Big news includes Netflix Inc (NASDAQ: NFLX) beating earnings estimates but having a weaker-than-expected forecast, Tesla Inc (NASDAQ: TSLA) cutting prices the sixth time this year, Meta Platforms Inc (NASDAQ: META) and Walt Disney Co (NYSE: DIS) commencing layoffs, and mortgage rates edging higher to ~6.4%.
Graphic: Retrieved from Bloomberg. “US mortgage rates increased last week by the most in two months to 6.43%, denting already sluggish demand.”
Equity markets are down, and equity implied volatility (IVOL) measures, including the Cboe Volatility Index or VIX, are climbing. Notwithstanding, the trend lower in IVOL is intact, and that’s good for traders biased short volatility.
Graphic: Retrieved from Bloomberg via Danny Kirsch of Piper Sandler Companies (NYSE: PIPR). Call option volatility for the $4,150.00 strike. May monthly expiration.
“With all the focus [on S&P 500 (INDEX: SPX)] 0 DTE lately, I look at how expensive these have been since 2022,” IPS Strategic Capital’s Pat Hennessy says, referencing a backtest he conducted selling a 1 DTE straddle and holding till maturity.
“Performance since the November CPI has been stellar, with a 63% win rate and an average gain of $20.00.”
Graphic: Retrieved from IPS Strategic Capital’s Pat Hennessy.
Volatility trader Darrin John agrees, noting volatility remains expensive, a detriment to those who may be biased long volatility.
“The VRP is so wide across all of the tenors I track,” John elaborates. “It’s going to be hard for gamma buyers to cover daily theta bills.”
Clouds are appearing on the horizon, however, and the trend higher (lower) in stocks (volatility) may not last. Bloomberg forecasts the largest fall in SPX earnings since the start of 2020. Notwithstanding, strength can continue for longer …
Graphic: Retrieved from Citigroup Inc Research (NYSE: C) via @tr8derz. “YTD rally stems from $1tn in CB liquidity. High-frequency indicators suggest this is already stalling, and coming weeks seem increasingly likely to bring a sharp reversal. Higher TGA and RRP, ECB QT and reduced China easing could easily see a net drain of some $6-800bn.”
… even with the SPX breadth reading poor. The SPX has rallied with multiples rising; strength came with positive earnings surprises, bond demand, and other things.
Graphic: Retrieved from Morgan Stanley (NYSE: MS) via Bloomberg.
Hence, at the risk of sounding like a broken record, the low-cost call structures we’ve talked about in the past remain attractive.
If markets move higher, you can monetize and roll profits into put spreads (i.e., buy put and sell another at a lower strike). This may work well if JPMorgan Chase & Co’s (NYSE: JPM) call that “even a mild recession would warrant retesting the previous lows” is realized.
Such structures work well as “a big pop in the market can result in a decent drop in the VIX…and vice versa, a market sell-off will result in a greater increase in the VIX now than it did in 2022,” says Alpha Exchange.
Alternatively, lean neutral and buy into cash or bonds yielding 4-5%. Some long box spreads yield 5.4% as of yesterday’s close.
In other news, Physik Invest’s first in-depth note is nearing completion and will be available for public viewing in short order. Take care and watch your risk!
About
Welcome to the Daily Brief by Physik Invest, a soon-to-launch research, consulting, trading, and asset management solutions provider. Learn about our origin story here, and consider subscribing for daily updates on the critical contexts that could lend to future market movement.
Separately, please don’t use this free letter as advice; all content is for informational purposes, and derivatives carry a substantial risk of loss. At this time, Capelj and Physik Invest, non-professional advisors, will never solicit others for capital or collect fees and disbursements. Separately, you may view this letter’s content calendar at this link.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 8:00 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 this letter. Click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. The CBOE VIX Volatility Index (INDEX: VVIX) reflects the attractiveness of owning volatility.
Positioning
After a rocky end to 2022, the result of rebalances and repositioning, stocks rallied in the face of incredibly bearish sentiment and off-sides positioning. The detailed Daily Brief for January 24 discussed this context.
Presently, the S&P 500 (INDEX: SPX) is riding above an important inflection (i.e., the 200-day simple moving average) which is a trigger for many traders to flip to owning stocks. At the same time, implied volatility (IVOL), as measured by measures such as the Cboe Volatility Index (INDEX: VIX), is trending higher, and that’s, in part, a result of options hedging in a lower liquidity environment.
Anyways, little is expected to change until the middle of February, this letter quoted Kai Volatility’s Cem Karsan stating, yesterday. Following mid-February, a window for weakness opens. This could be a problem for some traders who are short volatility.
The reason being is as follows. Traders’ disinterest in hedging downside leaves them offside should the market drop quickly. Consequently, the demand for hedges (puts) will coincide with a re-pricing in IVOL dangerous to anyone who is short volatility.
The wall of worry is increasingly being climbed and green chutes are appearing everywhere if you look closely, says @jam_croissant.
Given the unstable SPX and VIX up environment, attractive trades provide exposure to the upside while limiting the downside. Structures such as call butterflies or ratio spreads, as included in yesterday’s letter, may work well.
In yesterday’s example, owning the 20-point FEB 1×2 Tesla Call Ratio Spread resulted in about 400% profit in the span of 14 days or so (i.e., $0.20 db → $1.00 cr). The loss was limited* to about $20.00 at entry while the exit was marked in excess of $100.00.
*Note that losses can exceed the entry debit should the underlying stock trade very far beyond the ratio spread’s short strikes.
Similar trades can be structured in the indexes such as the Nasdaq 100 (INDEX: NDX) where there is a steeper skew that may enable us to collect more credit in the options we are short, helping us lower the cost of the entire spread we own.
If you’re leaning toward the indexes, then you may avoid some of the volatility we saw yesterday when large swaths of stocks on the Intercontinental Exchange Inc-owned (NYSE: ICE) New York Stock Exchange commenced trading with an open book some reports have suggested.
As SpotGamma explained yesterday, “movement-reducing hedging activities” in the indexes “can mask realized volatility (RV) under the hood in single stocks.” Therefore, your index positions may be better isolated from what’s going on under the hood.
As of 8:00 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
Our S&P 500 pivot for today is $3,998.25.
Key levels to the upside include $4,011.75, $4,028.75, and $4,045.75.
Key levels to the downside include $3,988.25, $3,979.75, and $3,965.25.
Click here to load updated key levels into the web-based TradingView platform. 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: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
In short, Renato Leonard Capelj is an economics graduate working in finance and journalism.
Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.
Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
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 this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Positioning
In Physik Invest’s Market Intelligence letter for December 21, we discussed the potential for “pressure on options prices [to] remain through December.” In short, on the odds that “nothing happens through the holidays,” it made sense to sell implied volatility (IVOL) after CPI and FOMC targeting an end-of-month expiration.
The downward trajectory in IVOL remains intact in spite of some pockets of weakness under the hood in index heavyweights like Tesla Inc (NASDAQ: TSLA); expectations of future movement remain mute at both the index and single stock levels. As a result, short volatility trades (e.g., short straddle) in the indexes and near current market prices, expiring later this month, are doing really well.
Graphic: Retrieved from Kris Sidial. Tesla Inc (NASDAQ: TSLA) 1-month IVOL “relatively muted throughout the pain.”
Part of the equation resulting in this sideways market and tame IVOL environment was discussed in the December 21 letter. Today we add color.
In short, traders’ anticipation of a market drop, as evidenced by them reducing equity exposures into and through the 2022 market decline, coupled with the exploitation of loopholes manifesting increased demand for short-dated exposure to movements (i.e., gamma), and a supply of IVOL that is farther-dated, has put a lid on broad equity IVOL measures like the Cboe Volatility Index (INDEX: VIX) and pushed skew lower.
Consequently, hedges performing well have a lot of +gamma intraday and exposure to realized volatility (RVOL), and less exposure to longer-dated IVOL. The other side of this trade (and those who may be warehousing this risk) has exposure to -gamma and, to hedge that, they must act in a manner that exacerbates realized movement, hence RVOL’s meaningful outperformance.
In fact, RVOL in 2022 is nearly two times the level of RVOL in 2021, all the while the IVOL term structure is basically at the “same place it was a year ago,” according to Danny Kirsch of Piper Sandler Companies (NYSE: PIPR).
Graphic: Retrieved from Danny Kirsch, the head of options at Piper Sandler Companies (NYSE: PIPR). “Rolling 1 year realized volatility [for] … 2022 nearly 2x the level of 2021, speaks to long gamma and not vega for 2022.”
In a two-and-a-half-hour Twitter Spaces discussion, Kai Volatility’s Cem Karsan discussed what is the potential cause of this. Some of the blame rests on the way margin calculations (i.e., the loophole mentioned earlier); less cash must be posted if trades are closed the same day, basically.
Anyways, at the macro level, yes, the trends continue. Generally speaking, IVOL is mute and not accounting for the activity in short-dated options, as discussed by The Ambrus Group’s recent paper, while RVOL is about two times the level it was in 2021, making +gamma profitable.
However, at the micro level, so to speak, as we started out this discussion, traders’ anticipation that “nothing happens through the holidays,” has resulted in the supply of short-dated volatility, boosting the stickiness of open interest at current market prices.
Let’s unpack this further and explain why this activity won’t continue forever.
Near current market prices sit large concentrations of options positions. For instance, we have the $3,835.00 SPX strike (the call part of a massively popular collar trade that is rolled every quarter). At $3,835.00 is the short strike of a big collar trade.
This means the trader (or fund owner) is short the call, hence -delta and -gamma. The other side (or counterpart) is long the call, hence +delta and +gamma.
In theory, the other side, in response to this exposure, will buy weakness and sell strength. In other words, to hedge a long call, the other side sells futures. If the market falls, the call’s delta will fall and become less positive. Therefore, the other side will buy back some of their initial futures hedges (reduce -delta from short futures) to neutralize delta risk. If the market rises, the other side will have more exposure to +delta. To neutralize the delta, the other side will sell more futures.
As a consequence, the market pins.
Graphic: Retrieved from Banco Santander SA (NYSE: SAN).
This is a trend, as we discussed on December 21, that likely continues through year-end. After year-end, the market is likely to “move more freely,” per SpotGamma, “because this options activity that is promoting mean reversion will no longer be there,” and, therefore, the indexes likely trade more “in sync with its wild constituents of the likes of Tesla and beyond.”
More on what’s next:
As Karsan dissected, yesterday, there’s a “liquidity premium” that’s getting crowded short; in this less well-hedged market environment, traders’ realization with respect to liquidity and collateral needs for supporting trading activities may provide the context for some sharp drops. But first, it’s likely (though not certain) the market experiences some relief. Knowing that the long-end is cheap (hence near-zero percentile skew) on a supply and demand basis, it does not make sense to sell options blindly out in time.
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 middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
Our S&P 500 pivot for today is $3,857.00.
Key levels to the upside include $3,879.25, $3,893.75, and $3,908.25.
Key levels to the downside include $3,838.25, $3,813.25, and $3,793.25.
Click here to load today’s key levels into the web-based TradingView platform. 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: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
In short, an economics graduate working in finance and journalism.
Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.
Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.
Physik Invest’s Daily Brief is read by thousands of subscribers. You, too, can join this community to learn about the fundamental and technical drivers of markets.
Graphic updated 5:30 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 this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Technical
As of 5:30 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
Our S&P 500 pivot for today is $3,908.25.
Key levels to the upside include $3,926.50, $3,943.25, and $3,960.25.
Key levels to the downside include $3,893.75, $3,879.25, and $3,867.75.
Click here to load today’s key levels into the web-based TradingView platform. 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.
Checking Bookmap, a tool that allows us to visualize market liquidity, today, we see orders near the $3,920.00 – $3,925.00 area in the E-mini S&P 500 (FUTURE: /ES). These are orders to enter or exit trades at the resistance area highlighted in the 65-minute profile chart above.
Graphic: Market liquidity in the E-mini S&P 500 Future via thinkorswim’s Bookmap integration.
Considerations: Traders may have noticed responsiveness near key-technical areas visually discernable on a chart. In the Daily Brief for December 21, we discussed the positioning contexts to blame for this. After big events last week, an absence of the unexpected (i.e., what traders sought to hedge and/or bet on) prompted the sale of options protection, a pressure on options prices.
Graphic: Retrieved from SpotGamma.
As a result, the S&P 500 is sliding into lower levels of fixed-strike and top-line implied volatility (IVOL) measures. Given the current positioning, when IVOL is on a downward trajectory, counterparties sell strength and buy weakness. For instance, there is a ton of short-call open interest at the $3,835.00 strike. Customers are (mainly) short these calls. Dealers (on the other side) sell underlying to re-hedge their rising positive Delta exposure from the in-the-money call. This mutes movement.
Graphic: Retrieved from SqueezeMetrics.
This more positive Delta is a consequence of IVOL falling and Gamma (sensitivity to movement) rising. A higher Gamma implies a more variable Delta and, hence, less stable directional risk.
Graphic: Retrieved from SpotGamma.
Basically, as IVOL falls, the extrinsic or time value (theta) of the option falls and, given that in this case, the option is in the money, its intrinsic value (Delta) rises.
Graphic: Retrieved from The Options Industry Council.
While this is happening (i.e., orderly index selling and lower IVOL), big constituents like Tesla Inc (NASDAQ: TSLA) are swinging far more amid traders’ uneasiness and bets, there.
Weakness under the hood, relative to the indexes, and responsiveness to very minute technical levels won’t last; yes, in the interim, you may lean on these levels provided. Again, however, don’t expect that to last.
IVOL is performing poorly and that’s resulted in investors moving to better-performing strategies including short volatility. As a consequence, the broader market is in a less-well-hedged position. Coupled with the removal of the index-level support contexts (i.e., positioning that’s promoting responses to key areas) and some exogenous catalysts, we could see higher realized volatility (RVOL) and less immunity from the weaknesses happening under the hood in single stocks, in the new year.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for long periods of time, it will be identified by low-volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
MCPOCs: Denote areas where two-sided trade was most prevalent over numerous sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
About
In short, an economics graduate working in finance and journalism.
Capelj spends most of his time as the founder of Physik Invest through which he invests and publishes daily analyses to subscribers, some of whom represent well-known institutions.
Separately, Capelj is an equity options analyst at SpotGamma and an accredited journalist interviewing global leaders in business, government, and finance.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!
Graphic updated 6:50 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Administrative
A longer note so stick with me!
Updates are pending for the above dashboard. Exciting! Beyond this, the newsletter is getting a revamp in other parts. If you have any feedback on what should be changed, please comment!
Also, I am going to refer everyone to a conversation between Joseph Wang and Andy Constan, as well as some updates Cem Karsan of Kai Volatility made (HERE and HERE). That is, in part, a primer for what we will be talking more about, soon.
Fundamental
Talked about yesterday was the prospects of contractionary monetary policy reducing inflation and growth. BlackRock Inc (NYSE: BLK) strategists, even, put forth that a “deep recession” is needed to stem inflation. In short, “there is no way around this,” they claim.
Graphic: Retrieved from The Market Ear. FedEx Corporation (NYSE: FDX) sold 20% on warning about the global economy.
From thereon, we talked about how rates rising would “bring private sector credit growth down,” as well as “private sector spending and, hence, the economy.”
Based on where rates are at, the market may still be too expensive.
Graphic: Retrieved from Bloomberg via Michael J. Kramer. “What is amazing is how expensive this market is relative to rates. The spread between the S&P 500 Earnings yield and the 10-Yr nominal rate is at multi-year lows.”
On the other hand, some argue inflation peaks are in. ARK Invest’s Cathie Wood suggests “deflation [is] in the pipeline, heading for the PPI, CPI, PCE Deflator.”
Tesla Inc’s (NASDAQ: TSLA) Elon Musk added that he thinks the Federal Reserve (Fed) may make a mistake noting “a major Fed rate hike risks deflation.” Musk suggested the Fed should drop 0.25%, basing his decision on non-lagging indicators, unlike the Fed.
That’s not in line with what CME Group Inc’s (NASDAQ: CME) FedWatch tool shows. Through this tool we see traders pricing an 80% chance of a 0.50-0.75% hike, all the while quantitative tightening (reducing Fed Treasuries and mortgage-backed securities holdings) accelerated on September 15.
UST and MBS will roll off (which could turn into “outright sales”) at a pace of $95 billion per month, now, increasing competition for funding among commercial banks, and bolstering borrowing costs, as explained, below.
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
According to Bank of America Corporation (NYSE: BAC), since 2010, nearly 50% of the moves in market price-to-earnings multiples were explained by quantitative easing (QE), the inverse of QT, through which the Fed (or central banks, in general) creates credit used to buy securities in open markets, MarketWatch explains.
Graphic: Retrieved from the Federal Reserve Bank of Richmond. “The Fed Is Shrinking Its Balance Sheet. What Does That Mean?”
The “purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risk assets as investors look elsewhere for higher returns. QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.”
Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via MarketWatch.
The liability side of the Fed’s balance sheet is what “matters to financial markets.”
Thus far, “reductions in Fed liabilities have been concentrated in the Treasury General Account, or TGA, which effectively serves as the government’s checking account” to run the day-to-day business.
Given that we’re talking about balance sheets, here, Fed liabilities must match assets. Thus, a rise in the TGA must be accompanied by a decline in bank reserves (which are liabilities to the Fed). This, as a result, decreases the room banks have to “lend or to finance trading activity by hedge funds and other financial market participants, [which] further [cuts into] market liquidity.”
With the Treasury set to increase debt issuance, boosting TGA, it will effectively take “money out of the economy and put[] it into the government’s checking account.” The linked reduction in bank deposits and reserves bolsters “repurchase agreement rates and borrowing benchmarks linked to them, like the Secured Overnight Financing Rate,” per Bloomberg.
Graphic: Retrieved from the Federal Reserve Bank of New York. “The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.”
Adding, this may play into “an additional tightening of overall financial conditions, in addition to the increase in the main fed funds rate target that the central bank intends to continue boosting.”
This will “put more pressure on the private sector to absorb those Treasurys, which means less money to put into other assets” that may be riskier, like equities, said Aidan Garrib, the head of global macro strategy and research at Montreal-based PGM Global.
Positioning
As of 6:50 AM ET, Friday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.44%. Net gamma exposures decreasing may promote generally more expansive ranges.
Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics.
Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of options structures.
This is as there’s been a lot of speculation, particularly on the downside (put options), setting the stage for a more volatile and fragile market environment, says Kai Volatility’s Cem Karsan.
“On the index level, people are not well hedged,” a departure from what the case was heading into and through much of 2022. It’s the case that heading into 2022, traders were well hedged. Into and through the decline, traders’ monetization of existing hedges, as well as counterparty reactions, “compressed volatility” realized across US equities, as explained on July 15, 2022.
This made for some attractive trade opportunities seen here.
Graphic: Retrieved from The Market Ear. “VIX has decoupled from cross-asset volatilities.”
Now, given that the go-to trade is to sell stock and puts, short interest has grown, as have other risks, associated with this activity; essentially people are “los[ing] faith in convexity and risk premia’s ability to work,” as a result of “poor performance of vol,” and, the reaction to their “pain and financial loss,” is setting the stage for tail risks heading into the Q1 and Q2 2023.
The sale (purchase) of the front (back) expirations will bolster market pinning; as SpotGamma puts forth, “the positive impact of put closers and rolls, as well as decay,” is easing the market drop. However, this “positioning likely compounds drops and adds to volatility,” in the future.
To quote: “Though the removal of put-heavy exposures can boost markets higher, too add, the positive impacts are dulled via the demand for put exposures at much lower prices.”
Graphic: Retrieved from SpotGamma.
These particular options, which are at much lower prices, “are far more sensitive to changes in direction and IVOL,” as I explained in a SpotGamma note. These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly.
Graphic: Via Mohamed Bouzoubaa et al’s Exotic Options and Hybrids.
“If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”
Graphic: Via Banco Santander SA (NYSE: SAN) research.
Technical
As of 6:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $3,909.25 MCPOC puts into play the $3,935.00 VPOC. Initiative trade beyond the latter could reach as high as the $3,964.75 HVNode and $4,001.00 VPOC, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $3,909.25 MCPOC puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as low as the $3,826.25 and $3,770.75 HVNodes, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: A feature of this 2022 down market was responsiveness near key-technical areas (that are discernable visually on a chart). This suggested to us that technically-driven traders with shorter time horizons were very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
That’s changing. The key levels, quoted above, are snapping far easier and are not as well respected. That means other time frame participants with wherewithal are initiating trades.
Those are the participants you should not fade.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
Gamma: Gamma is the sensitivity of an option to changes in the underlying price. Dealers that take the other side of options trades hedge their exposure to risk by buying and selling the underlying. When dealers are short-gamma, they hedge by buying into strength and selling into weakness. When dealers are long-gamma, they hedge by selling into strength and buying into weakness. The former exacerbates volatility. The latter calms volatility.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 750+ that read this report daily, below!
Graphic updated 6:35 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
Fundamental
Pardon the light read, today!
Jefferies Financial Group Inc (NYSE: JEF) analyses suggest that after the S&P 500’s nearly two standard deviation rally, outcomes are quite large in both directions.
However, “when the six-month performance into the rally is negative, there is a much greater chance of negative outcomes,” The Market Ear summarizes.
Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.
What is bolstering this relief rally?
This relief is the product of a “knee-jerk re-leveraging flow,” as explained by some, bolstered by a “cohort of quantitative-based investment strategies [buying] equities when volatility is lower.”
From hereon, some, like JPMorgan Chase & Co (NYSE: JPM) strategists, see equities rising on “robust corporate earnings [and] … better-than-feared economic data,” all the while others, from Morgan Stanley (NYSE: MS) and Goldman Sachs Group Inc (NYSE: GS), don’t see corporate profit margins expanding into 2023 because of “sticky cost pressures and receding demand.”
Graphic: Retrieved from The Market Ear. Via MS Research. Margins are in trouble “over the next several quarters … [as this is] the mirror image of what happened in 2020-21 when companies had extreme pricing power and costs were lagging.”
That said, however, MS explains said that “the next leg lower may have to wait until September when [their] negative operating leverage thesis is more reflected in earnings estimates.”
Graphic: Retrieved from The Market Ear. Via Societe Generale SA (OTC: SCGLY). “Not only are central banks not there to backstop markets as they have been in recent years, but Growth stock profits are proving somewhat fragile as well.”
The outlooks by corporates are far more positive, though, it appears.
Tesla Inc (NASDAQ: TSLA) CEO Elon Musk explained the trend in commodity prices is down, “which suggests we are past peak inflation.” This is as Loews Corporation (NYSE: L) CEO Jim Tisch says that the “significant reduction in inflation in the coming 6 to 12 months” should help avoid a “truly damaging wage-price inflation spiral that was so problematic in the 1970s.”
Full employment, healing supply chains, and easier consumer spending is among the factors balancing commitments to tighten and, potentially, put the economy on an “L” trajectory (i.e., drop and flatline for a period), as explained in our August 3 letter.
Graphic: Retrieved from Bloomberg. Data via Realtor.com. “The [Fed’s] effort to curb inflation by raising benchmark interest rates has put the brakes on the pandemic housing frenzy.”
Positioning
As of 6:35 AM ET, Tuesday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.14%. Net gamma exposures decreasing may promote larger trading ranges.
Given the market environment, read the August 5 letter for an in-depth take on how to position for the next move higher or lower, while lowering costs (and potential losses), if wrong.
Technical
As of 6:25 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher.
Any activity above the $4,153.25 HVNode puts into play the $4,189.25 LVNode. Initiative trade beyond the LVNode could reach as high as the $4,227.75 HVNode and $4,259.75 LVNode, or higher.
In the worst case, the S&P 500 trades lower.
Any activity below the $4,153.25 HVNode puts into play the $4,117.75 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $4,073.00 VPOC and $4,040.75 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: Updated 8/8/2022. 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Responsiveness near key-technical areas (that are discernable visually on a chart), suggests technically-driven traders with short time horizons are very active.
Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
MCPOCs: POCs are valuable as they denote areas where two-sided trade was most prevalent over numerous day sessions. Participants will respond to future tests of value as they offer favorable entry and exit.
Volume-Weighted Average Prices (VWAPs): A metric highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!
Overnight, equity index futures resolved a multi-day consolidation and auctioned higher, far beyond the prior day’s range. Commodities were mixed while bonds were lower.
The break from consolidation is one of the most bullish happenings in weeks. We’re monitoring whether participants add to their recent short volatility bets against direction, or whether there is repositioning and this bolsters the initiative probe.
Ahead is data on University of Michigan consumer sentiment, inflation expectations, and new home sales (10:00 AM ET), as well as some Fed speak (7:30 AM and 4:00 PM ET).
Graphic updated 6:40 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: To start, I want to apologize for any confusion, yesterday, with respect to the /GE Eurodollar quote. This newsletter said the peak of the Fed-rate-hike cycle – terminal rate – sat near December 2023.
That’s wrong. It’s December 2022.
Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. The Eurodollar (FUTURE: /GE) futures curve is a reflection of participants’ outlook on interest rates. The peak of the Fed-rate-hike cycle – terminal rate – is around DEC 20[22].
Okay, moving on, now!
New data is pointing to a “remarkable” drop in demand for goods and services during June, compared to months prior.
“US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter,” S&P Global (NYSE: SPGI) Market Intelligence’s Chris Williamson explained.
“The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.”
Graphic: Via S&P Global Inc. “This is a sizeable miss and evidence of a quick slowdown in demand, though it’s still in positive territory (above 50). This report is consistent with a shifting narrative away from inflation worries and towards growth worries.”
Businesses (particularly in retail) are way “more concerned about the outlook” of costs and demand, as well as the path in monetary policies and deterioration in financial conditions.
Graphic: Via Bloomberg. “Supply constraints, exacerbated by Russia’s war in Ukraine this year, account for about half of the surge in US inflation, with demand currently making up a third of the increase, according to new research from the Federal Reserve Bank of San Francisco.”
That’s validated by Tesla Inc’s (NASDAQ: TSLA) CEO Elon Musk speaking about the carmaker’s losses from new plants, supply chain problems, and the like.
Graphic: Via Bloomberg. “Long-term ocean freight rates between China and the US West Coast are higher than spot prices for the first time since April 2020.”
“The past two years have been an absolute nightmare of supply chain interruptions, one thing after another,” Musk said.
“We’re not out of it yet. That’s overwhelmingly our concern is how do we keep the factories operating so we can pay people and not go bankrupt.”
Graphic: Via Bloomberg. “Supply chains in Asia look to be on the mend,” though it will “ take a while for supply and demand to rebalance.”
It’s a global move into recession all at once, as Jeffrey Snider of Alhambra Investments says.
“Combine the potential for break in repo collateral with economy heading toward recession, no wonder the Euro[dollar] curve inversion is spreading as rapidly as it has. Possibility of something big going wrong, therefore ending rate hikes, is huge now.”
“Euro[dollar] squeeze, collateral shortage, deflationary potential in money, and now demand destruction in global real economy.”
Graphic: Via Alhambra Investments.
Over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted innovation and, by that token, deflation, ultimately creating “unimportance to cash flows,” as well put by Kai Volatility’s Cem Karsan.
Now, there’s a strong commitment to reducing liquidity and credit, all the while there are chokepoints monetary policymakers have little control over.
This has consequences on the real economy and asset prices, accordingly, which rose and kept deflationary pressures at bay. A stock market drop is both a recession and a direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s poor sentiments and economic data reflects this.
At the same time, “bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang puts it.
Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”
Retail buyers, who, according to Michael Wang of Prometheus Alternative Investments, “were a significant driver of the inflated valuations we saw in tech and crypto,” are capitulating in stocks, all the while froth in housing markets is soon to abate, likewise.
Notwithstanding, Mark Zandi of Moody’s Corporation (NYSE: MCO) does not see “the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values,” just as prices of raw materials are retreating as inventories are bloating.
As put forth, partially, earlier this week, one has to wonder about the likelihood that inflation is near its high and whether the de-rates have played their course.
Let’s keep an open mind and follow up on this, in detail, next week.
Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”
Positioning: Keeping this section short.
As stated yesterday, a feature of the equity sell-off is the suppression of implied volatility (IVOL) versus that which the market realizes (RVOL) given that participants are hedged and volatility remains in strong supply.
Options data and insights platform SqueezeMetrics explained that this is due in part to lower leverage, too.
“Leveraged long S&P lost favor (understandable), and marginal demand for puts went with it. Creeping into net selling territory is ‘smart’ bear market positioning. Short delta, short skew.”
As I said in SpotGamma’s note, last night, given “the high starting point in IVOL, as well as its place in relation to [RVOL], it makes sense to own structures that benefit either from sharp changes in underlying price or an abrupt repricing in volatility.”
Cutting into the realization of a sharp change in underlying price or a far-reaching rally, however, are short-volatility bets across shorter maturity periods (and the associated hedging), as well as big (and popularized) positions set to roll off at the quarter-end.
Liquidity providers, per SpotGamma, all else equal, will have to sell to re-hedge, and we will talk about this further, next week.
Graphic: Taken 6/22/2022. SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator points to selling of put and call options in the S&P 500 (INDEX: SPX) and S&P 500 ETF (SPY). Those liquidity providers, who are on the other side, are more exposed to long volatility, which they hedge by buying (selling) into weakness (strength) underlying.
Technical: As of 6:40 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,821.50 LVNode puts in play the $3,843.00 RTH High. Initiative trade beyond the RTH High could reach as high as the $3,911.00 VPOC and $3,943.25 HVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,821.50 LVNode puts in play the $3,793.25 ledge. Initiative trade beyond the ledge could reach as low as the $3,770.75 HVNode and $3,735.75 HVNode, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Recent trade has been lackluster and the overnight break is the most bullish happening in weeks. The go-to trade this week was short volatility. Participants responded to tests of key visual areas, and sold options, particularly in shorter maturities.
In the coming session(s), some of those participants will respond to the break in a manner that bolsters the initiative drive. Notwithstanding, the key to watch for is whether participants will use the bump as an opportunity to add to their most recent short volatility bets against the direction.
Ultimately, the more time that is spent outside of the prior consolidation area, the likelihood that the breakout is a signal to look for dips to buy and play rotations to key areas up above.
Definitions
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Balance-Break + Gap Scenarios: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) is occurring.
Monitor for acceptance (i.e., more than 1-hour of trade) outside of the balance area.
Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.
Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 300+ that read this report daily, below!
Overnight, the equity index and commodity futures were bid, all the while bonds and the dollar edged lower. This is after a week-long or so de-rate on tougher monetary policies.
Big headlines include the White House’s mulling of a U.S. gas tax suspension, Russia’s status as a top exporter of crude to China, Goldman Sachs Group Inc’s (NYSE: GS) recession warning, Elon Musk’s intent to cut Tesla Inc’s (NASDAQ: TSLA) workforce, and falling Iron ore prices on China’s building downturn.
Interesting reads from over the weekend include Dr. Pippa Malmgren’s letter on the market’s “nosedive” which is likely to be “followed by a newfound understanding of what is possible,” and how that plays into economic strength and military superiority.
Adding, timely was a Sohn 2022 conversation with Stanley Druckenmiller on his experiences and the current market environment.
Ahead is data on the Chicago Fed National Activity Index (8:30 AM ET), existing-home sales (10:00 AM ET), as well as Fed-speak by Loretta Mester (12:00 PM ET) and Tom Barkin (3:30 PM ET).
Graphic updated 6:30 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.
What To Expect
Fundamental: Keeping this letter brief, today.
The sale of both bonds and equities worsened in part due to the implications of inflation and the Federal Reserve’s (Fed) response to that inflation.
Graphic: Via Nordea Bank’s (OTC: NRDBY) research. “We suspect that the real economy will be less sensitive to a rise in interest rates this time, which means that the Fed could have to move rates more-than-expected before policy gets restrictive. The strongest argument is that the household balance sheets are in a much better shape to sustain their level of spending as the massive injections of money and credit through both monetary and fiscal stimulus have changed household balance sheets dramatically.”
Essentially, as Joseph Wang, who was a trader at the Fed, puts it, “[b]onds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol.”
“Investors in both bonds and stocks are reaching for cash by selling their assets, driving further asset price declines. For non-bank investors, ‘cash’ means bank deposits.”
Ultimately, an increase in the RRP (reverse repo) and QT (which is a direct flow of capital to capital markets) “would drain the pool of bank deposits by ~$1t by year-end,” and this may prompt investors to “continue to lower their selling prices to compete for the cash they want.”
Positioning: Detailed was Friday, June 17’s commentary that honed in on some of the implications of pre- and post-Federal Reserve meeting positioning.
Essentially, with the June monthly options expiration (OPEX), there was a roll-off of a large amount of customer negative delta exposure (via put options they owned).
Graphic: Via SpotGamma’s S&P 500 Index (INDEX: SPX) Gamma Model. Updated June 17, 2022.
With expiration, liquidity providers (who were short these put options, as well as underlying to hedge) re-hedged (bought back some of their static short-delta), and this removes pressure.
“The SPX index quarterly option notional is higher than usual, but the market is below the concentration of risk given the recent selloff,” said Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence, who we quoted last week.
“Price action will reflect the economic context, but flows from expiring in-the-money hedges may support the market.”
Accordingly, markets are off their lows. However, in the above text, we made little mention of participants’ rolling forward of their options bets to lower strikes, further out in time, as well as the impact of customers still maintaining a “sizable short put position,” a dynamic we’ve talked about before.
Graphic: Via SpotGamma. “Options flow, last week, was unsurprisingly dominated by index puts (red lines). Most interesting was index puts bought to cover (third chart) indicating there was a fairly sizable short put position heading into last week.”
Taken together, coupled with what SpotGamma observes is “anemic” call buying (viewed as the blue line in the top chart above), participants are hedged and volatility remains well-supplied.
Graphic: Via Nomura Holdings Inc (NYSE: NMR). Taken from The Market Ear. “The ‘muted’ VIX narrative goes on. The VIX vs SPX gap remains rather wide here. The second chart shows just how ‘depressed’ VIX remains vs the underlying px action. Most people have been stopped out/de-grossed risk, so there isn’t much demand to hedge exposure.”
Despite being stretched from a technical perspective, positioning-wise, lower prices are sticky and the context for a far-reaching bounce, all else equal, is not there.
We shall provide updates to this, later in the week. Read the Daily Brief for June 17, 2022, for more on how to position in light of the above information.
Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $3,735.75 HVNode puts in play the $3,749.00 ONH. Initiative trade beyond the ONH could reach as high as the $3,773.25 HVNode and $3,821.50 LVNode, or higher.
In the worst case, the S&P 500 trades lower; activity below the $3,735.75 HVNode puts in play the $3,722.50 LVNode. Initiative trade beyond the $3,722.50 LVNode could reach as low as the $3,690.25 HVNode and $3,639.00 RTH Low, or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Definitions
Volume Areas: Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
Overnight Rally Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj also develops insights around impactful options market dynamics at SpotGamma and is a Benzinga reporter.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
The Daily Brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 200+ that read this report daily, below!
Overnight, equity index futures auctioned sideways-to-lower after a mid-day price bump Thursday, on the heels of dismal earnings, among other things including a contraction in economic growth, last quarter.
Amazon Inc (NASDAQ: AMZN) shares fell after the company projected sluggish sales as well as higher costs.
Apple Inc (NASDAQ: AAPL) saw strong sales and profit help top estimates. The company announced a $90 billion share buyback and fears over supply constraints.
Tesla Inc’s (NASDAQ: TSLA) Elon Musk offloaded $4 billion worth of shares just after his deal to buy Twitter Inc (NYSE: TWTR) was reached days before.
Also in the news: Russia’s urgency to avoid a default. Food Inflation hits an all-time high. China’s currency plunge raises the risk of 2015-style panic. No-money-down crypto mortgages and why housing may be topping. Barclays PLC (NYSE: BCS) halts ETN sales.
Ahead is data on the employment cost index, PCE, personal income and consumer spending (8:30 AM ET), as well as Chicago PMI (9:45 AM ET), and University of Michigan consumer sentiment and inflation expectations (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: In hindsight, a very volatile week characterized by large, two-sided action and little constructive movement (i.e., a week that ended sideways rather than up or down).
Graphic: Via Bloomberg. Indexes sideways, mainly, as large constituents report their earnings.
This is ahead of what many think is likely to be front-loaded 50 basis point tightening next week and in June with rates, ultimately, trading in the range of 2.25-2.50% end-of-year.
Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool.
In light of tightening expectations, Columbia Threadneedle’s Gene Tannuzzo says “Tighter financial conditions are the mechanism that reduces demand and ultimately slows inflation.”
Graphic: Via Bloomberg. Financial conditions have started to tighten.
“If financial conditions don’t tighten [i.e., stocks regain their swagger] and inflation remains high, in their eyes, they need to hike more.”
Graphic: Via S&P Global Inc (NYSE: SPGI). Food Inflation Hits All-Time High, Fuels Security Risks.
In regards to balance sheet reduction, “QT will consist of run-off caps of USD 60bn for US Treasuries (UST) and USD 35bn for mortgage-backed securities (MBS), which will make up for a cap of USD 95bn per month going forward,” Nordea Bank (OTC: NRDBY) research says.
“The balance sheet reduction will revolve around coupon securities, with the Fed’s c. USD 326bn Treasury bills only allowed roll-off in months when maturing caps do not reach the cap. We expect the Fed to use a 3-month roll-on period in its reduction, which will make up for a relatively smooth and predictable treasury run-off.”
Positioning: Our April 27 discussion on positioning went into great detail on the likelihood of continued volatility and lower prices.
On April 28 we noted the implications of heightened implied volatility and no follow-through to the downside.
The returns distribution, based on implied volatility metrics alone, was skewed positive, albeit with a potential for large negative outliers.
Graphic: Via @HalfersPower. “In backwardation via $VIX: $VIX3M next month [realized volatility] is highest amongst the deciles (d10 >1) ~43% subsequent realized volatility.”
During Thursday’s trade, markets endured a near-vertical price rise alongside repositioning and what SpotGamma says is a “put-heavy expiration [Friday] (20% of gamma roll-off expected).”
Graphic: SpotGamma’s Hedging Impact of Real-Time Options indicator for the QQQ.
The idea is as follows: customers are well-hedged (customers own puts and/or are short calls) and this offers them 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 this exposure is to roll off or underlying prices reverse and move higher, these counterparties will re-hedge and buy underlying. That’s what SpotGamma is hinting at.
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.
SpotGamma also notes: “VIX call open interest (blue) is near March ’20 highs. With VIX near 1-yr highs put interest (red) is near lows. Equity rally/vol decline seems like it would catch most everyone offsides.”
Technical: As of 6:15 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.
In the best case, the S&P 500 trades higher; activity above the $4,235.00 overnight low (ONL) puts in play the $4,279.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,303.50 regular trade high (RTH High) and $4,337.00 untested point of control (VPOC), or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,235.00 ONL puts in play the $4,191.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,182.50 ONL and $4,156.75 regular trade low (RTH Low), or lower.
Click here to load today’s key levels into the web-based TradingView charting platform. Note that all levels are derived using the 65-minute timeframe. New links are produced, daily.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.
Considerations: Into this week, markets were extremely weak alongside hawkish remarks from the Fed and dismal responses to earnings results, among other things.
Then, as a major index – the Invesco QQQ Trust Series 1 (NASDAQ: QQQ) – tested a major VWAP anchored from the lows of March 2020. After, a rounded bottom began to form while implied volatility metrics continued to trend higher.
Graphic: Invesco QQQ Trust Series 1 (NASDAQ: QQQ) with anchored VWAPs.
Thursday’s price rise and volatility compression, particularly at the short-end of the term structure coincided with some of the strongest breadth in days.
Notwithstanding, the entire advance was taken back overnight and now the S&P 500 is trading back inside a multi-day consolidation.
If a short-term trader, playing responsively (i.e., fading edges) is likely the best course of action until the indexes, at least, are able to break above this week’s ranges and remain there (i.e., not trade back down).
Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).
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.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
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Tuesday’s selling came alongside Russia cutting gas to Poland and Bulgaria, Vice President Kamala Harris testing positive for COVID-19, and heavy selling in growth and tech stocks, amid doubts corporate profits can withstand the Federal Reserve’s bid to tame inflation.
As Jerome Schneider of Pacific Investment Management Co says, QT will “have a profound effect on the cost of liquidity and more importantly the cost of transacting business and reallocating assets from one avenue to another avenue.”
“There might not necessarily be a rapid deceleration or decline in the stock market or other risk assets, but there’s going to be a changing cost of capital that this balance sheet is going to be part of.”
After the close, weakness continued. Alphabet Inc (NASDAQ: GOOGL) (NASDAQ: GOOG) missed on slowing sales growth and digital-ad spending. One of the biggest losers was Tesla Inc (NASDAQ: TSLA) which shed 12% or so on news that Elon Musk would use his fortune, much of which is tied up in Tesla, to buy Twitter Inc (NYSE: TWTR).
Germany’s passage of a bigger borrowing budget, coupled with China’s pledge to boost infrastructure bolstered an overnight advance that fed into price action at home. The S&P 500, in particular, for a brief moment, took back a key level, negating much of yesterday’s liquidation.
Ahead is data on international trade in goods (8:30 AM ET), as well as pending home sales and the rental vacancy rate (10:00 AM ET).
Graphic updated 7:00 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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: Markets are positioned for continued volatility.
Based on a reading of market gamma exposure (GEX) and buying support (DIX), the returns distribution is skewed positive. There’s buying in the context of an environment in which the hedging of options positioning implies selling into weakness and buying of strength.
Graphic: Via Barclays PLC (NYSE: BCS) research.
In the most simple way that I can explain: when positioning is stretched one way, that often tends to mark a turning point – the returns distribution is either skewed positive or negative.
Graphic: Via Physik Invest. Data via SqueezeMetrics. Updated March of 2022. A high DIX/GEX ratio often portends positive 1-month returns.
An updated read, after Tuesday’s weak close, tells us that we can (1) definitely expect larger ranges to continue and (2) potential for short-term bounces.
Based on overnight activity, one of those is happening, now.
Graphic: Via Physik Invest. Data via SqueezeMetrics.
This is as participants are both well-hedged and using weakness as an opportunity to buy into a less highly valued 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).
See, below, E-mini S&P 500 book depth, a proxy for market liquidity, and how much it has declined since the end of last year when markets became more volatile and noise around the Federal Reserve’s intent to taper bond-buying and raise rates grew louder.
Graphic: Via CME Group Inc (NASDAQ: CME) Liquidity Tool. Note how in late March, book depth rose as markets rose and customer call activity solicited increased hedging of counterparty long-gamma exposure (i.e., buy weakness, sell strength), adding to market liquidity.
In the above environment, counterparty hedging matters; the market is more sensitive to the flow, so to speak. That sensitivity is expected to continue.
SpotGamma, an options data and analysis service, sees the early May period as pivotal. Then is the Federal Open Market Committee (FOMC) meeting and the potential Russian default, per Moody’s Corporation (NYSE: MCO).
As quoted: “Russia ‘may be considered in default’ if it does not pay two bonds in US dollars by end of a grace period on May 4.”
Until those events are resolved, participants will likely continue to (remain) hedge(d). Upon resolve, customers likely monetize their protection to offset losses on underlying equity exposure.
That means selling volatility which reduces counterparty exposure to short puts (negative gamma and positive delta). To re-hedge, underlying is bought back and that may support a price rise.
Graphic: VIX term structure via VIX Central. Expansion (higher) solicits counterparty selling which pressures the market lower. Compression (lower) solicits counterparty buying which bolsters attempts higher.
Whether that price rise has legs depends on what the fundamental situation is, then. See the below section titled Considerations for a full technical picture and the most likely turning points.
Technical: As of 7:00 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 $4,217.25 overnight high (ONH) puts in play the $4,267.75 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,303.75 ONH and $4,337.00 VPOC, or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,217.25 ONH puts in play the $4,193.25 spike base. Initiative trade beyond the spike base could reach as low as the $4,136.50 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), or lower.
Considerations: 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).
Additionally, the indexes continue to trade below their 20-, 50-, and 200-day simple moving averages, confirming the trend change and bearish tone (further validated by poor breadth).
Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).
All indexes remain, as stated, yesterday, below their volume-weighted average prices (VWAPs) anchored from the start of this year (or their respective peaks).
VWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Liquidity algorithms, too, are benchmarked and programmed to buy and sell around VWAPs.
The Invesco QQQ Trust Series 1 (NASDAQ: QQQ) just tested a major VWAP, yesterday, anchored from the lows of March 2020. That’s a fair price to pay for Nasdaq 100 exposure.
Graphic: Invesco QQQ Trust Series 1 (NASDAQ: QQQ) with anchored VWAPs.
Notwithstanding, notice the flat-to-declining AVWAP that’s black in color. So long as prices remain below this level, the index is likely a sell.
Should that level flatten (and begin to rise), and if the QQQ was able to trade above it for a sustained period, there is potential for sustained upside.
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.
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.
