Categories
Commentary

Daily Brief For October 5, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 1000+ that read this report daily, below!

Graphic updated 6:45 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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

Expect no letter on Friday, October 7, 2022.

Fundamental

Markets printed lower, this morning, ahead of the US cash-open. This bonds, commodities, and equities down phenomenon we’ve unpacked in detail many times before. 

At its core, supply chokepoints and a hot labor market are keeping inflation high and sticky. To lessen this inflation, policymakers are seeking to tighten monetary policy. 

That means raising interest rates and quantitative tightening (QT). 

As we discussed on September 20, the transmission mechanisms of these drivers vary with QT having a very weak transmission “to economic activity but very strong to financial markets.” On the other end are rates that have a stronger transmission to economic activity.

And so, on “the incremental effects on liquidity” these drivers pose, markets are trading more in sync; on the way up, through fiscal stimuli, interest rate decreases, and QE (i.e., buying of US Treasuries and mortgage securities), investors sought more yield elsewhere. 

Risk assets like stocks, crypto, and beyond thus enjoyed a boost.

In a way, the opposite is happening now, and selling across risk -on and -off assets is persistent. 

Liquidity measures (which we began unpacking months ago, and were covered in Bloomberg by Kevin Muir of TheMacroTourist.com, recently, too) show a near-lockstep decline in the S&P 500 (INDEX: SPX). Please check out Kevin Muir’s Substack, too!

Net liquidity (NL) we calculate by taking the size of the Fed’s balance sheet (BS) and subtracting both the amounts in the reverse repo operation (RRP) and Treasury General Account (TGA).

Muir said that “the liquidity created from QE and fiscal stimulus was so great that commercial banks no longer wanted deposits from large institutional clients because there were not enough safe assets available to purchase.” 

This prompted the expansion of RRP (beyond primary dealers to include the mutual funds and non-traditional accounts), a liquidity-draining operation (cash in the system removed through an increase in the number of bonds), through which the Fed would deliver “high-quality collateral with the promise to buy it back in a certain number of days at a higher price,” Muir explained.

Graphic: Retrieved from Bloomberg.

Other NL drivers include the TGA which, prior to Covid, was fairly well-balanced by taxes (i.e., money coming in) and the issue of fixed-income securities (i.e., money coming out). 

Post-Covid, the TGA increased a lot and this has “the same effect as QT … [as] bonds are issued and cash [is] withdrawn from the financial system, but the money is not distributed into the economy,” Muir elaborated.

Graphic: Retrieved from Bloomberg.

Combining the moves of the RRP and TGA, with the BS, provides us a measure of NL (shown below) that well explains stock price movements, as we’ve put forth in letters before.

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.

And, despite the far-spreading risk-on and -off context (i.e., stocks, crypto, and bonds down), it is believed that the large amounts in liquidity-draining operations (RRP and TGA), the impacts of QT, from hereon, may be lessened; per Muir, “[i]f the Fed had securities on its balance sheet that matched the maturity profile demanded by the institutions engaging in reverse repos, it could sell an amount equal to the total reverse repo balance to these institutions, reducing the need for reverse repos and elicit no change in the financial or real economy.”

“On top of that, the actual amount of monthly QT [$95 billion per month] is not that large,” Muir added. That’s because, over the span of five months, into the end of 2021 and the beginning of 2022, the TGA was up $816 billion. This equates to ~$163.2 or so billion per month of QT.

At the end of the day, though, the programs outlined above do less to provide market support. One can argue that the market has priced the programs and some economic slowing. It is not likely the market has priced the impacts of a sharply slowing economy and business.

That said, some data – less corporate profits falling out of bed – suggests “the stock market tends to do better when EPS growth rates are negative than when they are hugely positive.”

Graphic: Retrieved from Ned Davis Research via MarketWatch. “[A]n inverse relationship between earnings growth rates and the market’s average return.”

The key to explaining this is to remember markets are a forward-looking mechanism. 

“By the time earnings growth rates are extremely high–as they were late last year and early this–they have long since been reflected in stock prices.”

“During such periods, the market has instead shifted its focus to earnings several quarters hence—to factors such as the Fed having to put the brakes on an overheating economy.”

The reverse will happen when the year-over-year growth rate in trailing fourth-quarter EPS is negative; “investors will have shifted their focus to earnings’ likely imminent rebound.”

Positioning

Pending is a final resolution “tied to the incremental effects on liquidity,” (e.g., QT manifesting itself as “$4.5 billion less in demand for assets per day,” and buyback blackout).

Graphic: Retrieved from Barclays PLC (NYSE: BCS) via The Market Ear.

This is all the while options repositioning may actually make the case for increased fragility, as traders’ falling demand for put protection opens the door to less supportive hedging flows and more impact from macro-type flows (talked about above) if we will.

Graphic: Taken from @Alpha_Ex_LLC who retrieved from Bloomberg. S&P 500 (INDEX: SPX) October put option lower in price and volatility.

The last-mentioned SpotGamma explained well: 

“As traders realize that options protection is doing little to protect them, there may be a flip; the sale of volatility, which appears to be a good trade (now), could leave markets vulnerable to an event into which traders are no longer well-hedged. Should something bad happen and traders reach for protection, that could result in limit-down type of movement.”

If unsure of what direction to participate, consider pricing some Box Spreads that offer some competitive and guaranteed interest rates, similar to those earned with Treasury bills.

Technical

As of 6:40 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, 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 $3,771.25 HVNode puts into play the $3,826.25 HVNode. Initiative trade beyond the last-mentioned could reach as high as the $3,862.25 HVNode and $3,893.00 VPOC, or higher.

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

Any activity below the $3,771.25 HVNode puts into play the $3,722.50 LVNode. Initiative trade beyond the LVNode could reach as low as the $3,671.00 VPOC and $3,610.75 HVNode, or lower.

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

Definitions

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For September 16, 2022

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.

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 15, 2022

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

What Happened

The calm before the storm.

Overnight, equity index futures auctioned sideways, inside of a developing balance area. The S&P 500 was glued to the area above $3,700.00.

The Treasury rout cooled. T-Note (FUTURE: /ZN) and T-Bond (FUTURE: /ZB) futures were off their lows. Per Bloomberg, the sell-off in fixed income wiped nearly $10 trillion of value in global bonds, erasing post-Pandemic gains on stimulative central bank intervention.

This letter has talked about the bonds and equities down phenomenon before. It is the shifting in priorities at the policy level – from monetary to fiscal – driving (more) positive correlations.

Abroad, the slump solicited the attention of policymakers. The European Central Bank (ECB) said it would have an emergency meeting to discuss current market conditions. Policymakers are to sign off on the reinvestment of bond purchases conducted during the pandemic.

In other news, the American Petroleum Institute issued policies to unleash American energy and fuel recovery. The U.S. rebuffed China by calling the Taiwan Strait an international waterway as CEOs urge the U.S. Congress to pass a China competition bill. More news of layoffs hit the wire also. Coinbase Global Inc (NASDAQ: COIN) will lay off 18% of its workforce, alongside many other crypto companies. 

Elsewhere, Redfin Corporation (NASDAQ: RDFN) and Compass Inc (NYSE: COMP) are laying off workers, as are automotive manufacturers.

Ahead is a packed calendar. To be released is data on retail sales, import prices, and manufacturing (8:30 AM ET). Later is data on home building and inventories (10:00 AM ET).

Key is the Federal Open Market Committee (FOMC) statement, projections, and news conference (2:00 PM ET).

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

What To Expect

Fundamental: Let’s keep it short and to the point.

As talked about, yesterday, the FOMC is expected to raise rates by 75 basis points in light of new data. Per Bloomberg, “Powell will argue that a supersized move is needed to preempt inflation expectations from unanchoring.”

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

The peak in rates is somewhere in the 3.75-4.00% range out in early-to-mid 2023. Into that date range, there is a 100% the Fed will hike.

Graphic: Via Federal Home Loan Mortgage Corporation (OTC: FMCC). “The housing market is incredibly rate-sensitive, so as mortgage rates increase suddenly, demand again is pulling back.”

On the quantitative tightening (QT) side of things, which is the direct (out) flow of capital from capital markets, the Fed will stop reinvesting the proceeds of maturing Treasuries for the first time since the start of quantitative easing (QE).

Per the Financial Times, in May, FOMC members agreed to cap their monthly balance-sheet run-off at $30 billion in U.S. Treasuries (UST) and $17.5 billion for agency mortgage-backed securities (MBS). 

This will have an effect on prices “as liquidity – the ease with which investors can buy and sell assets – deteriorates as markets grapple with a larger amount of bond supply to absorb.”

Moreover, in the recent sale of bonds, liquidity was “worse than it was leading up to Lehman,” and, accordingly, this has played into repo dislocations.

“As customers sell their position to dealers, there’s limited liquidity in the off-the-run markets so the dealers short-sell currents,” Scott Skyrm of Curvature Securities says on increased buys and sells leading to more settlement activity, which plays into more fails.

“Market participants reduce their investments and leverage and go into ‘cash,’ leaving more actual cash in the repo market.”

Therefore, Treasury securities, across all tenors, have traded below the rate on overnight general collateral repurchase agreements. 

This could “be a sign of another shortage of collateral and that another systemic risk event might come up in the future,” as Fabian Wintersberger well explained in his newsletter.

Graphic: Via Fabian Wintersberger. Data from Bloomberg. 

Wintersberger adds: “All those things suggest that the storm we are currently facing in markets is just the beginning. The war in Ukraine, a rising interest rate environment, energy costs that subdue the outlook for the real economy, and finally, signals of stress in financial markets imply that there might be tough times ahead.”

Positioning: The divergence in volatility implied (IVOL) by participants’ options activity, versus that which the market realizes (RVOL) was resolved.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR).

As I wrote in my commentary for options data and analysis platform SpotGamma, yesterday, pursuant to remarks made in Physik Invest’s recent letters, volatility repriced and that was a boon for participants who bought into the implied skew convexity idea.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR).

Moreover, $3,700.00 SPX is a key level, per SpotGamma. This is because there is sizeable interest at that level expiring June 17, after FOMC. These options have little time to expiry and, thus, their gamma (options sensitivity to direction) grows rather large, at near-the-money strikes.

Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading. 

In theory, we see participants as owning protection against their stock exposures. Therefore, the counterparties are short puts (positive delta) and short stock or futures (negative delta).

As the time to expiry narrows, above the strike in question delta decays, and counterparts buy back their static delta hedges. 

As the time to expiry narrows, below the strike in question delta expands and counterparts sell more static delta to hedge.

Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading.

That means, depending on what happens with FOMC, if below $3,700.00, associated hedging, less any new reach for protection would pressure markets lower. If above $3,700.00, hedging, less any new sale of protection, would bolster markets higher.

Graphic: Taken by Physik Invest from Interactive Brokers Group Inc (NASDAQ: IBKR).

If lower, all else equal, the June 17 options expiration will coincide with the removal of the in-the-money options exposures in question. This opens a window during which markets may have less pressure to rally against.

Technical: As of 6:30 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a 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 $3,768.25 HVNode puts in play the $3,808.50 HVNode. Initiative trade beyond the $3,808.50 HVNode could reach as high as the $3,836.25 LVNode and $3,863.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,768.25 HVnode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as low as the $3,688.75 and $3,664.25 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.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures. Updated: 6/14/2022.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 14, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-higher, along with bonds, snapping the pricing in of tighter monetary policies and economic slowing.

Creeping up are expectations regarding the amount of tightening policymakers are to add. Treasury yields had their biggest jump in decades. U.S. 3-year Treasury yields, in particular, were up 25 basis points, to 3.49%, the highest since 2007, per Bloomberg.

Now, traders see nearly 200 basis points of tightening by the Federal Reserve’s (Fed) by September, as well as the possibility of a one-off 75 basis point hike. The overnight rate is expected to peak near 4% by mid-2023.

Accordingly, the U.S. and European real estate values have taken a hit amid rising rates and inflated prices, falling 5-10%. Rental demand has thinned, also. 

In other news, the U.S. sought to boost supplies of Russian fertilizer as “sanctions fears have led to a sharp drop in supplies, fueling spiraling global food costs.”

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 what seems to be “a coordinated attempt to guide the market through trusted journalists,” recent updates on the path of inflation may push policymakers to surprise markets.

Graphic: Via Tier1Alpha. “A disappointing CPI suggested that calls for inflation peaks were premature and now markets are trying to interpret Powell’s (and Lagarde’s) true intentions.”

Markets reacted, accordingly, pricing in a near-certainty of a 75 basis point hike, later this week.

Graphic: Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. In one session, participants priced in a near-certainty of a 75 basis point hike.

Looking into the future, Fed Funds target rates, based on the Fed Fund futures contract prices, are projected to peak into the mid-next year (Spring/Summer 2023).

Graphic: Via CME Group Inc’s FedWatch Tool

Accordingly, Treasury market turmoil continued with liquidity “worse than it was leading up to Lehman,” says Christian Hoffman, a portfolio manager for Thornburg Investment Management.

“That creates even more risk because if the market doesn’t have liquidity, it can gap down very quickly.”

Graphic: Via Bloomberg. Taken from @DonutShorts. This could “be a sign of another shortage of collateral and that another systemic risk event might come up in the future,” as Fabian Wintersberger well explained in his newsletter.

As talked about in past newsletters, pressures in the financial system, all the while the economy is slowing, are rising. This is amidst a dash for cash as fixed income and equity markets are not perceived to be as safe.

Graphic: Via Bloomberg. “Two-year US Treasury yields surged 29 basis points as bond prices tanked, … the biggest two-day increase since 2008, a sign of just how rapidly traders are adjusting where they think the Federal Reserve will take interest rates.”

“People are trying to process what’s behind these large moves,” Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA (OTC: SCGLY), said. She attributes some of the volatility to poor liquidity, panic selling, and margin calls.

Ultimately, according to Bloomberg’s John Authers, this is a tantrum the Fed is likely to let “rip for a while” before, potentially, suffocating “with more easy money.”

“The relationship between central banks and bond markets is, as I’ve said before, a lot like that between a parent and an angry toddler. Indulging the bond market early last year might prove a critical mistake in losing parental authority for the Fed.”

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. MS’s Mike Wilson says: “From our vantage point, both rates and ERP appeared to be mis-priced [and] we think the S&P 500 is headed toward 3,400 before a more tradable low is in.”

Positioning: Last night, as I wrote a report for SpotGamma’s subscribers, noteworthy is how “subdued” volatility was with, recently, “realized outpacing that which is implied by participants’ options activity.”

That dynamic resolved, Monday, as implied (IVOL) finally retook that which is realized (RVOL).

Read, also, the Daily Brief for Monday, June 13, 2022.

Graphic: Via Robson Chow.

Moreover, for much of the session, the equity markets were range-bound as most of the movement in both equity and volatility markets happened overnight. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for ES (SPX + SPY). Via SpotGamma, “Into weakness, participants mainly sold puts (a bullish trade). Into strength, they bought puts (a bearish trade). Throughout the session, too, there was light call buying (a bullish trade). This helps with understanding why the VIX moved much less during the day session.”

Noteworthy, was the absence of demand for protection that performs non-linearly with respect to changes in direction (delta) and volatility (vega).

“Fixed strike vols actually caught a bid, VIX futures are in backwardation,” The Ambrus Group’s Kris Sidial explains.

“However, that spot-vol relationship in the S&P still underperformed and skew was also lackluster.”

Graphic: Via TradingView. Taken by Physik Invest. The Cboe VVIX Index (INDEX: VVIX), the expected volatility of the 30-day forward price of the VIX, or the volatility of volatility (a naive but useful measure of skew), remains depressed, too, in comparison to the VIX, itself.

As said before, it is supply and demand dynamics that played into divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL). Participants are hedged and volatility remains well-supplied.

Was there to be forced selling and demand for protection en masse, we’d likely see that repricing in volatility we have been looking for.

To quote Benn Eifert of QVR Advisors: “Skew goes up if vol outperforms the skew curve a lot on a selloff.”

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

And so, to position for that, (although it is not as opportune as it was a week ago), it continues to make sense to own volatility structures (that, one, either sold very short-dated pre-FOMC and OPEX volatility to fund that which is farther-dated or, two, buy into implied skew convexity, non-linear with respect to delta [gamma] and vega [volga] changes).

Notwithstanding, per SpotGamma, a lower bound in the market is near $3,700.00. It is at this level options flows may shift from “inducing” to “reducing” volatility as, “beneath this level, all else equal, liquidity providers would have less and less pressure to add on further weakness.”

Ultimately, it is at higher levels of volatility that the marginal impact of further volatility compression is likely to do more to bolster equity market upside as liquidity providers buy back their negative delta hedges to positive delta (short put) exposures. 

SpotGamma’s founder, Brent Kochuba, adds: “Ultimately this expiration is clearing out a lot of equity put protection, which clears the way for lower lows in the weeks and months ahead.”

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 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 $3,768.25 HVNode puts in play the $3,808.50 HVNode. Initiative trade beyond the $3,808.50 HVNode could reach as high as the $3,836.25 LVNode and $3,863.25 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,768.25 HVnode puts in play the $3,727.75 HVNode. Initiative trade beyond the $3,727.75 HVNode could reach as low as the $3,688.75 and $3,664.25 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.
Graphic: 65-minute profile chart of the Micro E-mini S&P 500 Futures.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 26, 2022

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

Separately, the Daily Brief will be on pause from May 30, 2022, to June 7, 2022, due to the author’s overseas travel commitments. Apologies for the inconvenience and happy trading!

What Happened

Overnight, equity index futures were divergent, albeit nearly flat, after Wednesday’s release of minutes to the last Federal Open Market Committee (FOMC) meeting were less hawkish than expected, bolstering a small expansion of the range to the upside.

Though higher prices were held at the index level, some products like Apple Inc (NASDAQ: AAPL) were lower after issuing updates on its production. Yesterday, it was social media and advertising businesses like Snap Inc (NYSE: SNAP) that fell on forecasts for meager growth.

In other news, Sequoia Capital warned that the current environment for founders is a “crucible moment,” and there is no indication good times will return soon. 

Pursuant to that belief, we have firms like Klarna and Bolt, who just began laying off employees, preparing for slower growth and focusing on “short-term profitability.”

A chief concern, among participants at the World Economic Forum, beyond a global recession and inflation, is the potential for ongoing conflicts to cause “mass starvation” and “political instability around the world.”

Today we get updates on jobless claims, real gross domestic product, and income, as well as final sales to domestic purchasers (8:30 AM ET). Later, pending home sales (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: As was suggested could happen in Wednesday’s pre-market letter, the Federal Reserve (Fed) indicated potential policy flexibility, later this year.

Per the most recent FOMC minutes, officials are determined to achieve price stability with “50 basis-point increases in the target range … at the next couple of meetings.”

“Many participants judged that expediting the removal of policy accommodation would leave the committee well-positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments.”

Graphic: Via Bloomberg. “​​The swaps market and consensus forecasts to Bloomberg Economics both imply considerably faster rate hikes, while Bloomberg’s own forecast is more hawkish still.”

Accordingly, finalized were balance sheet reduction plans. Starting June 1, 2022, Treasury holdings will decline by $30 billion per month, rising to $60 billion per month in September. 

Mortgage-backed securities (MBS) holdings will shrink by $17.5 billion per month, ultimately rising to $35 billion, in accordance with our post-FOMC letter published May 5, 2022.

As stated, previously, with QT, central banks remove assets from their balance sheet either through outright sales or the non-reinvestment of the principal sum of maturing securities.

“QT is a direct flow of capital to capital markets” and the prospects of withdrawing this liquidity, when revealed in December’s FOMC meeting minutes, was what fed into a retreat from risk.

Graphic: Via Reuters.

Overall, the minutes left the tone unchanged and reaffirmed the Fed’s commitment to stable prices.

Bloomberg’s John Authers concludes, well: “If inflation should look as though it might fail to get down even to the revised forecast of 4.3% by the end of the year, there’s still a possibility that the Fed will have to be more hawkish than it currently intends, not less.”

“But at least the path until the end of summer looks clear.”

Graphic: Via Bloomberg.

Positioning: We’re carrying forward remarks from notes earlier this week as there has been a limited change in tone.

Based on current positioning, most products we monitor continue to trade in an environment that solicits more volatile hedging of put open interest and realized volatility (RVOL). This is because, naively, we look at participants as mainly owning protection to the downside. 

So, they have asymmetric (positive gamma) exposure to the downside (negative delta). On the other side, liquidity providers have a negative gamma and positive delta that they must sell into weakness and buy into strength underlying to hedge.

It is at a certain juncture, far above current prices (i.e., Zero Gamma), that the volatile effects of hedging this put open interest begin to cool. It is above these levels that participants’ exposure to calls solicits increased hedging activities which promote stability and less volatility.

Graphic: Via Tier1Alpha. “Spot SPX is currently over -8.55% below the gamma flipping point, a distance similar to the drawdown at the end of 2018. We’ll have to see quite a reverse in trend before a substantial regime shift can take place.”

It’s because, naively, we look at participants as financing their bets on the downside with call exposure. On the other side, liquidity providers, then, have a positive gamma and delta trade they hedge by buying into weakness and selling into strength.

We’re definitely not there yet but, based on remarks in past letters (e.g., stretched market and investors bidding “skew on the call side” amid their “fear of missing on the upside”), this letter’s author continues leaning toward strategies that have little to lose in case of further implied volatility (IVOL) compression or weakness into the June FOMC and OPEX.

Graphic: Via SpotGamma. “[C]all positions were added [above] $4,000.00, with $4,100.00 [and] $4,200.00 adding 10k + 15k [in open interest] respectively. That’s not huge, but it was enough to kink the gamma curve in an interesting way.”

Technical: As of 6:30 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively skewed overnight inventory, nearly 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 $3,951.00 VPOC puts in play the $3,997.75 RTH High. Initiative trade beyond the RTH High could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,951.00 VPOC puts in play the $3,909.25 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,863.25 LVNode and $3,831.00 VPOC, or lower.

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

Definitions

Overnight Highs And Lows (ONH and ONL): 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 value tests as they offer favorable entry and exit.

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 24, 2022

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

What Happened

Overnight, equity index futures softened after what appeared to be continued covering of shorts into Monday’s close. Commodities were mixed, bonds higher, and implied volatility higher.

In the news the amount of money parked at major Federal Reserve facilities climbed to another all-time high, passing $2 trillion. JPMorgan Chase & Co’s (NYSE: JPM) CEO Jamie Dimon said recently that the Fed must do quantitative tightening since there’s too much liquidity in the pipes.

Adding, the Fed’s Raphael Bostic said policymakers may hike rates by 0.50 basis points after their next two meetings before pausing in September to allow for observation. This is as banks UBS Group AG (NYSE: UBS) and JPMorgan Chase & Co cut their expectations for growth here and abroad.

Ahead is data on S&P Global Inc (NYSE: SPGI) manufacturing and services (9:45 AM ET). Later, participants get updates on new home sales (10:00 AM ET) and Fed-speak by Chair Jerome Powell. Later this week, on Wednesday, participants will receive minutes of the Fed’s most recent meeting which may provide further insight into the central bank’s intent to tighten.

Graphic updated 6:15 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: So long as market participants are using JPEG images of rocks as collateral for debt, it is likely we have not reached a more permanent bottom in the broad market. 

Kidding – just trying to lighten the mood, haha! Sorry to my crypto friends! 

For real, though, maybe the destruction of that market is what we’re to watch for.
Graphic: Via Corey Hoffstein. “You call it ‘tulip mania,’ but I’m gonna need to see evidence that the Dutch set up lending markets where they used paintings of rocks as collateral.”

Support of market excesses was liquidity in the financial system, a lot of which is now piling into the Fed’s overnight reverse repurchase agreement facility (RRPs).

Graphic: Via Bloomberg. Per the Federal Reserve Bank of New York: “A reverse repurchase agreement conducted by the Desk, also called a “reverse repo” or “RRP,” is a transaction in which the Desk sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the transaction.”

Since the start of the year, however, the anticipation and pricing in of the removal of some of this liquidity have fed into market weaknesses.

Per the Damped Spring Advisors’ Andy Constan, the “Fed will reduce their balance sheet by choosing not to reinvest the proceeds of maturity payments of existing holdings back into the market. The U.S. Treasury will need to find new buyers for the bonds it issues.”

Please read our Daily Brief For May 5, 2022, here, for more on the Federal Reserve’s updates.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, about double the maximum pace of $50 billion a month in 2017-2019.

Constan adds: “In June, that supply those markets will need to absorb will be $50 billion USD and will grow to $95 billion (of which some will be outright sales of mortgages by the Fed).”

Accordingly, “[j]ust as USD strength occurred as global investors chased U.S. assets, as the U.S. economy led the global economy out of the Covid chasm, the next leg of asset returns is more likely in countries that remain relatively easy and where the economy is still lagging.”

Goldman Sachs Group Inc’s (NYSE: GS) Vickie Chang notes: “Using history as a guide, in order for equities to come off their recent lows (and stop declining), this kind of monetary-tightening induced contraction is most likely to end when the Fed itself shifts.” 

“It may be that the market needs to see signs of the inflation deceleration that our US economists expect in the second half of the year in order to see sustained relief.”

Positioning: Pursuant to comments established last week, Dennis Davitt of Millbank Dartmoor Portsmouth explains that the “realized volatility of the underlying S&P 500 is above 27% … with implied volatility of options trading between 24%-27%,” which translates to a VIX at 30%.

“It is profitable to own options with such an active and volatile cash market. This is the opposite of 2017 where the VIX was at 10% and the realized was 7%,” a trade that leverage poured into and resulted in the spectacular short-volatility ‘Volmageddon’ blow-up in February of 2018.

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

What does this mean?

Davitt concludes that “18 months” out there are “elevated option prices which may foretell an increase in the volatility of the equity market through this time next year.”

Though the Cboe Volatility Index (INDEX: VIX) may print higher, it is likely that it does not spike and point to an immediate market bottom, all else equal, like it has in the very near past.

Graphic: Via Millbank Dartmoor Portsmouth.

How to play?

It makes more sense to have exposure to underlying markets, synthetically (i.e., own options). This is based on the current relationship between realized and implied volatility.

Graphic: Via Robson Chow, founder at Tradewell. “The spread between IV and RV remains quite low relative to the past 50 trading days and 1st decile in the historical data.  It is printing where, historically, the most forward realized volatility and the weakest relative mean returns over the next 60 days can be expected.”

This is in contrast to the thesis that “long volatility is a poor equity hedge” because, on average, it’s overpriced and has less than a 100% negative correlation with the equity market.

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

Given fundamental contexts, many foresee continued weaknesses. Notwithstanding, markets are stretched to the downside and the path of least resistance, based on prior comments, is up.

This is with the caveat that traders should look at the current window of time as a period during which markets have less pressure to rally against. Per SpotGamma, this is due to the put-heavy options expiration (OPEX), Friday. 

Still, the rally into Monday “pulled forward some of the energy from [those] options that were to roll off,” and now, participants are “much less hedged than they were.” Should demand return, that will bid options prices and likely solicit liquidity provider pressures which, all else equal, start to cool into the $3,700.00 S&P 500 area.

Graphic: Via SpotGamma.

Technical: As of 6:15 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a negatively skewed overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,943.25 HVNode puts in play the $3,969.00 VPOC. Initiative trade beyond the VPOC could reach as high as the $4,061.00 VPOC and $4,095.00 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,943.25 HVNode puts in play the $3,908.75 MCPOC. Initiative trade beyond the MCPOC could reach as low as the $3,862.75 LVNode and $3,831.00 VPOC, or lower.

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

Considerations: Push-and-pull, as well as responsiveness near key-technical areas (discernable visually on a chart), suggests technically-driven traders with shorter time horizons are very active.

Such traders often lack the wherewithal to defend retests.

Large participants (who often move by committee) seldom respond to key technical inflections. It is their activity that often results in poor reliability of our technical levels.

Sometimes, the better trade is to wait for the larger participants’ entry and use the expansion of the range as a confirmation of a new trend.

Catalysts to consider include the release of Federal Open Market Committee (FOMC) minutes, Wednesday.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 5, 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 took back a small chunk of Wednesday’s post-Federal Open Market Committee (FOMC) advance. Both bonds and equity indexes were lower while most commodities and the dollar were bid.

The Federal Reserve hiked interest rates by 50 basis points while knocking the odds of a larger hike (~0.75 or above) later this year, all else equal. The Fed’s holdings of U.S. Treasuries (UST) and mortgage-backed securities (MBS) are set to fall starting June 1.

As expected, the Fed will cut $95 billion a month from its holdings, split between $60 billion of USTs and $35 billion of MBS, per Reuters, in the span of three months.

Heading into the FOMC event, markets were sold and protection, particularly that which is shorter-dated, was demanded. This was evidenced via metrics like the VIX’s term structure which had short- and mid-term VIX futures prices higher than those that are longer-term.

The compression of implied volatility after the event affecting existing concentrations of options positioning, particularly at the short-end, coupled with lackluster options buying and selling at the index level, has us questioning the rally’s sustainability.

Ahead is data on jobless claims, productivity, and unit labor costs (8:30 AM 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 Fed is raising rates and reducing the size of its balance sheet in light of the economy’s “strong underlying momentum,” as Nordea Bank (OTC: NRDBY) research puts it, a hot labor market and elevated inflation.

During a press conference after the release of meeting statements, the Fed’s Jerome Powell assuaged participants of their fears regarding a 75 basis point hike in later meetings.

Instead, it’s likely the fed tightens twice more by 50 basis points before scaling back to 25 basis point hikes, helping bring inflation down to the 2% target.

On June 1, the Fed will start the process of balance sheet reduction at $47.5 billion ($30B UST and $17.5B MBS) a month for the first three months. This will increase to $95 billion ($60B UST and $35B MBS), after, “roughly double the maximum pace of $50 billion a month targeted in the 2017-2019 cycle.”

With QT, central banks remove assets from their balance sheet “either through the sale of assets they had purchased or deciding against reinvesting the principal sum of maturing securities,” as JH Investment Management explains

Since March, the Fed’s balance sheet was at $9 trillion, steadied by the reinvestment of proceeds from maturing securities. After a small run-up, starting in September, the Fed will allow for a maximum of $95 billion to roll off without reinvestment.

Per MarketWatch, “In this cycle, one key to markets is when the Fed might actually sell some of its holdings of mortgages $2.7 trillion. This will ripple out through U.S. debt markets.”

This, however, “would be announced well in advance,” enabling “suitable progress toward a longer-run … portfolio composed primarily of Treasury securities.”

When bonds fall in value, their yields rise. This may have the effect of driving yield-hungry investors into relatively less risky asset categories.

Graphic: Via Reuters.

Positioning: There was a large squeeze, post-FOMC. 

The prevailing narrative is that participants’ fears, with respect to how aggressive the Fed would tighten, were assuaged.

Per Standard Chartered’s (OTC: SCBFY) Steve Englander, at its core, “it is fair to say that positioning and excess pessimism reflect a big part of the market reaction.” ​​

“Overall, the tone was much more balanced than at the January and March FOMC meetings.”

As discussed in the past few letters, markets were stretched and participants were demanding protection in size. To quote the May 2 letter:

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

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

That’s precisely what happened. The question now is whether there’s a sustained reversal. 

Based on SpotGamma’s Hedging Impact of Real-Time Options Indicator (HIRO), participants’ reaction to the FOMC was lackluster and capital was not committed to bets further out in price and time at higher or lower prices. 

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. Capital was not committed to bets further out in price and time at higher or lower prices. 

If participants start to concentrate their bets at higher prices, further out in time, that confirms the odds of sustained follow-through. If not, it’s likely that indexes, after a short-term relief, will succumb to fundamental weaknesses.

According to Kai Volatility’s Cem Karsan, the rally was purely a function of “structural buyback” and the baseline is that the bear trend holds.

This is because Fed is expected to continue withdrawing liquidity, and this will prompt risk assets to converge with fundamentals as “QT is a direct flow of capital to capital markets.”

Technical: As of 6:30 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a negatively skewed overnight inventory, 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 $4,260.25 overnight low (ONL) puts in play the $4,303.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 high volume area (HVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,260.25 ONL puts in play the $4,177.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,142.75 RTH Low and $4,123.00 VPOC, or lower.

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

Considerations: Strong advance, yesterday, characterized by very supportive 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).

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

That indicator denotes the level at which the average buyer/seller is in. In other words, that’s the fairest price to pay for Nasdaq 100 exposure (since March 2020) and, instead of being construed as a so-called supply zone, the level ought to, again, be looked at as a demand area. 

What’s next? Looks like there are some key areas where supply is likely to show. Mainly the $340.00 and $360.00 areas in the QQQ are of significance. In the SPY, those areas include $435.00 and $445.00.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 4, 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 were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

A check on some naive measures suggests we’re in for an expansion of range (i.e., heightened realized volatility) in the coming session(s). Key, today, are Federal Open Market Committee (FOMC) updates (2:00 PM ET) and a news conference (2:30 PM ET). 

The expectation is a 50 basis point hike and balance sheet contraction with run-off caps of $95 billion. If the action is in line with expectations (priced in), the reaction is likely to be positive.

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (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

Fundamental: Expected is front-loaded tightening, by the Federal Reserve (Fed), today.

The consensus is anchored around a 50 basis-point hike in May and no adjustments to the Reverse Repo Rate (RRP) or Interest on Reserve Balances (IORB), says Nordea Bank (OTC: NRDBY) research. The Fed may opt, also, to initiate a 75 basis-point hike in June.

“We believe that after the FOMC hikes by a half-point in May and presents a detailed plan to reduce the Fed balance sheet,” imminently, says Anna Wong, Yelena Shulyatyeva, Andrew Husby, and Eliza Winger of Bloomberg. 

“Powell will avoid definitive guidance about the size of future hikes, as policymakers assess how the runoff is affecting the economy in coming months.”

Graphic: Via Nordea research. Heightened inflation, exacerbated by sticky supply pressures and the conflict in Ukraine, and trends in demand have played into a tough talk on monetary policies.

As noted before, the key (risk) is the statements on the Fed’s balance sheet and the (imminent) process to shrink it through quantitative tightening (QT).

Graphic: Via Mish Talk. “The Fed expanded QE aggressively for years. But nearly all of that expansion was longer-dated securities as the [] chart shows. If the Fed had short-term securities it could reduce its balance sheet simply by runoff. Instead, the Fed will aggressively have to sell securities, especially MBS, if it really wants to reduce its balance sheet as quickly as it has implied.

Per Nordea, QT is likely to consist of a 3-month phase-in period and run-off caps of $95 billion (i.e., $60 billion on U.S. Treasuries [USTs] and $35 billion in mortgage-backed securities [MBSs]), effectively lowering the Fed’s balance sheet by $670 billion by year-end.

Graphic: Via Bloomberg and Mitsubishi UFJ Financial Group Inc (NYSE: MUFG) U.S. Macro Strategy.

This is alongside the realization that “1Q may be the last good quarter of earnings as higher costs and increased recession risks weigh on future growth,” Morgan Stanley’s (NYSE: MS) Mike Wilson explains.

Graphic: Via Royal Bank of Canada (NYSE: RY) U.S. Equity Strategy and Bloomberg.

Market weakness in the past weeks was the result of “growing evidence that growth is slowing faster than most investors believe,” Wilson adds, and “the market is currently so oversold, any good news [such as Fed action being as expected] could lead to a vicious bear market rally.”

“We can’t rule anything out in the short term but we want to make it clear this bear market is far from complete.”

Positioning: Borrowing from yesterday’s letter, as little has changed, bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and highly sensitive to changes in implied volatility and direction.

Graphic: SqueezeMetrics on “how IV, direction, and moneyness cause option dealers to buy or sell the underlying.”

This exposure’s roll-off and compression in volatility ought to coincide with liquidity provider support to markets (i.e., relief of pressure from hedges to concentrated options positioning).

Per Kai Volatility’s Cem Karsan, on a Fed day, “the first move tends to be structural. A function of the inevitable rebalancing of dealer inventory post-event. The second move and final resolution, if you wait for it, is usually tied to the incremental effects on liquidity (QE/QT).”

Validation of the latter (move) ought to be confirmed by participants’ new concentration of bets. In other words, if participants start to concentrate their bets at higher prices, further out in time, that confirms (changing sentiment) and (improves) the odds of sustained follow-through.

If not, it’s likely that prices, after a short-term relief, will succumb to fundamental weaknesses.

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 upper part of a balanced overnight inventory, just 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 $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,157.00 VPOC puts in play the $4,123.00 VPOC. Initiative trade beyond the $4,123.00 VPOC could reach as low as the $4,055.75 and $3,978.50 low volume areas (LVNodes), 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.

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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