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What Happened
Overnight, equity index futures auctioned lower as participants looked to price in the implications of heightened inflation and risk of recession amidst geopolitical tensions.
Ahead is data on consumer credit (3:00 PM ET).
What To Expect
Fundamental: Hawkishness with respect to monetary policy, in the face of heightened inflation and slowing economic growth, is affecting global markets.
Overseas markets have sold more, relatively, and the pricing of equity market risk in Europe is far outpacing that in the U.S.
Last week, we unpacked the potential factors behind (and the implications of) divergences in cross-asset volatility. Mainly, the fear in one market tends to feed into the fear of another.
Pursuant to those remarks on this push-and-pull comes as Goldman Sachs Group Inc’s (NYSE: GS) prime brokerage saw hedge-fund clients unloading risk at the fastest rate in three months, while JPMorgan Chase & Co (NYSE: JPM) saw retail buying nearly $4.1 billion, “with money sent to S&P 500-linked ETFs more than 2 standard deviations above the 12-month average.”
Per Bloomberg’s John Authers, market professionals likely view reactions to geopolitical tension “as increasing the risk of stagflation, a rare combination of high inflation and a recession.”
“This looks like 2007, on the eve of the Global Financial Crisis, with even higher inflation expectations and a yield curve that has not quite yet inverted.”
UBS Group AG (NYSE: UBS) ran a machine-learning analysis that “reckons the Russia/Ukraine conflict could send the S&P 500 anywhere from 3,800 to 4,800 – a 26% range – depending on how it resolves.”
Perspectives: “Every other market is consistent with the idea that the economy is in trouble and there’s stress in the markets,” said Jim Bianco, president of Bianco Research LLC in Chicago.
“The stock market historically does this — it’s the last market to turn, it’s the slowest market to understand the problems. It’s the market driven by narratives and hope.”
Alternatively, BCA Research Ltd suggests that “Even if World War III is ultimately averted, markets could experience a freak-out moment over the next few weeks, similar to what happened at the outset of the pandemic. Google searches for nuclear war are already spiking.”
“Despite the risk of nuclear war, it makes sense to stay constructive on stocks over the next 12 months. If an ICBM is heading your way, the size and composition of your portfolio becomes irrelevant. Thus, from a purely financial perspective, you should largely ignore existential risk, even if you do care about it greatly from a personal perspective.”
Positioning: The fundamental picture is clouded by the options market positioning.
At present, in the face of continued passive buying support, the overwhelming demand for downside (put) protection (a negative delta, positive gamma trade) results in counterparty hedging that may exacerbate weakness.
The reason why? The counterparty has exposure to positive delta and negative gamma. If underlying prices print lower and/or measures of implied volatility rise (given increased fear and demand for protection), short puts rise in value (and counterparty losses are multiplied).
To overcome these potential losses, counterparties sell the underlying to hedge. If nothing happens, the protection decays, and counterparties buy back their hedges potentially bolstering the underlying market’s calmness or attempts higher.
As noted earlier and explained in detail last week, the pricing of risk across markets has diverged and the S&P 500, among other U.S. indices, is relatively strong (unlike peers in Europe and Asia).
Among other things, one dynamic balancing this pressure from puts is negative-delta trade, by customers, on the call side. In selling calls, dealers are long (a positive delta, positive gamma trade that makes money if the underlying rises). To hedge, dealers tend towards selling strength and buying weakness, adding liquidity to the market.
Still, again, the news is bad, and returns into monthly options expirations (like the one coming up next week) are often weak.
So, there is potential that weakness climaxes into the options expiration. Thereafter, the reduction in put-heavy positioning may coincide with less counterparty exposure to the positive delta.
Still, the return distributions, based on where the implied volatility term structure is at, point to continued chop and expanded ranges.
And, according to some, the “real deleveraging hasn’t hit yet.”
Technical: As of 5:45 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 negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.
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.
In the best case, the S&P 500 trades higher; activity above the visual $4,282.75 balance boundary puts in play the $4,319.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,346.75 high volume area (HVNode) and $4,375.00 VPOC, or higher.
In the worst case, the S&P 500 trades lower; activity below the $4,282.75 balance boundary puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,227.75 overnight low (ONL) and $4,177.25 HVNode, or lower.
Considerations: The $4,282.75 level has solicited mechanical responses over the past weeks.
Therefore it is considered to be a level at which short-term participants will lack the wherewithal (both emotional and financial) to respond to a successful break.
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.
Volume Areas: A structurally sound market will build on areas of high volume (HVNodes). Should the market trend for long periods of time, it will lack sound structure, identified as low volume areas (LVNodes). LVNodes denote directional conviction and ought to offer support on any test.
If participants were to auction and find acceptance into areas of prior low volume (LVNodes), then future discovery ought to be volatile and quick as participants look to HVNodes for favorable entry or exit.
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
About
After years of self-education, strategy development, mentorship, and trial-and-error, Renato Leonard Capelj began trading full-time and founded Physik Invest to detail his methods, research, and performance in the markets.
Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.
Disclaimer
Physik Invest does not carry the right to provide advice.
In no way should the materials herein be construed as advice. Derivatives carry a substantial risk of loss. All content is for informational purposes only.
