Tag: The Macro Compass

Daily Brief For February 16, 2022

Post author By Renato L. Capelj
Post date February 16, 2022
No Comments on Daily Brief For February 16, 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

After auctioning up into a key supply area, overnight, equity indices were responsively sold.

Ahead is data on retail sales and import prices (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), business inventories, and the NAHB home builders’ index (10:00 AM ET), as well as the release of Federal Open Market Committee (FOMC) minutes (2:00 PM ET).

*Graphic updated 6:40 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 market has de-rated substantially at the single-stock level.

“Stocks have been de-rating for almost a year now as investors began to anticipate the inevitable tightening from the Fed, given the robustness of the recovery and building imbalances,” Morgan Stanley’s (NYSE: MS) Michael Wilson says.

Graphic: Via Bank of America Corporation (NYSE: BAC). Taken from Bloomberg. “Perhaps most strikingly, fund managers are now more thoroughly underweight in technology stocks than at any time since 2006.”

“We think this de-rating is about 80% done at the stock level with the S&P 500 P/E still about 10% too high (19.5x versus our 18x target). In other words, the de-rating is more complete at the stock level than at the index level, at least for the high-quality S&P 500.”

At the same time, the bond market’s pricing of risk – reflected by the Merrill Lynch Option Volatility Estimate (INDEX: MOVE) – is not in line with the pricing of equity market risk, via the CBOE Volatility Index (INDEX: VIX).

*Graphic: MOVE Index. Taken from* *Lisa Abramowicz*.

That said, fear in one market tends to feed into the fear of another; regardless of the cause, equity and bond market participants are not on the same page.

*Graphic: Via True Insight. Taken from* *The Market Ear*.

Moreover, prevailing monetary frameworks and max liquidity promoted a large divergence in price from fundamentals. Growth in passive investing – the effect of increased moneyness among nonmonetary assets – and derivatives trading imply a lot of left-tail risks.

The “provision of liquidity and the creation of wealth through higher asset prices are intimately connected over time,” John Authers of Bloomberg explains.

“Falling liquidity, while obviously necessary now that the emergency has passed and inflation is rising, could well signal problems ahead.”

*Graphic: Via CrossBorder Capital. Taken from Bloomberg.*

To establish the point, these shifts in liquidity have large effects on bond markets, too, and that’s what participants are likely pricing in via MOVE.

A “flatter yield curve tends to be followed quite swiftly by rising credit spreads. While there is no great issue with solvency at present, this suggests that credit may already be causing problems by the end of this year.”

*Graphic: Via Bank of America Corporation (NYSE: BAC). Taken from* *Samantha LaDuc*.

“The U.S. high yield OAS (option-adjusted spread) is breaking out above resistance to suggest a year-long risk-off bottom for this credit spread,” Bank of America explains.

“Deteriorating credit conditions are a bearish leading indicator, increasing the risk that the S&P 500 (INDEX: SPX) completes the head and shoulders top highlighted in the chart below.”

Taken together, it is the above-mentioned dynamics that will ultimately make it hard for the Fed to continue with rate hikes, Authers adds.

Graphic: Via Bloomberg, “there is a 50-year history that the Fed never hikes rates once the fed funds rate has risen above the five-year yield. That point could come before the end of 2022, and suggests that it will be very difficult to continue with tightening to the extent that the Fed currently believes necessary to bring down inflation to its target.”

To conclude this section, I quote Alfonso Peccatiello, the former head of a $20 billion investment portfolio and author of The Macro Compass: “If the Fed pushes the hawkish narrative further, we might see deeper cracks in the walls.”

*Graphic: Via The Macro Compass, “Once real yields approach equilibrium levels, subsequent S&P500 returns tend to be poor.”*

Positioning: In the past weeks this commentary expressed a more bullish tilt.

This tilt is not entirely incorrect. Indeed, there are (as pointed to in past commentaries) few metrics that suggest that there have been strong(er) levels of accumulation.

*Graphic: Via EPFR. Taken from* *The Market Ear. A “nice steady tune of >$50bn per month into global equities.”*

However, other positioning metrics point to an increased potential for instability, and implied volatility, though heightened, may not provide much of a boost if further compressed.

As options modeling and analysis provider SqueezeMetrics explains, “I don’t see the upside catalyst in the data right now. VIX back at 25 isn’t compelling from a vanna-rally perspective (back to 20 seems possible, but how much more?).”

“Have enough puts been bought to propel prices from vanna rally and subsequent vol rolldown? Mehhh.”

To put it in simpler terms, “it is a lot easier to knock [the market] down than it is to lift up.”

What’s known for sure is that this week’s put-heavy options expiration (OPEX) “may make gamma exposures less negative,” according to options analysis provider SpotGamma.

For context, delta is an options exposure to direction. Gamma is the rate of change in delta.

“In an environment characterized by negative gamma (wherein an options delta falls with stock price rises and rises when stock prices fall), options expiries ought to make gamma less negative.”

Therefore, with a reduction in negative gamma, “there will be a removal of [counterparties’] linear short (-delta) hedges which may further bolster attempts higher.”

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 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 $4,438.00 key response area (balance boundary, high-volume area, and prior overnight low) puts in play the $4,483.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,499.00 untested point of control (VPOC) and $4,526.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,438.00 key response area puts in play the $4,393.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,365.00 POC and $4,332.25 HVNode, or lower.

Considerations: Tuesday’s trade built out areas of high volume via the cave-fill process in locations where prior discovery left weak structure – gaps and p-shaped emotional, multiple distribution profile structures (i.e., Friday’s knee-jerk liquidation of poorly positioned longs).

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.

*Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.*

Definitions

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

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.

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 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.

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.

Commentary

Daily Brief For February 15, 2022

Post author By Renato L. Capelj
Post date February 15, 2022
No Comments on Daily Brief For February 15, 2022

What Happened

Overnight, equity index futures auctioned sharply higher after Russia announced a pullback of some forces near Ukraine.

Ahead is data on the Producer Price Index and Empire State Manufacturing Index (8:30 AM ET).

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

What To Expect

Fundamental: In the face of what participants feel will be an aggressive wave of monetary tightening and geopolitical tensions, markets had sold.

The number of interest-rate increases implied by the market for overnight index swaps, according to Bloomberg, increased to seven. Higher rates ding valuations, hurting most high-flying technology stocks and junk bonds.

*Graphic: Via* *The Macro Compass* – The 5y-30y OIS curve, which is may eventually invert, “trades at a meager 16 bps and Powell didn’t remove the hawkish Fed tail risks (e.g. 50 bps hike in March or hiking at every meeting) and validated the aggressive hiking cycle pricing amidst a clear slowdown in economic growth impulse.”

JPMorgan Chase & Co strategists led by Marko Kolanovic suggest what the market is pricing will not materialize.

“We believe risky asset markets have mostly adjusted to monetary policy shifts by now,” the JPMorgan analysts wrote. “Short-term rates markets have likely moved too far vs. what CBs will ultimately deliver in hikes this year.”

The team at JPMorgan concludes that though the risk of conflict in Ukraine is high, the impact on global equity markets would be limited and “likely prompt a dovish reassessment by CBs.”

“We expect risky asset markets to rebound as they digest these risks and sentiment improves, aided by inflows from systematic investors and corporate buybacks.”

Pursuant to those remarks, Goldman Sachs Group Inc (NYSE: GS) “saw the largest net buying since late December (+1.0SDs), driven by risk-on flows with long buys outpacing short sales 8 to 1.”

“All regions were net bought led by North America (driven by long buys) and to a lesser extent DM Asia (driven by short covers). 8 of 11 global sectors were net bought led in $ terms by Info Tech, Materials, Financials, and Consumer Disc. Net buying in US Info Tech continued this week.”

Positioning: As much as this newsletter sounds like a broken record, not much has changed in terms of positioning.

Lower prices and higher implied volatility (the byproduct of demand for protection) compounded macro flows, exacerbating weakness.

*Graphic: SqueezeMetrics* *details* *the implications of customer activity in the options market, on the underlying’s order book.*

According to options modeling and analysis provider SpotGamma, “When long a put, investors are offered the potential to make asymmetric payouts. They are long gamma and have positive exposure to convexity.”

Dealers, on the other side, have the potential to realize multiplied losses if markets trade down.

“To protect against ‘blowout’ situations, dealers can and will buy puts against their existing exposure. At a certain point, the convexity of the dealers’ own insurance kicks in and basically reduces the amount of added hedges needed on increases in volatility or lower markets.”

Therefore, markets have reached a potential lower bound, in light of this dynamic. Participants, en masse, would have to commit more capital to strike prices much further down and out in time to indirectly add pressure.

Taking into account this options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed.

*Graphic: Data SqueezeMetrics. Graph via Physik Invest.*

To conclude, the dip lower and demand for protection may prime the market for upside (when volatility starts to compress again and counterparties unwind hedges to put-heavy exposures).

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.

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 $4,438.00 puts in play the $4,499.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,526.25 high volume area (HVNode) and $4,565.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,438.00 puts in play the $4,393.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,365.00 POC and $4,332.25 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.

What People Are Saying

In trading you have to face your issues head on. Be honest with with yourself on what you’re doing wrong & fix it in the moment. There may not be a tomorrow if you don’t fix your issues in the moment the next time.

This is an in the moment business, not a fix later business.
— Anthony Crudele (@AnthonyCrudele) February 15, 2022

All the successful portfolio managers I am friends with have one discernible common trait.

They care lots about making money and protecting their downside risks, and zero about feeding their ego.

Do you want to believe you are always right, or do you want to make money?
— Alf (@MacroAlf) February 15, 2022

Definitions

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

About

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.

Tags Gap, GS - Goldman Sachs Group Inc, HVN - High Volume Node, JPM - JPMorgan Chase & Co, Marko Kolanovic, OIS - Overnight Index Swaps, ONL - Overnight Low, POC - Point Of Control, PPI - Producer Price Index, SpotGamma, SqueezeMetrics, The Macro Compass, VPOC - Virgin Point Of Control

Commentary

Daily Brief For February 11, 2022

Post author By Renato L. Capelj
Post date February 11, 2022
No Comments on Daily Brief For February 11, 2022

What Happened

Overnight, equity index futures continued lower after the hottest inflation reading in decades and hawkish (i.e., favoring contractionary policy) Fed-speak by St. Louis Fed Chair James Bullard.

Ahead is data on University of Michigan sentiment and inflation expectations (10:00 AM ET).

*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: Bonds and equities were sold, yesterday.

This is after the hottest inflation reading in four decades and comments by the Fed’s Bullard that the central bank should hike rates by 100 basis points over the next three meetings.

*Graphic: Via* *Bloomberg, “This is a heat map produced by the Bloomberg ECAN function, and it shows every indicator relevant to U.S. inflation now well above its recent mean.”*

“Bullard’s plan involves spreading the increases over three meetings, shrinking the Fed’s balance sheet starting in the second quarter and then deciding on the path of rates in the second half based on updated data,” Bloomberg explained.

“Markets boosted bets on rate hikes, pricing a full percentage-point increase over three meetings, which would require the first 50 basis-point increase since 2000 unless a move was made between Fed meetings.”

Further, though this FOMC participant’s more hawkish tilt differs from what the entire committee has committed to, so long as “the market expects it, … the odds of a 50bp hike in March or May are higher.”

This trend in expectations has been worsening with each major macroeconomic event in 2022. The Fed’s Minutes, FOMC meeting, Nonfarm Payrolls, and CPI have all played a part in the disruption of long-term trends in yields which has a negative impact on valuations, to put simply.

Though earnings growth may offset the negative valuation impact of higher rates, as discussed in detail days ago, the yield curve – e.g., spread between 10- and 2-year – is on its way toward an inversion, as is the yield curve measure involving overnight index swaps (OIS).

For context, per Reuters, an “OIS transaction involves exchanging an overnight rate such as the federal funds rate for a fixed one. For instance, in a U.S. 2-year OIS swap, one party to the transaction receives a fixed two-year rate in exchange for paying the fed funds rate daily over the next two years.”

The OIS market is also a reflection of traders’ expectations for rates. An inversion (which may signal the expectation of aggressive action against inflation that could also stifle economic growth) previously occurred in July 2018. Months later, markets sold and the Fed cut rates.

Per Alfonso Peccatiello, the former head of a $20 billion investment portfolio and author of The Macro Compass: The inversion of the OIS curve may worsen a downturn in the economy as short-term refinancing credit becomes more expensive and markets price weaker long-term growth.

The OIS curve is “a cleaner indication of yield curve inversions,” Peccatiello added.

Positioning: Bonds down. Equities down. What the heck?

This newsletter has talked about this dynamic in the past and will borrow from that, below.

In short, over the past 40 or so years, monetary policy was used as a cru t ch to support the economy. This promoted deflation, innovation, and the subsequent rise in valuations.

With rates near zero and lifting, that’s a headwind; coupled with participants’ increased exposure to rate and equity market risk, which can play into cross-market hedging and de-leveraging cascades, 60/40 turns into somewhat of a poor hedge.

Why? Higher rates have the potential to decrease the present value of future earnings, making stocks, especially those that are high growth, less attractive.

According to a note published by Andy Constan of Damped Spring Advisors, “The lack of additional liquidity provided by Fed purchase will also remove a damper for the market and the economy keeping asset volatility well bid, while also causing asset diversification benefit to fall, generating rising portfolio volatility and the risk demanded to hold assets.”

“Now, with the Fed poised to hike interest rates to combat raging inflation, the bond-stock relationship could be upended,” Bloomberg explains.

“At stake are trillions of dollars that are managed at risk parity funds, balanced mutual funds, and pension funds that follow the framework of 60/40 asset allocation.”

Why mention any of this? Well, it forces us to look elsewhere for protection.

In this case, the growing asset class of volatility, so to speak, is that protection. Investors are aware of both the protective and speculative efficiency afforded to them by options and that is the primary reason option volumes are so comparable to stock volumes, now.

Notwithstanding, with option volumes higher, related hedging flows can represent an increased share of volume in underlying stocks. Therefore, the correlation of stock moves, versus options activity, is more pronounced.

To put it simply, we can look to the options market for clues on where to next, for lack of better phrasing. So, let’s do that!

Heading into Thursday’s session, participants were committing capital to bets on lower volatility.

The counterparties to this short volatility trade were long; if the market were to trade higher (lower), they would sell (buy) futures against increased (decreased) positive delta exposure.

*Graphic: A rudimentary* *exa*mple of what is involved in hedging a long call option.

However, Thursday’s post-CPI trade disrupted the balance of trade; lower prices and demand for protection, in the face of lower levels of “on-screen liquidity,” solicited dealer selling to hedge increased exposure to the positive delta from demanded short-dated, highly convex options.

*Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator; “customers bought put options (a negative delta trade) leaving dealers short (a positive delta trade).”*

The demand for shorter-dated protection is better visualized by the VIX term structure which shifted markedly at the front-end, yesterday.

*Graphic: VIX term structure shifts higher (dramatically at the front-end).*

As direction (delta) and volatility (vega) are inputs to the pricing of options, lower prices and higher volatility (a reflection of fear and demand for protection) will mark options higher. Hedging pressures will exacerbate weakness, as a result of real selling (as talked about above), at the index and single-stock level.

Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), positioning metrics remain positively skewed.

To conclude, the dip lower and demand for protection could serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher). All eyes are on next week’s monthly options expiration (OPEX). We will discuss the implications of this, later.

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

In the best case, the S&P 500 trades higher; activity above the $4,473.00 point of control (POC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,565.00 untested POC (VPOC) and $4,585.00 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,473.00 POC puts in play the key response area at $4,438.75 (BAL/ONL/HVNode). Initiative trade beyond the key response area could reach as low as the $4,393.75 HVNode and $4,365.00 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.

Definitions

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

Options Expiration (OPEX): Traditionally, option expiries mark an end to trend or 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 reset in dealer gamma exposure.

About

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.

Commentary

Daily Brief For February 8, 2022

Post author By Renato L. Capelj
Post date February 8, 2022
No Comments on Daily Brief For February 8, 2022

What Happened

Overnight, equity index futures were divergent and weighed by the tech- and growth-heavy Nasdaq 100. Most commodity and bond products were much weaker, also.

This stocks down, bonds down dynamic points to a continued deleveraging.

Notwithstanding, sideways after a fast move lower, is not a bad thing. It’s one of the better cases to have given certain mechanics with respect to the options market, for instance.

Ahead is data on international trade (8:30 AM ET) and real household debt (11:00 AM ET).

*Graphic updated 6:20 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: Ranges, at the index level, have tightened markedly since the January sell-off culminating in a cross-market deleveraging cascade.

The situation is different at the single-stock level. There are a couple of factors behind this.

For one, ARK Invest’s Catherine Wood recently made an interesting point suggesting events of today are the exact opposite of the events leading into the tech-and-telecom bust.

“During the tech-and-telecom bubble, … investors were falling all over each other, trying to one-up each other, to get a bigger tech position, because tech in the indexes had moved to 35%. We saw many portfolios with 40%, 50% tech.”

Basically, Wood thinks that investors are dumping single-stocks for index exposure. The below data supports this.

“We think that decision is going to prove to be just as incorrect as the decision to move en masse in the late 90s.”

*Graphic: Per* *Nasdaq*, “we’ve seen patches of retail selling of stocks that have mostly lasted for less than a week (blue bars in Chart 2). Interestingly, ETFs (yellow bars) remained net buy every single day, albeit at lower levels than usual in the last week of January.”

There is also the increasing demand for positive delta (long) exposure in the indexes as participants hedge their negative delta (short) exposure in the single stocks.

Then, there is also the supply and demand for options protection, at the index level.

Mainly, the indexes are where the world will hedge and so the effects of dealers re-hedging their risks to decaying options protection provide markets a sort of passive buying support.

The S&P 500, which carries a more liquid derivatives complex and less exposure to tech- and growth-heavy constituents (when compared to the Nasdaq 100 and Russell 2000), appears stronger, but not as strong as the Dow Jones Industrial Average, a clear beneficiary of the rotation out of growth- and innovation-names to value- and cyclical-type stocks.

Graphic: Anchored Volume Weighted Average Price (VWAP) analysis via Physik Invest. Notice Dow Jones Industrial Average (bottom right) and S&P 500 (top left) strength, as well as Nasdaq 100 (top right) and Russell 2000 (bottom left) weakness. Key pivots marked off.

All the last-mentioned point is trying to make is the following: try hard enough and you’ll find an explanation for anything.

Sometimes, though, a focus on the simplest of explanations (e.g., demand for assets that perform better in higher rate environments) may suffice in navigating volatility.

Going forward, despite many index heavy-weights reporting, the earnings season is set to accelerate over the coming weeks, and equity index futures traders have positioned themselves (as evidenced by tight, sideways trade) to react to new information accordingly.

*Graphic: Via @MikeZaccardi. Retrieved from Callum Thomas.*

Per JPMorgan Chase & Co (NYSE: JPM) strategists, the bull thesis remains intact.

The pace of economic growth is to stabilize in 2022 and the Federal Reserve is unlikely to move further into the hawkish territory.

We’re “Continuously seeing gains for earnings. Consensus projections for 2022 will most likely prove too low again,” JPM explains. “P/E multiples are elevated, but not equity yields vs credit & bond yields. We expect further, mild and benign, P/E compression in 2022. Overall, the picture is favorable, post the recent de-risking.”

*Graphic: Via The Market Ear. As money supply (which played a part in increased CPI figures) is slated to fall, there have been large outflows from Treasury Inflation-Protected Securities.* *@MacroAlf* *notes that these are some of the largest outflows “since the pandemic crash in March 2020. CPI might be 7% today, but markets are forward-looking.”*

Positioning: Though markets will tend toward instability so long as volatility is heightened and products (especially the index constituents) remain in negative gamma, the dip lower and demand for protection may serve to prime the market for upside (when volatility starts to compress again and counterparties unwind hedges thus supporting any attempt higher).

*Graphic: VIX term structure compresses markedly at the front end affecting most shorter-dated options more sensitive to the effects of direction and volatility.*

“Failure to expand the range, lower, on the index level, at least, likely invokes supportive dealer hedging flows with respect to time (‘charm’) and volatility (‘vanna’),” SpotGamma adds.

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.”

Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics point to “[m]odest bullishness on the 1-month timeframe.”

Technical: As of 6:20 AM ET, Tuesday’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.

Balance-Break Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) may soon occur.

Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area. Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.

In the best case, the S&P 500 trades higher; activity above the $4,497.00 untested point of control (VPOC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,555.00 VPOC and $4,586.00 RTH High (regular trade high), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,497.00 VPOC puts in play the $4,438.25 HVNode. Initiative trade beyond the $4,438.25 HVNode could reach as low as the $4,393.75 HVNode and $4,365.00 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.

Definitions

About

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.

Commentary

Daily Brief For February 7, 2022

Post author By Renato L. Capelj
Post date February 7, 2022
No Comments on Daily Brief For February 7, 2022

What Happened

Overnight, markets were calm as most equity index, commodity, and bond futures traded in tandem.

Ahead is data on consumer credit (3:00 PM ET).

*Graphic updated 7:50 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* *Gam*ma (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: On the back of divergent breadth, geopolitical tensions, the prospect of reduced stimulus to combat inflation, wild responses to earnings, and disappointments in real demand and growth, 2022 has panned out as an incredibly bearish year for the stock and bond market.

Amidst this deleveraging of sorts, the S&P 500, in particular, traded well into correction territory, albeit in line with the average non-recessionary pullback of about 15%, and seasonality patterns of mid-term election years.

*Graphic: Via* *Seth Golden, “Not sure investors realize just how BEARISH this year has been to date.”*

According to an article from Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh, retail investors have become even more active, setting “a new record for gross trading (buying and selling).”

To note, despite the recent “3.9 standard deviation share disposal,” when “retail investors offloaded a net $1.36 billion worth of stock by noon,” January 24, as discussed in prior Daily Briefs, retail investors “were still net buyers of stocks in January, adding $5 billion to their holdings for the month.”

What’s interesting though is retail’s reduced interest in ETF products tracking growth (those which have the most to lose in a higher rate environment).

*Graphic: “Suddenly retail have less interest in growth ETFs,” via* *Nasdaq*.

That’s amidst the fear of contractionary monetary policy, so to speak.

To explain, with additions in money supply, there were increases in consumer prices and monetary policymakers are now looking to temper those (supposed non-transitory) increases.

According to ARK Invest’s Catherine Wood, “we’ve seen money growth go from 27% at its peak during the coronavirus, to 13%, recently.”

In tempering this inflation, Wood, too, thinks that rate hikes are on the table heading into the mid-term election cycle.

Contrary to commentary that alludes to the Federal Reserve (Fed) hiking between 4 and 7 times, Wood thinks that “50 basis points is the number that the Fed will basically [use to] telegraph that it means business and that it’s going to head inflation off.”

*Graphic: Per* *Bloomberg, “Wall Street* *expects* *front-loaded hikes: Goldman Sachs Group Inc. and JPMorgan Chase & Co. are aligned on five hikes in 2022, while Bank of America Corp. is out front with a seven-hike forecast.”*

“They might want to do the 50 basis points just to say: ‘Okay, we’re done for a while, now,’ … [because] I think the Fed could overdo it quite quickly.”

Wood’s fears come as @MacroAlf put well recently:

“If the fast increase in the rate of change of money supply (M2) led to a sharp increase in the rate of change of prices (CPI),” what happens to inflation if M2 is falling?

Pursuant to Wood and @MacroAlf’s comments are large outflows from Treasury Inflation-Protected Securities (TIPS) that “protect against inflation because they mirror the movements of the consumer price index (CPI),” according to Nerd Wallet.

*Graphic:* *@MacroAlf* *notes: “Largest weekly outflow from TIPS since the pandemic crash in March 2020. CPI might be 7% today, but markets are forward-looking.”*

Positioning: Over the past weeks, measures of implied volatility (IV) expanded amidst heightened demand for negative-delta (short call and long put) exposure on the part of customers.

Counterparties, in hedging their positive-delta (long call, short put) risk, sold stock and futures (added negative delta hedges), and this pressured markets.

However, as SqueezeMetrics puts it well, “When investors buy puts, but the underlying doesn’t violently go down, those puts decay.”

*Graphic: Ratio of puts bought to sold, via SqueezeMetrics.*

Basically, demand for protection can result in options decay briefly taking a back seat, if you will.

As markets settle, though, “decay returns with vengeance,” according to SpotGamma.

“As time and volatility trend to zero (as all options expire), given the current market environment, dealers’ exposure to the risk of out-of-the-money protection will decline. All that means is that the market ought to be supported by positive vanna and charm flows as dealers unwind short-delta hedges to decaying positive-delta protection (they are short).”

Technical: As of 6:20 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 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 $4,474.75 point of control (POC) puts in play the $4,526.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,555.00 untested point of control (VPOC) and $4,586.00 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,474.75 POC puts in play the $4,438.25 HVNode. Initiative trade beyond the $4,438.25 HVNode could reach as low as the $4,393.75 HVNode and $4,365.00 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.

What People Are Saying

Are you tired from constantly living in the dark, fully unaware of the current Gamma Exposure?

Are you frustrated from having to guess the Zero Gamma level ALL THE TIME?

Are you annoyed from not knowing what the f*ck all of this even means!?!

I know, I was.

👇 pic.twitter.com/XxxmUHB5Gu
— Sergei Perfiliev 🇺🇦 (@perfiliev) February 3, 2022

Definitions

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

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

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

About

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.

Commentary

Daily Brief For January 28, 2022

Post author By Renato L. Capelj
Post date January 28, 2022
No Comments on Daily Brief For January 28, 2022

Editor’s Note: Thanks for subscribing to The Daily Brief, a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products.

In the coming week, commentaries are set to pause as I go on vacation. Look forward to providing valuable market color when I return, on February 7, 2022.

Talk to you soon!

What Happened

Despite certain index heavy-weights trading higher in light of earnings announcements, equity index futures remain weak, trading sideways to lower overnight with bonds.

Measures of implied volatility (IV) remain bid while certain metrics continue to show buying support. Given the way counterparties to customer options trades hedge, a compression in volatility may bolster a move higher.

Though the odds point to a counter-trend rally, continued selling is not out of the question. A break of multi-session support levels, combined with rising IV, would pressure indices further.

Ahead is data on PCE Inflation, incomes, spending, and the Employment Cost Index (8:30 AM ET). After is University of Michigan data on sentiment and inflation expectations (10:00 AM ET).

*Graphic updated 6:55 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: Equity indices are struggling to catch a bid amidst a more hawkish Fed, persistent geopolitical tensions, and data showing slowing growth at home and abroad.

*Graphic: @MacroAlf* *plots credit impulse as a percent of GDP and SPX year-over-year earnings.*

This is in the face of heavyweights, like Apple Inc (NASDAQ: AAPL) which posted its highest-ever quarterly earnings after sales climbed 11% to a record $124 billion, trading higher.

Coming back to comments from yesterday, the Federal Open Market Committee (FOMC) revealed asset purchases would stop in March. Then, in the face of an economy that’s much stronger than at the start of the last hiking cycle, the window for higher rates would be opened.

What spooked markets was Fed Chair Jerome Powell “saying that the Fed has plenty of room to raise interest rates without harming the labor market,” according to an analysis by Moody’s Corporation (NYSE: MCO).

“Powell didn’t push back against market expectations for three to four rate hikes this year, but he signaled the central bank will have zero tolerance for any upside surprises in inflation.”

According to a write-up by Nasdaq Inc’s (NASDAQ: NDAQ) Phil Mackintosh, “some economists are already worrying whether the Fed can engineer a ‘soft landing’ for the economy, which is where rate hikes slow the economy and inflation but don’t cause a recession.”

Based on the data, though, “selloffs in rate hike cycles, especially since 1975, are mostly much smaller corrections,” Mackintosh adds.

“So, it seems we should worry much more about a recession than hikes.”

Graphic: Per Nasdaq, “[S]tock market corrections are much more dependent on the business cycle than the rates cycle. That makes sense—during rate-hike cycles, companies have strong demand and revenue growth recessions. Whereas, during recessions, unemployment and spending usually contract.”

Complicating the Fed’s job, per Nasdaq, are outside influences such as waning fiscal stimulus and further supply shocks (the good and bad ones).

However, “annualized returns for the S&P 500 during rate hike cycles are mostly positive, … [as] rising rates usually equals a strong economy, which is usually good for companies, leading to earnings growth.”

“That earnings growth more than offsets the valuation impact of higher rates.”

*Graphic: Per Nasdaq, annualized S&P 500 returns during rate-hike cycles.*

To assuage some fears, Goldman Sachs Group Inc (NYSE: GS) thinks that the “interplay of Fed policy, financial conditions, and the growth outlook could make it hard for the Fed to actually deliver consecutive hikes, even if they feel like a natural forecast along the way.”

*Graphic: Goldman Sachs sees a (small) tightening in financial conditions. Graphic* *retrieved* *from The Market Ear. According to* *Bloomberg, “there is quite a long way to go before the Fed would feel any great need to come to their rescue.”*

Positioning: A short-gamma environment (wherein an options delta falls with stock price rises and rises when stock prices fall) portends increased two-way volatility.

This is as the counterparties to customer options trades hedge in a manner that exacerbates movement (i.e., buying strength and selling weakness).

*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).

As noted in past commentaries, the removal of put-heavy exposure, after the January monthly options expiration (OPEX), as well as the reduction in event premiums tied to FOMC, opened a window of strength, wherein dealers would have less positive delta to sell against.

In other words, as measures of implied volatility were to compress, as is the case when there is less demand (or more supply) of downside put protection (a positive-delta trade for the dealers), the dealer’s exposure to positive delta declines.

However, the failure to expand range is punishing toward highly demanded protection with a shorter time to maturity. These options, which are more “convex” and sensitive to changes in direction and volatility, have the most to lose as markets settle and “decay returns with vengeance,” according to SpotGamma, an options modeling and data service.

“As time and volatility trend to zero (as all options expire), given the current market environment, dealers’ exposure to the risk of out-of-the-money protection will decline.”

That solicits the dealers’ unwind of “short-delta hedges to decaying positive-delta protection.”

Those delta hedging flows with respect to time (charm) and volatility (vanna) are to reinforce the strong buying support (as measured by liquidity provision on the market-making side).

*Graphic: From* *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.

At present, in putting it simply, markets would really have to (1) fall out of bed or (2) demand for protection to explode for options counterparties, at least, to pressure markets much further.

As SpotGamma (which you can check out by clicking here) puts well:

“In other words, the frantic hedging that destabilizes markets as customers reach for protection en masse has already happened. There would have to be an addition of macro flows for sale and/or new put buying for dealers to sell.”

Updated $SPY IV for 30 delta options expiring <30 days.

For these put holders, a market that goes nowhere is painful, a rally is painful, and a just little selling doesn't really help. pic.twitter.com/nDfM6XOsQj
— SpotGamma (@spotgamma) January 27, 2022

Technical: As of 6:55 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a 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 $4,332.25 high volume area (HVNode) puts in play the $4,370.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,393.75 HVNode and $4,421.50 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,332.25 HVNode puts in play the $4,299.25 RTH Low. Initiative trade beyond the RTH Low could reach as low as the $4,263.25 overnight low (ONL) and $4,212.50 RTH Low, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.

Definitions

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

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

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

About

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.

Commentary

Daily Brief For January 26, 2022

Post author By Renato L. Capelj
Post date January 26, 2022
No Comments on Daily Brief For January 26, 2022

Editor’s Note: Our newsletter service provider is not working, today. Our apologies if you were not able to receive the note via email, as usual.

What Happened

Overnight, equity index futures auctioned sideways to higher as some metrics show investors bought the dip, aggressively, after Monday’s liquidation.

At the same time measures of implied volatility compressed and the flows associated with that, too, are supporting the recovery.

Still “a rising interest rate environment [which] is leading to a revaluation,” is a key concern, and investors will be looking for clarity on monetary policy from the Federal Open Market Committee, today, after 2:00 PM ET.

Other data to be released today include trade in goods (8:30 AM ET) and new home sales (10:00 AM ET).

*Graphic updated 6:00 AM ET. Sentiment* ***Neutral*** *if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted;* *click here* *for the latest levels. SqueezeMetrics* *Dark Pool* *Index (DIX) and* *Gamma* *(GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences* *available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility.* *Learn* *the implications of volatility, direction, and moneyness.* *SHIFT* data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: As Bloomberg’s John Authers puts it well, drops in the market may make it more difficult to raise capital and this can tighten financial conditions.

“This leads to the hope that the stock market has already done some of the Fed’s job, so there will be less need for higher fed funds rates — and also that the Fed might have to act at some point if the stock market fall tightens conditions too much.”

*Graphic: The “annual rate of change in the Fed Funds rate” via topdowncharts.com.*

Though this most recent liquidation tightened financial conditions, it is not likely that the Federal Reserve (Fed) will change its tone amidst heightened inflation, among other things.

*Graphic: Per* *Bloomberg, “there is quite a long way to go before the Fed would feel any great need to come to their rescue.”*

In fact, according to Nordea Bank’s (OTC: NRDBY) research arm, though there are lower odds of a much “faster tapering,” the Fed is to continue “building towards a March hike.”

Flexibility in policy, as well as a potential dismissal of a 50 basis point hike given geopolitical tensions, some poor responses to earnings results, and disappointments in real demand and growth, “could make for a brief market relief.”

“Our forecast includes four hikes for the year, which is consistent with current market pricing,” Nordea adds on in a statement on the Fed not hiking by more than 25 basis points since the early 2000s. “In our view balances are tilted towards balance sheet tightening rather than adding a fifth or sixth hike this year.”

*Graphic: Nordea says that “short-end pricing could take a break in the short-term.”*

In the end, though, monetary frameworks and max liquidity promoted a divergence in price from fundamentals. Expected monetary policy evolution will make valuations much less justifiable.

“The mechanical impact of QT should result in less liquidity and more net issuance thereby rising rates, but the empirical story, supported by growth prospects, [] is different,” Nordea says.

Still, an “abundance of excess liquidity could provide a cushion as the Fed drains liquidity, a cushion that did not exist in 2018.”

*Graphic: Per* *Bloomberg*, “As Savita Subramanian of Bank of America Corporation (NYSE: BAC) shows in the following chart, expected earnings are far less helpful in explaining market outcomes since 2010 than they were before. Meanwhile, changes in the Fed’s balance sheet, the amount of money it’s making available to markets, have become hugely important.”

Perspectives: Matt Maley of Miller Tabak + Co. suggests “the amount of leverage that built up over the past several years will take longer to unwind,” and “we’ve moved into a period where investors should sell the rallies rather than buy the dips.”

This is somewhat in opposition to JPMorgan Chase & Co’s (NYSE: JPM) Mark Kolanovic statements that “worries around rates and corporate margins are overdone,” and “the earnings season [will] reassure, and in a worst-case scenario could see a return of the ‘Fed put.’”

When examining extraordinary actions by the Fed, “the average ‘exercise price’ is a -23.8% peak to trough (equating currently to SPX 3,670.00),” Evercore Inc (NYSE: EVR) adds.

“The Fed is likely to ‘exercise the Fed put’ should the average -23.8% strike price come into view.”

Positioning: A lower liquidity, short-gamma environment (wherein an options delta falls with stock price rises and rises when stock prices fall) has led to more erratic moves, as a result of counterparty hedging activities.

*Graphic: Analysis of book depth for the E-mini S&P 500 futures contract, via CME Group Inc’s (NASDAQ: CME)* *Liquidity Tool. For more on the implications of participants’ options positioning and dealer hedging,* *read here*.

The removal of put-heavy exposure, post-monthly options expiration (OPEX), and a reduction in embedded event premiums tied to the approaching FOMC, opens up a window of strength, wherein dealers have less positive delta exposure to sell against.

In other words, as measures of implied volatility compress, as is the case when there is less demand for downside put protection (a positive-delta trade for the dealers), the dealer’s exposure to positive delta declines.

*Graphic: VIX term structure compresses.*

All else equal, this solicits dealer buying of the underlying (a reduction of short-delta hedges).

Taking into account options positioning, versus buying pressure (measured via short sales or liquidity provision on the market-making side), metrics are positively skewed, much more than yesterday. Tuesday the tone changed and the dip was bought.

Technical: As of 6:00 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, just inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Gap Scenarios In Play (Potentially): 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 $4,411.75 regular trade high (RTH High) puts in play the $4,449.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,486.76 RTH High and $4,526.25 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,411.75 RTH High puts in play the $4,346.75 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,276.50 and $4,212.50 RTH Low, or lower.

Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.

What People Are Saying

Are we at the lower bound?

Dealers likely own tail risk protection, which may reduce hedging demands as markets crash.https://t.co/VKN7rt7cgo
— SpotGamma (@spotgamma) January 25, 2022

A new interview with writer David Orrell takes the volatility series further in a complex systems direction, before we slingshot back with @jam_croissant to the land of volatility. I enjoyed this freewheeling discussion greatly.https://t.co/FkLE8KYYrc
— Hari P. Krishnan (@HariPKrishnan2) January 26, 2022

Definitions

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

About

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.

Commentary

Daily Brief For January 18, 2022

Post author By Renato L. Capelj
Post date January 18, 2022
No Comments on Daily Brief For January 18, 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 lower alongside a surge in bond yields. Rate-sensitive sectors were weakest in pre-market trade, in comparison to the value and cyclical names.

Earnings are now in focus. Participants shall use earnings updates to gauge how companies are performing in spite of omicron, among other challenges.

Ahead is data on the Empire Manufacturing Index (8:30 AM ET) and NAHB Home Builders Index (10:00 AM ET).

What To Expect

Fundamental: Ahead of earnings releases from Goldman Sachs Group (NYSE: GS), Morgan Stanley (NYSE: MS), Bank of America (NYSE: BAC), and Netflix (NASDAQ: NFLX), as well as key rate decisions, indices sold heavy.

The Nasdaq 100 led the decline after holiday-trade, Monday, as yields surged alongside concerns central banks would tighten monetary policy sooner than expected.

This is as higher rates have the potential to decrease the present value of future earnings, making stocks, especially those that are high growth, less attractive.

“The rationale behind this is the trade-off,” Grit Capital put well in a recent newsletter.

“Why would I park my money somewhere that is only yielding 1%, when I can invest in riskier assets that can raise my return?”

*Graphic: Per Grit Capital, “A common proxy that a lot of people look at is the S&P500’s earnings yield (yellow) vs. the 10yr (white).”*

At the same time, narratives around quantitative tightening (i.e., the reduction in the size of the Federal Reserve’s balance sheet) are growing louder.

*Graphic: QT mechanics per* *The Macro Compass*.

This is what Andy Constan of Damped Spring Advisors refers to as the QT drumbeat.

This drumbeat is to intensify in spite of strong economic and earnings growth, as well as a moderation in inflation, Constan says.

“The lack of additional liquidity provided by Fed purchase will also remove a damper for the market and the economy keeping asset volatility well bid, while also causing asset diversification benefit to fall, generating rising portfolio volatility and the risk demanded to hold assets.”

Note: Check out this Constan’s really interesting story, below!

*Graphic: Via* *The Market Ear, “Temporary relief from Powell – slow reverse QE’ confirmed. Powell says Fed will stop replacing maturing bonds, but will not sell holdings: slow QT.”*

“If current, priced in, inflation and growth expectations are exactly realized we predict that risk premiums on 30-year yields will increase by 15bp and equity risk premium by 30bp,” Constan adds. “These risk premium expansions will generate a 2% headwind on long bond prices and a 10% headwind for equity prices.”

Constan’s comments line up with that of Morgan Stanley’s which sees markets selling down 10-20% during H1 2022, as expectations call for five 25 bp hikes. History is in alignment, below.

*Graphic: S&P 500 performance before and after rate hikes, via* *The Market Ear*.

So, despite recent inflows and “light positioning,” taking all of the above comments together, the window for stocks to rally is closing.

Positioning: The coming January 19 expiration of options on the Cboe Volatility Index (INDEX: VIX) and January 21 monthly equity options expiration (OPEX) has major implications.

According to Constan, the “[o]ptions expiration which includes lots of LEAP contracts will be a catalyst for a squeeze rally and a post-OpEx sell-off.”

This is as, according to Kai Volatility’s Cem Karsan, there is a constant structural positioning that naturally drives markets higher.

“I use this analogy of a jet,” he explained, referencing the three factors – the change in the underlying price (gamma), implied volatility (vanna), and time (charm) – that are well known to impact an options exposure to directional risk or delta.

“[T]he hedging vanna and charm flows, and whatnot will push the markets higher.”

To note, though, with narratives around higher rates and QT strengthening, so to speak, divergences between the S&P 500 and metrics like the Bond Closed-End Fund (CEF) Advance-Decline line have already appeared.

As McClellan Financial Publications explains, “liquidity has suddenly become a problem, and it is affecting the more liquidity-sensitive issues first. That can be a prelude to that same illiquidity coming around and biting the big cap stocks that drive the major averages.”

*Graphic: Bond CEF A-D showing liquidity problems, via* *McClellan Financial Publications*.

As an aside, some believe that the Fed’s removal of liquidity has the potential to prick the bubble, prompting a cascading reaction that exacerbates underlying price movements.

“It’s not a coincidence that the mid-February to mid-March 2020 downturn literally started the day after February expiration and ended the day of March quarterly expiration,” Karsan adds.

“These derivatives are incredibly embedded in how the tail reacts and there’s not enough liquidity, given the leverage, if the Fed were to taper.”

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 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 $4,593.00 point of control (POC) puts in play the $4,624.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,633.00 POC and $4,650.75 regular trade low (RTH Low), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,593.00 POC puts in play the $4,574.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as low as the $4,549.00 VPOC and $4,520.00 RTH Low, or lower.

Considerations: The S&P 500 remains above its 200-day simple moving average. The long-term trend remains up.

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.

Definitions

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.

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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.