trade beyond the $3,836.25 LVNode could reach as high as the $3,863.25 LVNode and $3,911.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,808.50 HVNode puts in play the $3,768.25 HVNode. Initiative trade beyond the $3,768.25 HVNode could reach as low as the $3,727.75 and $3,688.75 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.

Point Of Control: 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.

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 17, 2022

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

What Happened

Overnight, equity index futures were higher. The S&P 500, in particular, probed the high end of the low-volume (gap) area it broke into on May 9, 2022.

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

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

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

Graphic updated 6:50 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: Out of all the news, it was noteworthy when Elon Musk broke with the prevailing opinion to declare the U.S. was facing a tough recession that would last up to 18 months. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

SqueezeMetrics adds

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

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

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

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

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

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

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

Considerations: A push-and-pull between the largest of S&P 500 weights.

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

Graphic: Via Bloomberg.

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

Graphic: Via Bloomberg.

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

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

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 6, 2022

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

What Happened

Overnight, equity index futures auctioned weak, inside of the prior day’s large trading range.

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

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

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

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

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

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

What To Expect

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

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

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

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

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

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

Graphic: Via Toggle.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: The VVIX via Physik Invest.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,148.25 high volume area (HVNode) puts in play the $4,184.25 HVNode. Initiative trade beyond the $4,184.25 HVNode could reach as high as the $4,212.25 micro composite point of control (MCPOC) and $4,303.00 weak high (obvious breakout level), or higher.

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 2, 2022

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

What Happened

Overnight, equity index futures auctioned off of Friday’s regular trade lows. Yields, the dollar, and implied volatility metrics were bid.

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

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

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

What To Expect

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

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

Graphic: Via Bloomberg.

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

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

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

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

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

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

Graphic: Via Bloomberg.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

So, what now?

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

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

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

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

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

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

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

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

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

Caution.

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

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

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

In the worst case, the S&P 500 trades lower; activity below the $4,118.75 RTH Low puts in play the $4,101.25 overnight low (ONL). Initiative trade beyond the ONL could reach as low as the $4,055.75 low volume area (LVNode) and $3,978.50 low volume area (LVNode), or lower.

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

Considerations: Terribly weak price action, last week, with the S&P 500, Nasdaq 100, and Russell 2000 all flirting with early 2022 lows.

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 30, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to lower while most commodities and the ten-year yield were higher.

The bullishness of the past days, driven in part by breakthroughs in Russia and Ukraine peace talks is threatened by new updates. Now, the Kremlin said that its talks with Ukraine yielded no breakthroughs. Geopolitical matters and supply chain issues are major headwinds for markets.

Ahead is data on ADP employment (8:15 AM ET), GDP revision, gross domestic income, and corporate profits (8:30 AM ET), as well as Fed-speak. Tom Barkin speaks at 9:15 AM ET and Esther George speaks at 1:00 PM 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

Positioning: Buying the March 14 S&P 500 low would have yielded you nearly a 12% gain. Buying and holding the Nasdaq 100 low would have yielded you about 17%.

Graphic: Via Bloomberg.

The forward returns when the 10-day S&P 500 return crosses above 10% are mixed. 

From 2000 to 2009, forward returns are weak. From 2009 and beyond, returns are strong.

Graphic: Via @HalfersPower. “Every time the $SPY has a 10-day return crossing above 10%, and fwd returns from those dates.  2000-2009 weak forward returns, 2009 fwd, strong fwd returns.”

These powerful moves are due in part to the “reflexive dynamic coming from structural flows,” explains The Ambrus Group’s Kris Sidial who sees a lot of opportunity in the “front of the term structure.”

Sidial and I have spoken a couple of times regarding the implications of increased derivatives exposures and the transmission of those risks associated to underlyings. 

Mainly, counterparties, as a result of regulatory frameworks, among other things, lend to cascading reactions that exacerbate underlying price movements.

Graphic: Via VIX Central. Shorter-dated implied volatility is sold aggressively at the front end. The steepening of this curve bolstered a near-vertical price rise as options counterparts bought back stock and futures hedges to downside (put) protection they were short.

Further, this recovery is in the context of geopolitical tension and monetary uncertainties that have lent to volatility spikes across other asset classes. Though fear tends to spread across markets, it is not, today, as discussed in past commentaries.

Basically, the equity market’s pricing of risk, which we use the CBOE Volatility Index (INDEX: VIX) as a proxy for, is not moving in lockstep with that of measures in FX and rate markets. 

Notwithstanding, as SqueezeMetrics explains, there are no “hardcore vol[atility] sellers in the SPX right now,” and this may actually be a good thing.

As SqueezeMetrics explains in their Implied Order Book paper, “Selling options is a tough business, since you’re on the wrong end of a derivative with a convex payoff.”

“In terms of gamma [an option deltas sensitivity to direction] and vanna [delta hedging flow with respect to changing levels of implied volatility], crash risk is a function of how many investors have sold puts [which] … are, quite literally, a bunch of huge buy limit orders below the market, and then a bunch of liquidity-taking stop-losses further down.”

Graphic: Via SqueezeMetrics. Learn the implications of volatility, direction, and moneyness.

Heading into the early-to-mid March reversal period, this newsletter revealed the forecasted returns distribution of a comparison of proxies for buying (DIX) and gamma exposure (GEX). 

At the time, the returns distribution was skewed positive given a deeply negative GEX and strong DIX.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

The bullishness of those metrics was taken with a bit of a discount, given the aforementioned cross-asset divergences, as a result of geopolitical conflict, among other things.

In hindsight, the right call would have been to buy hand over fist.

A bout of speculative demand (expressed through short-dated options highly sensitive to direction), as well as the compression of ultra short-dated volatility heading into and through the Federal Open Market Committee (FOMC) meeting and large March monthly options expiration (OPEX) bolstered strong buying support and lent to the market’s resolve higher.

The price rise, now, has likely reached a climax. The S&P 500, in particular, is at an overbought level: the concentrations of call open interest at and around $4,600.00.

As SpotGamma explained well, recently, “customers are short calls up top (to finance put options, or bets on the downside, down below). As underlying SPX prices rise, the call (put) side solicits more (less) hedging.” 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for the S&P 500 SPY ETF on 3/29/2022.

“Since counterparties’ call positions provide positive exposure to direction (positive delta) and profits are amplified to the upside (positive gamma), counterparties must sell into higher prices and buy into lower prices, thereby adding liquidity and supporting the market.”

Participants’ selling of volatility at these higher levels suggests increased odds of sideways, rather than up or down; as time and volatility trend to zero for these options, their gamma increases, and the reaction to this will result in the promotion of pinning.

Thereafter, the clearing of this options exposure likely opens the door to underlying breadth which has improved markedly since early March. 

Though today’s market is unprecedented, so to speak, improvements in breadth support a historical case for sideways-to-higher through tightening cycles.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM).

In opposition to this narrative (i.e., higher prices through the tightening cycle) are some Bank of America Corporation (NYSE: BAC) strategists.

“The worsening macro backdrop and market-unfriendly Fed make sustained U.S. equity gains unlikely,” Bank of America strategists said in a statement that recommended investors sell upside (call) protection to hedge downside. 

If Bank of America is correct, it’s possible that, given the recent clearing of puts, participants’ demand for protection, and the hedging of this exposure, would add velocity to the move lower.

SqueezeMetrics’ remark on hardcore volatility selling, however, has us a little less concerned (about some sort of armageddon situation).

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

In the best case, the S&P 500 trades higher; activity above the $4,597.00 untested point of control (VPOC) puts in play the $4,611.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,631.00 regular trade high (RTH High) and $4,641.75 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,597.00 VPOC puts in play the $4,574.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 Spike Base and $4,533.00 VPOC, or lower.

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

Definitions

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

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

DIX: For every buyer is a seller (usually a market maker). Using DIX — which is derived from short sales (i.e., liquidity provision on the market-making side) — we can measure buying pressure.

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

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

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.

Options Expiration (OPEX): Traditionally, option expiries mark a reduction in dealer gamma exposure.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 18, 2022

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

What Happened

Ahead of Friday’s triple witching derivatives expiry, the equity index and most commodity futures auctioned sideways to lower.

Ahead is data on existing home sales and leading economic indicators (10:00 AM ET), as well as Fed-speak by Tom Barkin (1:20 PM ET).

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

What To Expect

Fundamental: Today’s focus is on market positioning. Therefore, the fundamental section is (more) lighthearted.

Equity markets rose in the context of a sharp multi-month drawdown. This is, in part, masking the concern over Russia’s economic situation, a slowing in the flow of U.S. credit, supply and demand imbalances, the impact of COVID-19, and other things.

Graphic: Via Bloomberg.

Further, in spite of the Federal Reserve’s (Fed) comments on the strength of the economy and its likely resilience in the face of tighter policies, Goldman Sachs Group Inc (NYSE: GS) said the odds of a recession were “broadly in line with the 20-35% odds currently implied by models based on the slope of the yield curve.”

Graphic: Via Bloomberg. “Whenever the yield curve inverts, it tends to function as an early warning for a recession, suggesting that in the medium-term rates will have to fall.”

The forecast “implies below potential growth in 2022 Q1 and 2022 Q2 and potential growth for 2022 overall.”

With the Fed now eyeing about six more rate hikes in 2022 – putting the policy rate at ~2.8% before 2024 – commentators were quick to point out the “central bank’s patchy record on not tipping the economy into recession.”

Graphic: Via Bloomberg.

Alhambra Investments’ Jeffrey Snider, however, made an interesting point.

“To believe the Fed is behind all this or can do something useful about it, like the rate hikes you would have to be” born yesterday, he said.

“On the contrary, bond curve recession probabilities are more attuned to why production levels have struggled despite prices, having more to do with global conditions and the lack of actual volume expansion. Consumer, producer, and commodity prices have obscured, to some substantial extent, the true underlying economic situation.”

Moreover, Goldman forecasts the S&P 500 (INDEX: SPX) to end 2022 near $4,700.00 (down from $4,000.00), ~6% higher than today’s prices.

“The S&P 500 has dropped about 24% from peak-to-trough around past recessions (based on the median),” Goldman said in one newsletter. 

“But when the U.S. economy avoids a sustained contraction after a 10% market correction, the index has returned 15% over the next 12 months.”

Positioning: Friday marks the quarterly triple witching options expiry and index rebalancing.

Through this event, ~$3.5 trillion in options are set to expire, according to Goldman, with “more near-the-money options are maturing than at any time since 2019.”

Graphic: Via Goldman Sachs Group Inc.

In terms of the index rebalance, according to Howard Silverblatt of S&P Global Inc’s (NYSE: SPGI) Dow Jones Indices, “the rebalance in the index alone could spur $33 billion of stock trades.”

This newsletter has talked about the implications of derivatives and their expirations, too, ad nauseam.

Mainly, stock moves and options activity is more correlated and this is the result of participants’ increased exposure to derivatives products (particularly those with less time to expiration).

The demand for this derivatives exposure is transmitted to underlying stocks, via the risk management of counterparties; with option volumes heightened, related hedging flows may represent an increased share of volume in underlying stocks.

As I talked about this in conversations with the Ambrus Group’s Kris Sidial and Kai Volatility’s Cem Karsan, among others, the counterparties’ response to this options trading is impactful (and often predictable).

“Moreover, heading into Wednesday’s FOMC, we saw the market well-hedged,” SpotGamma, an options modeling and analysis service explained. “Participants’ demand for protection is concentrated in options with little time to expiry (given the monthly options expiration and roll-off a significant size of S&P delta).”

“Adding, the compression of volatility [post-FOMC and into OPEX], coupled with trade higher, solicits less counterparty hedging of put protection … [and] less positive delta = less selling to hedge = less pressure.”

Graphic: Implied volatility term structure shifts inward. This solicits positive hedging (vanna) flows as counterparty exposure to positive delta declines. In other words, short stock and futures hedges (against options) are bought back.

So, at a high level, this week’s events (a ”rally [that’s] been fueled by dealers covering short positions to balance exposures while demand for stock hedges is elevated”) have bolstered positive price action. 

Graphic: Via Bloomberg.

What’s interesting, also, is the S&P 500’s response to the $4,400.00, level. At this level is a concentration of call exposure.

Graphic: Via Goldman Sachs Group Inc. SPX resistance at $4,400.00.

As noted before, the dominant customer positioning, at least at the index level, is short call and long put (i.e., finance downside insurance by selling upside to hedge equity exposure).

The counterparty, in such a case, is short downside and long upside protection; when volatility contracts and underlying prices move higher, the put side, as noted above, solicits less active hedging whilst the call side solicits more active hedging.

In other words, the counterparty has less exposure to negative gamma (from puts) and more exposure to positive gamma (from calls), meaning gains are multiplied to the upside).

Graphic: Via SqueezeMetrics. Market gamma turns positive.

Knowing that “the range of spot prices across which option deltas shift from near-zero to near-100% becomes very narrow as options approach maturity (and at maturity, options on one side of the settlement value have zero delta and the other side have 100% delta),” trading into that concentration of calls (which have increased sensitivity to direction or gamma) quickly adds to counterparty positive delta exposure.

This must be offset with counterparty negative delta in the underlying (selling futures and stock to hedge). If there are enough “contracts sitting close to the spot price this time around,” that leads to more frenetic hedging as participants “actively trade around those positions,” and pressure upside, even.

Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from ZeroHedge. “SPX / SPY currently “pinning” btwn 4400 strike ($4.1B $Gamma), 4350 ($2.5B), 4300 ($2.4B); currently see ~43% of the $Gamma dropping-off for Friday’s expiration; currently at “Zero Gamma” level, “Max Short Gamma” at 4125 and -$17B per 1% move.”

Ultimately, this post-FOMC price rise may put the market in an underhedged position. In such a case, as talked about yesterday, new demand for protection would add fuel to weakness (later). 

“I’ve never seen an environment where you’ve had so many potential overhangs in the market that can not be controlled,” said David Wagner, a portfolio manager at Aptus Capital Advisors. “We’ll see if people can see to redeploy their puts.”

SpotGamma’s Delta Tilt indicator. Current readings rival that of Dec ’18 and Mar ’20. These expirations can be correlated to sharp rallies in the S&P (red line).

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

In the best case, the S&P 500 trades higher; activity above the $4,395.25 high volume area (HVNode) puts in play the $4,418.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,438.25 HVNode and $4,464.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,395.25 HVNode puts in play the $4,355.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as low as the $4,314.75 and $4,285.25 HVNodes, or lower.

Considerations: Push-and-pull, as well as 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.

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

Definitions

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

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For March 9, 2022

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

What Happened

Overnight, equity index futures, led by the tech- and growth-heavy Nasdaq 100 auctioned higher. This is immediately after a session characterized by rampant, two-way volatility. 

Much of the action in the equity indices and commodity markets is headline-driven. 

For instance, at one point, alongside news that Ukraine would no longer insist on NATO membership, the S&P 500 auctioned higher nearly 3%. Thereafter, responsive selling at a very key technical level preceded the index’s over 3% drop shortly after.

This push-and-pull, as well as 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.

Ahead is data on job openings and quits (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: The prevailing narrative is concerned with the slowdown in economic growth, the intent to withdraw monetary stimulus, and the response to Russia’s invasion of Ukraine.

Graphic: Bloomberg. U.S. equity indexes spared of recent bloodshed, abroad.

Pursuant to the response to Russia’s invasion of Ukraine has been a disruption in supply chains; commodities, like oil and nickel, have risen and that has inflation and growth impacts.

Graphic: Via Bloomberg, Oxford Economics. “The war in Ukraine is making it harder and more costly for goods to move freely across the globe. Key shipping routes are blocked, and others are feeling ripple effects from the conflict.”

In the coming days and weeks, central banks will announce their monetary policy decisions. Per Bloomberg, commodity costs underline the inflation challenge to the Federal Reserve.

Graphic: Via Bloomberg. The historical analogy is different but close (as today’s economy is less dependent on oil); the “Fed responded to the [1973] shock, and to the growing wave of inflation that preceded it, with a massive tightening.”

With breakevens on 30-year inflation-linked Treasuries – an indicator of the pace of price gains over three decades – climbing to their highest level, the Fed is expected to hike rates 25 bps.

Graphic: Via CME Group Inc (NASDAQ: CME). Participants price in an increased probability of a shift in the target rate. Click here to access the FedWatch Tool.

In the past days, there have been a variety of takes on what’s going on. A pessimistic, yet, interesting take is offered by Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar.

Mainly, there is a commodity crisis. Commodities are collateral and collateral is money.

Graphic: Via Bloomberg. The “FRA/OIS, a key gauge of interbank funding risk, as of the close on Monday.” Click here to listen to Zoltan Pozsar’s Bloomberg conversation on Russia, Gold, and the U.S. dollar.

“[E]very crisis occurs at the intersection of funding and collateral markets and that, in the presently unfolding crisis, commodities are collateral, and more precisely, Russian commodities are like subprime collateral and all other stuff is prime.”

Pozsar explains that instability in commodity prices feeds into financial instability as margin calls trigger the failure of commodity traders and (potentially) commodity exchanges.

Graphic: Via Bloomberg. Commodity price rises solicit margin calls.

“Again, commodity correlations are at 1, which is never a good thing,” he says. “The Fed and other central banks will be able to provide liquidity backstops, … but those will be Band-Aid solutions.”

Liquidity is the manifestation of a larger problem – the Russian-non-Russian commodities basis – and its resolve portends a “regime shift” which Pozsar posits China will be at the front of.

“When this crisis (and war) is over, the U.S. dollar should be much weaker and, on the flip side, the renminbi much stronger, backed by a basket of commodities.”

MUFG Securities’ (NYSE: MUFG) George Goncalves makes a similar point, drawing parallels to the early days of 2008. 

“The situation in Europe is precarious enough on its own, but if conditions worsen in a highly connected financial system, balance sheets may get curtailed via haircuts,” Concalves wrote

“Meanwhile there is an eerily similar pattern to the current action in [short-term interest rates] and oil prices to the early summer of 2008. Recall, in response to inflation and central bank hawkishness, markets priced in nearly 150bps in hikes in 2008 before GFC cracked.”

Positioning: Based on metrics often quoted in this morning letter, buying support appears to be cooling. Overlaying options positioning metrics, the returns distribution is skewed positive, still.

This is in opposition to some of the reporting by large outlets. The narrative is along the lines of institutional investors offloading equities to retail.

Graphic: Via Bank of America Corporation (NYSE: BAC).

According to statements by The Ambrus Group’s Kris Sidial, “This is partially a byproduct of the long equity firms that have programs that are designed to exit when Cboe Volatility Index (INDEX: VIX) gets over a certain level and equities drop under a certain percentage.”

Graphic: Via Pat Hennessy. “ES goes +2%, -2%, +3%, -3% in 14 hours! Yes – the close/close move was weak, but the intraday moves were massive – IMO enough to support a 37 VIX. Strange to see vols so soft given intraday realized + close on lows.”

“There is no doubt about it that we have noticed heavier institutional flow throughout the day over the last two weeks. However, there are still large institutions that are putting cash to work in equities. Ironically a rotation out of some European equities into U.S., [and] there is also a good amount of buyback flow that is projected to hit some areas in U.S equities.

Pursuant to remarks in the fundamental section (and Sidial’s note on the heavier institutional flow), we saw some noteworthy put buying in products like the cash-settled Nasdaq 100 (INDEX: NDX) and iShares iBoxx $ Inv Grade Corporate Bond ETF (NYSE: LQD).

Graphic: Via SHIFT. Buying closer strikes. Selling farther strikes.

Whether these are hedges, the replacement of existing linear short positions, or speculation on the downside, it all plays into this negative gamma environment markets are in.

When customers demand downside (put) protection (a negative delta, positive gamma trade that has its gains multiplied to the downside), counterparties sell underlying futures and stock to hedge their positive delta, negative gamma trade which has the effect of pressuring markets.

The compression of volatility (via passage of FOMC) or removal of counterparty negative exposure (via OPEX) may serve to alleviate some of this pressure. Until then, participants can expect the options landscape to add to market volatility.

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

In the best case, the S&P 500 trades higher; activity above the $4,248.25 overnight high (ONH) puts in play the $4,285.50 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,319.00 untested point of control (VPOC) and $4,346.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,248.25 ONH puts in play the $4,227.75 HVNode. Initiative trade beyond the $4,227.75 HVNode could reach as low as the $4,177.25 HVNode and $4,138.75 ONL, or lower.

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

Definitions

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

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 24, 2022

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

What Happened

Overnight, equity index futures added to losses after news that Russia invaded Ukraine

The MOEX Russia Index fell nearly 50% while, at home in the U.S., equity index futures were off about 3%. Bonds rose with commodities which were led by crude oil (up ~9%). 

The CBOE Volatility Index (INDEX: VIX), a measure of implied volatility or participants’ forecast of likely movement in prices, printed 37.79 a ~7.00 jump from Wednesday.

This high-level context suggests to us the need for patience. Ranges will be wide. Positioning will compound headline-driven moves. Technical analyses will fail. Caution.

Ahead is data on jobless claims, gross domestic product, gross domestic income (8:30 AM ET), as well as new home sales (10:00 AM ET).

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

What To Expect

Fundamental: “The ‘bad news = good news’ narrative for markets doesn’t work if the Fed is tightening amidst a slowdown and a military escalation risk. In this case, bad news = bad news.”

Pursuant to this remark by Alfonso Peccatiello, Russian equities fell the most on record (nearly 50%) after President Vladimir Putin ordered the demilitarization of Ukraine. 

Graphic: Via Bloomberg.

According to Bloomberg, this crisis comes “after the U.S. and its allies crossed Russia’s ‘red lines’ by expanding the NATO alliance.”

In terms of the economic implications of Russia sanctions, it is “Cyprus and eastern European countries [that] are the most reliant on Russian imports in the EU.” 

Ukraine’s crisis also throws a wrench at monetary tightening initiatives, abroad; “the European Central Bank will put even greater emphasis on its flexibility and options as it exits stimulus measures and shifts toward raising rates,” Governing Council member Francois Villeroy de Galhau said.

Graphic: Via Bloomberg.

Positioning: Implied volatility expands as heightened demand for protection is priced in.

Graphic: VIX term structure shifts higher, especially at the front-end. This denotes the heightened potential for instability.

This comes after, according to views expressed by The Ambrus Group’s Kris Sidial, “we saw larger inflow[s] into equity funds, outflow[s] out of money markets, larger buying in the ATSs, with no real put buying.”

Graphic: Via EPFR, Barclays, and Bloomberg. Taken from The Market Ear.

In other words, measures of implied volatility were not performing; participants opportunistically buying the dip witnessed an SPX down, VIX down environment in which hedges were not being marked up accordingly.

Graphic: Per Tier1Alpha, “In the past, when the $SPX/ $VIX correlation goes back to negative, there have been some pretty memorable volatility events. Worth keeping in mind.”

The implications of this action are staggering. 

As stated yesterday, as most participants, at least at the index level, own protection, the counterparties to this trade are short protection. 

These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

With measures of implied volatility expanding, as is the case when there is heightened demand for downside put protection, protection is bid and the dealer’s exposure to positive delta rises, which solicits more selling in the underlying (addition of short-delta hedges).

Graphic: SqueezeMetrics details the implications of customer activity in the options market, on the underlying’s order book. For instance, in selling a put, customers add liquidity and stabilize the market. How? The market maker long the put will buy (sell) the underlying to neutralize directional risk as price falls (rises).

To monitor for capitulation, we may look for when the volatility expectations of implied volatility metrics rise to extremes. Learn more about VVIX, here.

Graphic: Charting the CBOE Volatility-Of-Volatility Index (INDEX: VVIX). In that reach for highly “convex” options, counterparties react in a manner that exacerbates underlying price movement.

We may also measure for one-sidedness in sentiment by looking to naive metrics like the put/call ratio. Learn more about PCALL, here.

Graphic: Using the put/call ratio to gauge sentiment.

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,122.25 high volume area (HVNode) puts in play the $4,177.25 HVNode. Initiative trade beyond the HVNodes could reach as high as the $4,212.25 regular trade low (RTH Low) and $4,249.25 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,122.25 HVNode puts in play the $4,055.75 LVNode. Initiative trade beyond the latter could reach as low as the $3,978.50 LVNode and $3,943.25 HVNode, or lower.

Considerations: If you are not well-versed in navigating trade at heightened levels of volatility, it is best to sit on your hands (SOH) or trade with a smaller size. Often, on large gaps, indexes may move sideways (and not up or down). This can be frustrating. 

Also, in high volatility, negative-gamma environments, headlines matter, and technical analyses often fail. Do not think “this time is as others” and let this event lead to your demise. Caution.

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

What People Are Saying

Definitions

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

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

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 is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 18, 2022

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

What Happened

Overnight, equity index futures auctioned back up into range after a spike lower from multi-day balance. The overnight response, higher, happened after Russian Foreign Minister Sergei Lavrov agreed to meet U.S. Secretary of State Antony Blinken for talks in Europe next week.

Ahead is data on existing home sales and leading economic indicators (10:00 AM ET), as well as Fed-speak by Christopher Waller (10:15 AM ET), John Williams (11:00 AM ET), and Lael Brainard (1:30 PM ET).

In observance of Washington’s Birthday, markets are closed Monday, February 21, 2022.

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: Given the persistence of mechanical responses to key levels, visually-driven, weaker-handed participants (which seldom bear the wherewithal to defend retests) carry a heavier hand in recent price discovery.

The takeaway is that the larger, other time frame (OTF) participants are waiting for more information before committing to substantial expansion of range via large sales or buys.

Information the OTFs are seeking to process and position themselves in accordance with are (but not limited to) geopolitical tensions and contractionary monetary policy.

Thursday’s commentary went in-depth on the implications of more severe Fed-action. Mainly, to slow inflation and rid the market of excesses, “a Volcker moment” is needed a strategist said.

Graphic: Via MacroTrends & Cboe Options Institute. “Value stocks started to outperform when the Federal Reserve (under Greenspan) communicated their intent to tighten policy. Value fell out of favor in the middle of 2007 following a UST yield curve inversion and looser monetary policy (under Bernanke).”

The Ambrus Group’s Kris Sidial, and others, expressed their differing sentiments on the issue, given that equities are so intertwined with consumer savings.

“There is no way the fed looks to use additional volatility as a policeman,” he explained. “It’s one of those things that sounds ok in theory but will not work in real-world applications.”

As Moody’s Corporation (NYSE: MCO) puts well, “This cycle is unlike any recent one and, while there are a ton of reasons to be optimistic about the U.S. economy’s near-term prospects, there are also reasons to worry that a recession isn’t far off on the horizon.”

Graphic: Via St. Louis Fed. Taken from Cboe Global Markets Inc (BATS: CBOE). “In fact, a dynamic where short-dated bond yields are higher than longer-dated bonds can reinforce an economic slowdown. The cost of capital is perhaps the most important component for evaluating so many other market relationships. Any investment that involves borrowed money becomes more expensive when the cost of capital increases. More is spent on interest payments. Higher rates incentivize saving (as opposed to consumption) which impacts businesses and the economy as a whole.”

“If the Fed is forced to raise the fed funds rate above its neutral rate to tame inflation, the stage will be set for recession. Also, some Fed officials believe they are falling further behind the curve, which could lead to a more aggressive tightening cycle, a recipe for an economic downturn in 2023 or 2024.”

Based on this sentiment, investors have already bet – via the eurodollar futures contract – on the Fed reversing its tightening course in late 2023. The current baseline calls for four 25-basis point rate hikes this year.

Graphic: Via Bloomberg. “In the eurodollar futures markets, the spread between the December 2023 and December 2025 contracts has dropped further into negative territory on Monday — implying a near-25 basis point cut in the federal funds benchmark over this 24-month timeframe.”

“We, therefore, think that the more likely path is a longer series of 25-basis point increases in the target range for the fed funds rate and we may need to add an additional rate hike to our baseline forecast in March,” Moody’s says in response to more hawkish pricings as a result of market focus on comments by hawkish regional Fed presidents.

Graphic: Via TS Lombard. Taken from The Market Ear. “Flattening is normal when the Fed is tightening. Looking at the past eight hiking cycles, almost every segment of the curve has flattened on average without immediately triggering a recession.”

On that note, Mark Haefele, chief investment officer at UBS Group AG’s (NYSE: UBS) Global Wealth Management arm says that “Despite the recent volatility, it’s important to remember that we are still in an environment of robust economic and earnings growth.”

Graphic: Via Bloomberg. “If market dysfunction is reflected in tighter conditions, then this chart shows we’re nowhere near stressed levels — after all, central bank policy globally is historically loose.”

“Our base case we expect upside for equity markets over the balance of the year.”

Positioning: Passive buying flows persist alongside a drop in bearish sentiment readings.

Graphic: Via EPFR, Barclays PLC (NYSE: BCS), and Bloomberg. Taken from The Market Ear

This action is in the face of a collapse in margin debt.

Graphic: Via Tier1Alpha. Taken from The Market Ear. “Margin debt is a big part of the puzzle, but even more important is the “delta” of the margin debt. The YoY % change of FINRA margin debt looks slightly scary.”

In the credit markets, investment-grade spreads are at some of their widest levels since 2020. Per Bloomberg, put option (bets on the downside) open interest in corporate bond ETFs is at an all-time high.

“Rotate into credit now,” Chris Sheldon, the co-head of credit and markets at KKR, explained, taking a contrarian view. “As the rate volatility plays through the market segment, we think high yield could become more attractive very quickly.”

On the single-stock and index-level, options positioning suggests participants should continue to brace for volatility. Participants’ demand for protection (negative delta exposure) has left counterparties (dealers taking the other side and warehousing risk) adding negative delta exposure linearly (via stock and futures sales) to hedge.

To note, owning an option offers someone positive exposure to gamma or convexity (to have profits multiplied if the direction is correct, all else equal). On the other side, though, participants who are short gamma or convexity may have their losses multiplied if incorrect.

Making some naive assumptions on the build-in interest in options strikes at lower prices, we may surmise that dealers are exposed to increased negative gamma exposure. 

To hedge this, if volatility were to remain unchanged, dealers must sell (buy) into weakness (strength) to hedge increasing (decreasing) negative gamma exposure. If volatility rises (drops), then more stock and futures must be sold (bought/covered).

Pictured: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

The monthly options expiration (OPEX) will coincide with the removal of lots of put-heavy exposures. This will decrease the dealers’ positive exposure to delta and make gamma exposures less negative. 

Therefore, absent some exogenous event that increases demand for protection, again, there is the potential for strength, post-OPEX. That’s when that real-money buying, alluded to above, may resolve in higher prices.

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 positively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

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

In the best case, the S&P 500 trades higher; activity above the $4,415.00 untested point of control (VPOC) puts in play the $4,438.00 key response area (balance boundary and high volume area). Initiative trade beyond the key response area could reach as high as the $4,464.75 low volume area (LVNode) and $4,485.00 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,415.00 VPOC puts in play the $4,401.50 spike base. Initiative trade beyond the spike base could reach as low as the $4,367.25 regular trade low (RTH Low) and $4,332.75 high volume area (HVNode), or lower.

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

Definitions

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

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

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

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

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure. In recent history, this reset in dealer positioning has been front-run; prior, there was an increase in volatility after the removal of large options positions and associated hedging.

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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.