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 June 8, 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 took back some of Tuesday’s sharp advance which happened against the trend of prevailing options activity (discussed further below).

This is as narratives remain unchanged. Investors are pricing the implications of the actions to address heightened inflation, as well as how that may play into (further) economic slowing.

Ahead is data on wholesale inventories (10:00 AM ET). Below is a light commentary to rebuild our narrative after the week-long pause.

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: On Friday, participants will receive an update on inflation when consumer price data is released.

Graphic: Taken from Morningstar Inc (NASDAQ: MORN). Forecasts for this week’s remaining U.S. data from a survey compiled by The Wall Street Journal.

It is one of the Federal Reserve’s commitments to promote stable prices; the institution is aiming for a soft landing just as supply chains, higher prices, and borrowing costs, among other things, are cutting into growth. 

Graphic: Via the New York Federal Reserve. Taken from Bloomberg. “The gauge brings together 27 variables that take the temperature of everything from cross-border transportation costs to country-level manufacturing data in the euro area, China, Japan, South Korea, Taiwan, the UK and the US.”

“The Fed is in a major jam,” said Oren Klachkin of Oxford Economics. “They don’t want to let inflation spiral but they also don’t want to kill the expansion. Finding the middle ground between those is hard, and their tools are blunt, so the task before them is monumental.”

Graphic: Via Bloomberg analysis of the World Bank Group’s Flagship Report – Global Economic Prospects – for 2022. “Against the challenging backdrop of higher inflation, weaker growth, tighter financial conditions, and limited fiscal policy space, governments will need to reprioritize spending toward targeted relief for vulnerable populations.”

Last Wednesday marked the start of quantitative tightening (QT), a practice used to shrink the Fed’s balance sheet and amplify the effect of rate hikes, further cutting into financial conditions, “the mechanism through which the Fed [impacts] the real economy,” explains Dennis DeBusschere of 22V Research.

“If the data doesn’t slow, financial conditions will need to tighten more,” and this will play into less demand for goods and services, many of which (are continuing to) remain in short supply.

Graphic: Taken from S&P Global Inc (NYSE: SPGI). 

Accordingly, Joseph Wang, who was a trader at the Fed, explains well that cash, which has been spared from the market rout, is set to become scarcer.

“Bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” he said. “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.”

Graphic: Via the Investment Company Institute. Taken from Joseph Wang. “Investors are selling everything for cash.”

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.”

Graphic: Via the St. Louis Fed’s (FRED) Federal Reserve Economic Data. Taken from Joseph Wang. “The overall level of bank deposits is declining even as demand for bank deposits from investors is increasing.”

Positioning: Responsive trade is the status quo, as validated by SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator.

Graphic: Via SpotGamma. “Delta hedging flows with respect to changes in volatility (vanna) likely helped dampen some of the negativity of options buys and sells.”

Accordingly, measures of implied volatility, based on supply and demand dynamics talked about in the past, are falling from already low levels, and thus, the marginal impact of further volatility compression does less to bolster equity market upside.

To note 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), dropped off largely, too, in comparison to the VIX, itself.

Graphic: Updated June 3, 2022. Via Tier1Alpha. “Several commentators have noticed that the price of volatility on the VIX, VVIX, has retreated sharply versus the past two years. If we look over a longer time horizon, this seems less so with a structural bid VIX tails driving higher implied hedging costs at each level of the VIX.  The current sub-100 VVIX level, while certainly lower than the past two years, is far from cheap historically.”

Given this all, SpotGamma suggests ultra-short-dated volatility, before the Federal Open Market Committee (FOMC) meeting, is likely to be sold, further depressing the front-end of the term structure while the “proceeds of that trade are funneled into farther-dated post-FOMC volatility.”

In other words, participants could sell short-dated volatility for exposure to that which is farther dated and, even, non-linear with respect to changes in delta (gamma) and vega (volga). 

Ultimately, such a structure would assist participants in lowering the cost of directional exposure.

Graphic: Text taken from Exotic Options and Hybrids: A Guide to Structuring, Pricing and Trading. In a long calendar spread, the trader sells shorter-dated implied volatility and uses the proceeds of that sale to fund, in part, longer-dated implied volatility exposure at the same strike.

More to come in future commentaries.

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

In the best case, the S&P 500 trades higher; activity above the $4,133.00 VPOC puts in play the $4,164.25 RTH High. Initiative trade beyond the RTH High could reach as high as the $4,189.25 LVNode and $4,227.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,133.00 VPOC puts in play the $4,101.25 LVNode. Initiative trade beyond the LVNode could reach as low as the $4,073.25 Weak H/L and $4,055.75 LVNode, or lower.

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

Definitions

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, 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 27, 2022

The Daily Brief will be on pause till June 7, 2022, due to the author’s travel commitments. Apologies for this inconvenience.

What Happened

Overnight, U.S. equity index futures came off of their Thursday peaks before, late in the morning, trading to a new rally high, at which is a confluence of technical nuances.

Thursday’s cash session was characterized by a near-vertical advance into mid-day. Then, trade became two-sided, a feature of short-covering and not new buying. More on this, later.

In the news was Citigroup Inc’s (NYSE: C) downgrading of U.S. stocks on recession risks and the “elements of a deflating bubble,” while leaning optimistic on China assets due to marginal policy support, there. This is on the heels of similar conclusions put forward by BlackRock Inc (NYSE: BLK) and Morgan Stanley (NYSE: MS).

Mortgage rates staged their biggest drop since April of 2020 as “the housing market has clearly slowed, and the deceleration is spreading to other segments of the economy,” the Federal Home Loan Mortgage Corporation’s (OTC: FMCC) Sam Khater explained.

In other news, Secretary of State Antony Blinken took aim at China, commenting on the U.S.’s intention to “shape the strategic environment around Beijing to advance [its] vision for an open, inclusive international system.” This is as the U.S. also plans economic talks with Taiwan.

Pippa Malmgren, who is a former White House adviser and economist we wrote on earlier this week, discussed more of this decoupling and coordination among Eastern and Western powers.

In a two-part series, she explains the challenging of U.S. island bases by China and Russia, as well as their maritime strategies, “island hopping [and] shopping.” Check them out.

Today we received data on PCE inflation, real disposable and personal income, along with consumer spending and trade in goods (8:30 AM ET). University of Michigan Sentiment and five-year inflation expectations come later (10:00 AM ET).

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

What To Expect

Fundamental: At its core, there’s a commitment to cutting liquidity and credit after the spending of COVID-era “benefits and lockdown savings … created a lot of demand,” and inflation.

Graphic: Via the Federal Reserve. Taken from Nasdaq Inc (NASDAQ: NDAQ). “Rates have risen dramatically this year, impacting valuations of stocks and bonds.”

This has consequences on the real economy and asset prices, accordingly, which rose and kept the deflationary pressures of prevailing monetary policies at bay.

Graphic: Taken from Nasdaq Inc. “At a very simple level, rising rates increase interest expenses, reducing profits. But they also cause investors, who can earn more interest on safe cash deposits, to demand stronger returns from all other investments too.”

As unpacked, in detail, on May 18, 2022, there is an argument that stock market drops are both a recession and a reflection of the unwind of carry (or investment in long-duration bets with cheap debt) – a deflationary shock.

Graphic: Via Bloomberg. “Tighter financial conditions themselves are a clear success story for the Fed — it is the only way they can reduce inflationary pressures,” said Seema Shah, chief strategist at Principal Global Investors.

“The Fed has a mandate … to control price stability,” Kai Volatility’s Cem Karsan had explained.

“With supply-side economics, the only way that they can control this ultimately is to pull back. And slow capital markets decrease via the wealth effect. Ultimately, there’s a significant lag, so they are not in a position to ultimately control inflation without bringing down markets.”

Graphic: Via Bloomberg. “Of course, economic growth is a good thing. But too much of that good thing will just continue to stoke inflation. With that perspective in mind, the slowdown in surprises is positive.”

Accordingly, in our May 25, 2022 commentary, in which we discussed what to search for in the minutes of the last Federal Open Market Committee (FOMC) meeting. Knowing that there’s a lag in policy impact, we accurately floated the potential for the Federal Reserve (Fed) to “shift gears” late this summer if further cooling of inflation and “evidence of a growth slowdown.”

Graphic: Via Bloomberg. “After hitting a record above 3% last month, 10-year breakevens are on track for their biggest monthly drop since March 2020. The so-called five-year, five-year forward — the Fed’s favored measure — is set to post its biggest drop in May since August 2019.”

“Policy works with a lag,” as Diane Swonk of Grant Thorton explained. The Fed may pause as it seeks to “catch up but not outrun the market in its effort to tighten credit market conditions.” 

“There is still more progress to be made in bringing inflation expectations down to resonate with the Committee’s target, but current valuations are at least in the realm of acceptable,” Ian Lyngen, who is head of U.S. rates strategy at the Bank of Montreal (NYSE: BMO), said

“The market is showing some faith in Powell’s inflation-fighting creditability.”

Graphic: Taken from Nasdaq Inc. “Although inflation is high right now, it’s because of Covid and the Ukraine war. Both, hopefully, will pass, and 3%-4% inflation a year from now seems possible if the economy slows to a more normal level. In turn, that means the interest rate that keeps the U.S. economy growing slowly is likely much lower than we might currently be thinking. It might, in fact, be right around where bond rates are now.”

Concluding the fundamental section with remarks from a March 2022 Substack newsletter published by Andreas Steno Larsen of the Stenos Signals Substack.

“I simply don’t find >3.5% territory for the Fed Funds feasible as the hiking cycle peaked at 2.25-2.50% in 2018/2019 and fundamentals have worsened since. Debt loads are much higher, demographics have weakened, and the labour force is smaller, which suggests that the neutral rate is lower, not higher, than in 2018/2019.”

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.”

Positioning: Per Bank of America Corporation (NYSE: BAC) notes, investors poured nearly $20 billion into global stocks (in the week to May 25, 2022).

As I wrote in a SpotGamma note, notable was the reversal in beaten-down areas of the market, as well as the implosion at the front-end of the volatility term structure, affecting protection most sensitive to changes in direction and volatility.

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), dropped off markedly, too, in comparison to the VIX, itself.

Graphic: Via Physik Invest. Taken from TradingView. VVIX, top. VIX, bottom.

Further, as stated in SpotGamma’s note, a “falling VVIX (and VIX term structure drop off) may be the product of a collapse in the value of customers’ long put exposures concentrated in very short-dated timeframes (potentially exposures hedging tail risks with respect to the release of FOMC minutes, among other things).”

“It is then as the skew, here, decays, and term structure compresses, that liquidity providers buy back their hedges to the puts they are short (i.e., the vanna dynamic pointed to, earlier).”

This market-generated information helps us give context to this most recent equity market rally that is characterized by a little change in demand for bets on upside further in price and time 

All else equal, this is not a feature of sustainable market rallies.

Why you ask?

Those names that have been most depressed, and are now reversing, were recipients of heavy demand for protection in the months prior.

For this reason – participants being well hedged – selling was orderly, rather than violent as in past episodes of market shock when the reach for protection solicited a cascading reaction that exacerbated underlying price movements due to liquidity providers’ hedging.

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

The large drop off in term structure, as well as the VVIX versus the VIX, is affecting protection most sensitive to changes in direction and volatility and the unwind of liquidity providers’ short futures and stock hedges to this protection is, in part, playing into this internally weak rally.

So, what? How do you play this? Good question.

It still may make sense to have exposure to underlying markets, synthetically (i.e., own options), as detailed, well, May 25, 2022. Read that letter for detail on how to think about trade structure.

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

In the best case, the S&P 500 trades higher; activity above the $4,069.25 HVNode puts in play the $4,095.00 ONH. Initiative trade beyond the ONH could reach as high as the $4,119.00 VPOC and $4,148.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,069.25 HVNode puts in play the $3,997.75 RTH High. Initiative trade beyond the RTH High could reach as low as the $3,982.75 LVNode and $3,951.00 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 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 11, 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, index and commodity futures were bid while yields and the Cboe Volatility Index (INDEX: VIX) came in, little.

In the news was continued crypto market turmoil. The TerraUSD stablecoin maintained its break with the U.S. dollar, trading as low as ~0.25. Shanghai reported a drop in new COVID-19 cases.

Key, today, is data on consumer prices (8:30 AM ET). If Wednesday’s print shows price pressures continuing to mount, traders will put more weight on the potential for larger hikes.

Later, is some Fed speak (12:00 PM ET) and federal budget updates (2:00 PM ET).

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

What To Expect

Fundamental: Shortened commentary, today.

Participants expect inflation to have peaked. This would be confirmed by the annual CPI printing 8.1%, down from 8.5% in March.

Graphic: Via Bloomberg.

“Perhaps the tightest questions will concern core inflation (excluding food and fuel, which continue to be roiled by the situation in Ukraine),” says Bloomberg’s John Authers. 

“Now, if the economists polled by Bloomberg are correct, core month-on-month inflation is going to rise a bit. That does not help the narrative that the peak is in. If this particular number comes in below expectations, we can expect that to be taken very, very positively on the markets.”

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

Positioning: Participants are most concerned and hedging against aggressive monetary policy action and economic chokepoints.

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

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

Barring a worst-case scenario, if markets do not perform to the downside (i.e., do not trade lower), those highly-priced (often very short-dated) bets on direction will continue to decay (i.e., removal of event premiums).

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

Accordingly, hedging flows with respect to time and volatility may, then, 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.”

The alternative is that participants’ fears for whatever matter are not assuaged. In case of an imbalance, demand for protection may kick off a repricing of volatility, particularly that which is further away from current prices (i.e., skew), depressed by strong supply.

Graphic: Updated May 10, 2022. The VVIX via Physik Invest. Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress. When realized volatility is as high as it has been, the VVIX typically trades closer to 150.

Whether any price rise kicks off a sustained reversal depends on what the fundamental situation is, then.

Presently, some of the largest index constituents (e.g., Apple Inc [NASDAQ: AAPL]) are starting to succumb to the fundamental situation, if we will, and that may feed into the indexes which are pinned due to passive and hedging flows.

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

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics. A higher DIX/GEX ratio has historically been associated with S&P 500 outperformance in the subsequent month. A very low DIX/GEX ratio has historically been associated with positive S&P 500 performance in the subsequent month, though there are many more negative outliers.

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

In the best case, the S&P 500 trades higher; activity above the $4,055.75 low volume node (LVNode) puts into play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,153.25 regular trade high (RTH High) and $4,212.25 micro composite point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,055.75 LVNode puts into play the $3,978.50 LVNode. Initiative trade beyond the $3,978.50 LVNode could reach as low as the $3,943.25 and $3,907.75 high volume areas (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.

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.

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 10, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to higher, inside of the prior day’s range. Most other commodity and bond futures were bid while implied volatility metrics came in a bit.

Notable was the depth and breadth of Monday’s decline. Though the indexes were tame, some of which is attributable to suppressive hedging, single stocks expanded their ranges, greatly, to the downside, and this points to potential capitulation.

On the news front, a U.S. central bank report found that “the risk of a sudden significant deterioration [in liquidity] appears higher than normal” and stablecoin use to meet margin requirements in crypto trades makes them “vulnerable to runs.”

This is just as some algorithmic stablecoins have lost their peg (e.g., UST/USD ~$0.60).

Additionally, the report found elevated inflation, as well as the reaction to that “could negatively affect domestic economic activity, asset prices, credit quality, and financial conditions.”

Ahead is data on real household debt (11:00 AM ET).

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

Context: We continue to build out the narrative.

A market-wide drop, Monday, pointed to signs of capitulation as “small-time investors offloaded a net of about $1 billion in equities, the most aggressive selling in 14 months,” per JPMorgan Chase & Co (NYSE: JPM).

Graphic: Via @TaviCosta. “Nasdaq has already declined almost as much as it did during the March 2020 crash. Back then, the Fed was all about saving the stock market and the economy. Today, it’s all about how much more they are going to hike rates.

Notwithstanding, the volatility divergences this letter has pointed to, in the face of pronounced realized volatility, continue.

Graphic: Via Topdown Charts. Wednesday (FOMC) price rise (right) versus Thursday (post-FOMC) liquidation.

As Pat Hennessy of IPS Strategic Capital explains, at-the-money implied volatility is high and term structure is in backwardation, which are reflections of uncertainty and demand for hedges.

Graphic: Via SpotGamma. At-the-money implied volatility is backwardated given the heightened demand for shorter-dated protection, relative to that which is longer-dated.

“It’s just rare to see wingy short-dated puts like this so cheap relative to ATM.”

As explained in Monday’s letter (and in greater detail, Friday), a measure like the Cboe VVIX Index (INDEX: VVIX), or the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

When realized volatility is as high as it is, today, the VVIX typically trades closer to 150.

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

Graphic: Updated May 9, 2022. The VVIX via Physik Invest.

What’s going on? 

There is really negative sentiment and emotion, both of which are playing into market weaknesses and realized volatility. However, that realized volatility is not priced in.

There are “plenty of put-buyers, but nearly as many sellers,” SqueezeMetrics explains

You “don’t have to protect what you don’t own. Some investors de-grossed. Short momo (e.g., CTA) wants to bet on a bleed (a la 2000), but not on a crash. Put underwriting! No carry trades elsewhere. Sell SPX vol!”

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, the SPDR S&P 500 ETF Trust (NYSE: SPY) was a recipient of heavy put selling and call buying on 5/9/22.

Why does this matter?

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

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

So, in all, it is a question of whether the reward is worth the risk (see below “How To Play”).

Based on stretched positioning, equity markets are positioned for upside. Notwithstanding, the potential for large negative outliers, remains. In the case of an outlier, the consequent repricing of volatility may increase the reward, relative to the risk, for selling options, particularly puts.

As The Ambrus Group’s Kris Sidial sums well: 

With an S&P 500 below $4,000.00, “I would expect more of an aggressive reach for hedges … that spot- vol correlation break (weakness) would not be as present.”

“Spot- vol correlation has sucked recently, but vol relative strength should kick in.”

How I’m Playing: Borrowing from May 3’s letter, here.

Presently, the market is stretched to the downside and, as SpotGamma says, “traders are underpricing right-tail risk,” which opens the window for unique ways to play a returns distribution that continues to be skewed positive (albeit with large negative outliers).

This letter’s author is concentrated on zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals.

This letter’s author is structured positive delta and gamma in the Nasdaq 100 (INDEX: NDX) via ratios spread (1×2) and butterfly (1x2x1) structures.

Graphic: Via Banco Santander SA (NYSE: SAN) research, the return profile, at expiry, of a classic 1×2 (long 1, short 2 further away) ratio spread.

The concern with these strategies is the width and time to expiry. Should either of those be wrong, then spreads initially positive gamma turn negative, meaning losses are amplified.

For instance, in the Nasdaq 100, to put in short, 500-1000 points wide ratio spreads (buy the closer leg, sell two of the farther legs) expiring in ten to fifteen days work well.

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk, and, as explained, the risk has yet to meet the reward.

Read more about these strategies, here. The above is NOT a trade recommendation or advice.

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 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 $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode/gap boundary puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 could reach as low as the $3,907.75 HVNode and $3,862.75 LVNode, or lower.

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

Definitions

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

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.

Gamma: Gamma is the sensitivity of an option to changes in the underlying price.

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

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

Options: If an option buyer was short (long) stock, he or she would buy a call (put) to hedge upside (downside) exposure. Option buyers can also use options as an efficient way to gain directional exposure.

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.

Options Expiration (OPEX): Reduction of dealer gamma exposure.

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

About

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

Capelj 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 April 29, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-lower 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.”

Graphic: Via SpotGamma.

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.

Graphic: Via Bloomberg.

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.

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 April 28, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-higher alongside some upbeat earnings announcements.

Meta Platforms Inc (NASDAQ: FB) surged post-market, yesterday, after its main social network Facebook added more users than expected. 

PayPal Holdings Inc (NYSE: PYPL) vowed to rein in costs and boost profits while Qualcomm Inc (NASDAQ: QCOM) rose on an upbeat forecast.

There’s a strong push-and-pull between what’s good and bad. File Deutsche Bank’s (NYSE: DB) recent comments on a pending recession under what’s bad.

The bank sees the Fed Target Rate reaching up to 6% which “will push the economy into a significant recession by late next year.”

Graphic updated 7:00 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: Divergences across different assets and markets continue.

For instance, the equity market’s pricing of risk which we can take as being reflected by the CBOE Volatility Index [INDEX: VIX]) is not moving lock-step with that of measures elsewhere.

Graphic: Via Bloomberg.

The fear in one market tends to spread to others. Regardless of the cause, it seems that equity and bond market participants are not on the same page.

Is that really true, though? Not necessarily. 

If we look at some single stocks, Netflix Inc (NASDAQ: NFLX), among others (all the while S&P 500 earnings have been revised up) has suffered through a substantial de-rate and volatility as participants priced the implications of policy evolution, slower economic growth, and beyond.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear.

That has us returning to pinning at the index level, relative to what the constituents are doing.

As well explained in Physik Invest’s March 3, 2022 commentary, this is more so a function of positioning and structural flows, or supply of liquidity.

Absent some exogenous event, participants are well-hedged for what is known (e.g., rate hikes and quantitative tightening (QT), COVID resurgences, Russia and Ukraine, among other things).

The caveat is that the Federal Reserve is far more aggressive than expected, ramping up QT, “a direct flow of capital to capital markets or flow out of,” per Kai Volatility’s Cem Karsan. 

For context, it is the intention to take from the max liquidity (which pushed participants out of the risk curve and promoted a divergence from fundamentals) markets were supplied with, and this has the effect of removing market excesses, some of which have fed into volatility markets.

In part, some of the QT has been reflected in bond prices, JPMorgan Chase & Co (NYSE: JPM) explains. However, should there be far more aggressive monetary action, as Deutsche research suggests, coupled with a worsening of the geopolitical and/or economic situation abroad (e.g., Russian default), markets are likely to succumb.

“Using the balance sheet as a tightening tool represents a large change in the Fed’s attitude, and IS NOT priced into the market,” MacroTourist’s Kevin Muir adds.

“An increase in the pace of tightening of QT should mean lower stocks, wider credit spreads, and a slight reduction in the need for front-end hikes.”

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. The “Nasdaq has underperformed the S&P 500 but by less than what the move in real yields would suggest.”

Positioning: Volatility to continue as markets have traded lower and participants have priced up the cost of insurance – particularly at the short-end – on underlying equity exposure.

Graphic: SPX volatility term structure via Refinitiv. Taken from The Market Ear.

This is due to options delta (exposure to direction) being far more sensitive (gamma) across shorter time horizons (i.e., the range across which options deltas shift from “near-zero to near-100% becomes very narrow.”)

Yesterday, markets were pinned after exploring lower in the days prior. The activity was concentrated in short-dated bets at those levels, and that’s in part a result of some of the hedging that went on.

Graphic: Via SpotGamma’s Hedging Impact of Real-Time Options Indicator.

If markets do not perform to the downside (i.e., do not trade lower), those short-dated bets on direction will quickly decay, and hedging flows with respect to time (charm) and volatility (vanna) may bolster sharp rallies.

Whether those price rises have legs depends on what the fundamental situation is, then. Regardless, the returns distribution, based on implied volatility metrics alone, is skewed positive, albeit there are some 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.”

Technical: As of 7:00 AM ET, Thursday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the middle part of a positively skewed overnight inventory, 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 $4,236.25 regular trade high (RTH High) puts in play the $4,267.75 RTH High. Initiative trade beyond the $4,267.75 RTH High could reach as high as the $4,303.75 overnight high (ONH) and $4,337.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,236.25 RTH High puts in play the $4,191.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,136.00 regular trade low (RTH Low) and $4,101.25 overnight low (ONL), or lower.

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

Considerations: Markets are higher after testing some key levels outlined in prior letters.

The Invesco QQQ Trust Series 1 (NASDAQ: QQQ), one of the weakest products this letter monitors, just tested a major VWAP, yesterday, anchored from the lows of March 2020. 

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

The Nasdaq has led the market down. It may lead the market higher on reversals. We’ll continue to monitor market breadth, among other metrics, for signs of strength.

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.

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

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

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

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 April 27, 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 probed higher, essentially negating Tuesday’s end-of-day, knee-jerk liquidation.

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.”

Graphic: Via Bloomberg.

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.

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

Disclaimer

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

Categories
Commentary

Daily Brief For March 31, 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

A mixed bag, overnight, with U.S. equity indexes pinned at their most recent swing highs ahead of large options expirations (OPEX). 

News, too, was mixed. Notable was the United States’ potential release of oil reserves amounting to nearly a million extra barrels of oil a day. Oil sold alongside this update. 

Geopolitical tensions remain. Mainly, Russia and Ukraine tensions are ongoing and there’s a lack of clarity on what’s going on with the negotiations between the two parties.

Additionally, China is weighing the raise of billions to stabilize its economy and cut off the spread of the crisis. The money would stem risks from small, weakened banks and developers.

Ahead is data on jobless claims, personal income and consumer spending, PCE price index, as well as real disposable income and consumer spending (8:30 AM ET). Later, Chicago PMI is posted (9:45 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: Carry trades (i.e., the act of borrowing at low rates and investing where there are higher rates to make money so long as nothing [bad] happens) are receiving attention, again.

In recent days, it’s been the sale of the Japanese yen and the purchase of the Aussie dollar.

Example: Via Bloomberg.

Prior to 2008, this carry trade, according to a commentary by Bloomberg’s John Authers, which “became very correlated with speculative equity investing, … suffered an almighty crash as the yen appreciated dramatically against the Aussie dollar in 2008.”

Basically, Bank of Japan (BoJ) interventions are dovish and consistent, as Authers explains, buying bonds at a massive scale and “making the country an irresistible source of [cheap] funds.”

The risk of the trade is that the yen appreciates. In such a case, the opposite of what is going on now (similar to what happened during the Global Financial Crisis or GFC) occurs.

A great book on this – “The Rise of Carry: The Dangerous Consequences of Volatility Suppression and the New Financial Order of Decay Growth and Recurring Crisis – discusses many of the different forms of carry, their attractiveness, and the implications of their failure.

Mainly, such strategies are characterized by a sawtooth wave returns pattern (i.e., steady positive returns followed by sharp drops).

Graphic: Via Risky Finance. “Cumulative log returns from shorting the VIX future, a common carry strategy. Notice the poor returns in 2008 and other market crises.”

One such trade is that which captures the VIX futures curve roll yield.

Basically, the VIX futures curve is (usually) in contango (i.e., sloping upward) as farther-dated contracts are priced up (since portfolio insurance [should] cost more over longer periods). 

As those contracts near expiration, they converge with spot.

If volatility is flat (all else equal), the sale of farter-dated contracts allows you to capture the difference between the future and spot (or shorter-dated contracts). 

It’s a bit more complex, but that’s a general idea. Such trades attract lots of capital (and leverage) as they work (most of the time); positioning turns one-sided and complacency builds.

Eventually, markets move and this hurts those with not much wherewithal such as during 2020 when yield-seeking participants (who were forced out the risk curve given the reduction in rates and market stabilization programs) deleveraged en masse.

Since 2020, hardcore volatility selling (especially that which is short-dated), if you will, hasn’t returned and, as stated in yesterday’s commentary, this “has us a little less concerned (about some sort of armageddon situation).”

According to Banco Santander SA’s (NYSE: SAN) cross-asset research, “[t]he supply of volatility remains very subdued in a trend that has continued since the pandemic. For example, there are still virtually zero sales in short-term index variance swaps.”

“We did observe some activity in 4Q21 and 1Q this year, but almost all of that was unwinding of existing positions from earlier, and these were not new trades.”

Graphic: Via SG Cross Asset Research. Taken from Corey Hoffstein.

Notwithstanding, Santander’s research says that the demand for volatility (to hedge) remains strong “amidst the elevated uncertainty from geopolitics and central banks.”

With there being less of a supply of something, demand is not as easily absorbed and may have greater implications for the pricing of that something (such as the volatility of volatility itself).

Graphic: Cboe VIX Volatility Index (INDEX: VVIX). Per the Milken Institute, “The VIX is a measure of the expected volatility in S&P 500 index options. It trades as a futures contract, and there are also options traded on this futures contract,” and the VVIX, which is the “expected volatility of the VIX futures contract,” is referred to as “the VIX of the VIX.”

Hence, we see sharper moves in measures of volatility itself as the counterparts to this demand seek to absorb and hedge their risks (in the underlying), in accordance with prevailing regulatory frameworks, among other things.

Though we’ll, once again, explore this phenomenon in later commentaries, as well as the potential implications of its return in size, below is an interesting conversation featuring Kevin Coldiron, co-author of the “Rise of Carry” book pointed to earlier. Check it out!

Positioning: Yesterday’s commentary explained well the implications of recent positioning. If you haven’t checked it out, click here.

Conditions, today, are similar. OPEX’s clearing of existing options exposure, in the coming days, likely opens the door to underlying breadth which has improved markedly since early March. 

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

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

Should there be some exogenous event or weakness on fundamentals, any new demand for protection (in size) likely adds velocity to a leg lower. Caution new buyers.

Graphic: Via Morgan Stanley (NYSE: MS).

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 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 $4,611.75 low volume area (LVNode) puts in play the $4,618.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,631.00 regular trade high and $4,641.75 LVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,611.75 LVNode puts in play the $4,573.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,546.00 spike base and $4,533.00 untested point of control (VPOC), or lower.

Considerations: The market is in balance. This is rotational trade that denotes current prices offer favorable entry and exit. Balance areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

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

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

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

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, 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.