Tag: Volga

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Daily Brief For November 23, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

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Graphic updated 6:45 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Team, it’s been insane on my end. Physik Invest’s Daily Brief will be paused through the end of this week (November 24 and 25). Wishing you happy holidays!

Hopefully, clearer notes and consistent releases to resume, after the break.

Crypto Turmoil Persists:

The FTX (CRYPTO: FTT) debacle has induced even more illiquidity.

Bloomberg’s Matt Levine wrote that the fall in liquidity “has been dubbed the ‘Alameda Gap,’” noting that “[p]lunges in liquidity usually come during periods of volatility as trading shops pull bids and asks from their order books.”

Turmoil and Opportunity:

You may take advantage of the aforementioned uncertainties through arbitrage (i.e., buy at a lower price at one venue and sell at a higher price at another venue). Notice the ~$500 spread on BTC/USDT, for instance.

Graphic: Retrieved from Shift Search at 6:53 AM ET on November 23, 2022.

Elsewhere, the Grayscale Bitcoin Trust (OTC: GBTC) is trading at a ~43.00% discount to the value of the Bitcoin (CRYPTO: BTC) it holds.

Per Bloomberg, “US regulators have repeatedly denied applications to convert GBTC into a physically-backed exchange-traded fund,” and that means the fund is not “able to redeem shares to keep pace with shifting demand.”

To note, the discount pales in comparison to the 101.00% premium to the net-asset value achieved in December 2017. The average net-asset value is a 12.00% premium.

Graphic: Retrieved from Bloomberg.

Anyways, in greater detail, we discussed the crypto turmoil on November 9 and 10. Those notes may be of interest if the context is desired. Though this is not a crypto-focused letter, crypto is “tied up in the liquidity bubble that exists across all assets.”

Graphic: Retrieved from Physik Invest’s Daily Brief posted on November 10, 2022.

As an example, during the week of November 8, when the narrative surrounding FTX’s demise was at its peak, the S&P 500 (INDEX: SPX), Bitcoin (CRYPTO: BTC), and FTX Trading token (CRYPTO: FTT) slid lower, bottomed, and rallied in sync.

Uncertainty, Correlation, and Positioning:

This is a part of the letter that may appear somewhat similar. We continue carrying forward and building on past analyses.

At its core, breakages in correlations some may have observed are accentuated by positioning forces we have talked about recently, as well as the above. These forces are important as you may have noticed the S&P 500’s tendency in responding to areas quoted by this letter.

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

In a nutshell, in light of a “de-grossing of ‘shorts’” per Nomura Holdings Inc (NYSE: NMR), the sale of the volatility investors owned, after events such as elections and CPI, boosted markets indirectly (i.e., counterparty exposure to risk declines as the market rises and investors sell volatility → counterparty reduces the size of their negative Delta hedges → this reduces market pressure and bolsters a rally).

Graphic: Retrieved from Nomura Holdings Inc (NYSE: NMR) via ZeroHedge.

Investors’ continued supply of protection, all the while markets were rising, resulted in further indirect support and, later, prompted responsiveness to key areas at which the options activity was concentrated. This was better detailed on November 16 and 18.

Graphic: Retrieved from Bloomberg.

While this activity is happening – the S&P pinning – underlying constituents are swinging far more amid traders’ own “uneasiness” in stocks and the crypto turmoil; if there are forces pinning and supporting the S&P, all the while there are constraints connecting it to wild(er) components, then something (e.g., correlation) has to give.

Expecting More Of The Same For Now:

Nonetheless, it’s likely for this wild activity under the surface to continue, and for the S&P 500, itself, to be the recipient of even more supportive flows.

For example, the buyback related to the pulled-forward decay of options’ Delta with respect to time (Charm) and continued sale of volatility (Vanna), in a lower liquidity environment, likely results in hedging flows enforcing seasonality and masking the wild(ness) mentioned above.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS) via The Market Ear.

Risks Building Under The Surface:

However, what is happening right now may set the stage for persistently high realized volatility (RVOL) when something bad does happen and those flows we talked about do less to resist that underlying volatility and weakness.

To explain, implied volatility (IVOL) has performed poorly in the context of 2022’s far-reaching decline. That’s in part the result of proactive hedging and monetization of protection (i.e., supply) into the decline.

Graphic: Retrieved from Bloomberg. Measures of equity IVOL tame relative to bonds and FX.

Investors, with IVOL performing poorly, are pushed into better-performing strategies. That includes selling IVOL which does less and less to boost the markets more and more (i.e., per SpotGamma, “the marginal impact of added volatility compression is far lower” at this juncture).

Accordingly, the market is left in a more precarious, less well-hedged position, and that’s concerning given some of the cracks that have appeared including the Credit Suisse Group AG (NYSE: CS) debacle covered in October, the UK liability-driven investment funds covered in September, interest rate swap risks, and beyond.

SCT Capital’s Hari Krishnan talked about some of these risks on a recent podcast.

In Essence, It’s Cheap To Hedge:

According to SpotGamma, “if you wanted to hedge, … it is historically cheap.”

Graphic: Cboe VVIX (INDEX: VVIX) measuring the expected volatility of the 30-day forward price of the VIX. Retrieved from TradingView. Via SpotGamma: “The VVIX is a naive check of participants’ exposure to the volatility of volatility itself (i.e., the non-linear sensitivity of an options price to changes in volatility or Vega convexity). This goes back to the point about the marginal impact of much more volatility compression; the marginal impact of volatility (expansion) compression would have a (bigger) smaller impact, comparatively.”

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma or positive exposure to directional movement).

When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga or positive exposure to IVOL changes).

If there’s a large change in direction (RVOL) or IVOL repricing, you may make money.

As an example, in mid-June, a trading partner and I noticed a change in tone in the non-linearity of volatility and skew with respect to linear changes in the price of the market (or S&P 500). The prices of ratio spread structures (i.e., long or short one option near-the-money, short or long two or more further out-of-the-money) changed by hundreds of percent for only a few basis points of change in the indexes.

At the time, Kai Volatility’s Cem Karsan noted this was “a spike in short-dated -sticky skew, [the] first we’ve seen since [the] secular decline began and it hints [at] a potentially critical change in dealer positioning [and] the distribution of underlying outcomes.” 

“We’re transitioning to a fat left tail, right-based distribution,” he added. 

So why does any of this matter?

In essence, it’s cheap to hedge and the context is there for you to do so, at least from a volatility (not directional) perspective. 

Here is an excerpt from Mohamed Bouzoubaa et al’s book Exotic Options and Hybrids to support some of the earlier statements.

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” Bouzoubaa et al explain. “ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.” 

In other words, by owning protection that’s far from current prices, you are positioned to monetize on a non-linear repricing of volatility, something we saw earlier this year and may continue to see.

Doing this in a manner that cuts decay (when nothing happens) is the difficult part.

Calendar and diagonal spreads come to mind (i.e., sell a short-dated option and buy a far-dated option). You are betting against movement (negative Gamma) over a span of time you don’t think the market will move (e.g., Thanksgiving). And, you are betting on movement (positive Gamma) over a larger span of time (e.g., after Thanksgiving) where decay may not be as accelerated.

Graphic: Retrieved from Trading Volatility, Correlation, Term Structure and Skew by Colin Bennett et al. Originally sourced via Academia.edu.

Ultimately, counterparties’ response to new demands for protection, if something bad happens later, would exacerbate movement and aid in the repricing of IVOL.

At that new IVOL level, there would be more stored energy to catalyze a rally and this letter would express that.

To sell downside volatility (or puts) at this juncture (with time) is a poor trade. To sell downside volatility as part of a larger, more complex structure could be a good trade (e.g., sell a call spread to finance an ultra-wide SPX put ratio spread).

It all depends on structure and management.

Technical

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

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,027.00, $4,051.00, and $4,069.25. 

Key levels to the downside include $3,985.00, $3,965.25, and $3,923.00.

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

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

Definitions

Volume Areas: 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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For November 18, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

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Graphic updated 9:00 AM ET. Sentiment Risk-On if expected /ES open is above the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

A short commentary today after Wednesday’s detailed letter. Take a look at that letter and, some of the below, for context on what we are likely to discuss next. If you are pressed for time, focus on the bolded statements. Have a good weekend!

Positioning

Keeping with the spirit of Wednesday’s ultra-detailed newsletter.

A key point in that letter was traders’ increased activity across short-term options and “anchoring to key areas such as $4,000.00 in the S&P 500.” This activity, in the face of a multi-week price rise, told us a lot about the state of the market. In short, the bigger participants, some of whom move by a committee and seldom respond to technical nuances, were probably waiting for more information before entering.

For that reason, our key S&P levels, quoted in recent letters, are holding.

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

That’s part of the big point we have attempted to get across, recently. Traders “have been flocking to short-dated contracts to cope with the market whiplash of late, an activity that has exerted outsize impact on the underlying equities,” per Bloomberg. Per data shown by SpotGamma, concentrations in these options have prompted pinning near key areas like $4,000.00 in the S&P, before its descent on Thursday.

You can go to Wednesday’s letter for the detailed explanation but, in short, the reach for positive exposure to the upside (+Delta) lent to recent market relief. Then, per the sales of volatility, just this last week, the sentiment changed to a wait-and-see stance.

Graphic: Retrieved from JPMorgan Chase & Co (NYSE: JPM).

As already stated, this wait-and-see stance was expressed through short-dated options that are highly sensitive to changes in direction (i.e., these options can go from having a lot of value or Delta to little, over a short window of time). This sensitivity is expressed via the higher Gamma of near-the-money options.

Graphic: Retrieved from Bloomberg.

For a quick check of how sticky these areas may be, one has to look at the level of +Gamma which has been on an uptrend.

As traders wait for more information and take bets against the market movement (i.e., volatility is sold or -Gamma) counterparties take on more +Gamma (i.e., their side of the bet does better when the market moves).

In hedging this +Gamma, counterparties reduce market movement (i.e., counterparty buy call and sell [buy] futures into price rise [dip]).

The shorter-dated the options, the more sensitive they are; options values (or Delta) can rise or fall quickly as Gamma increases when time passes. That may mean that the reaction results in movement reducing (further), and pinning near key areas.

Again, see Wednesday’s ultra-detailed newsletter for more detail.

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

Another consequence, as picked up by individuals online including Darrin John, the S&P 500’s realized volatility (RVOL) “is so high” with “a basket of 500 of the ‘best’ stocks in the US [wildly] swing[ing] +5% in a single day,” while the S&P 500 is relatively mute, or your letter writer sees it.

That’s because of the following:

If there are forces that are pinning the S&P 500, all the while there are arbitrage constraints connecting its wilder components (in which traders are more uncertain and actively betting on direction and hedging), then correlation must suffer.

Graphic: Retrieved from Bloomberg.

In the face of brewing uncertainties, reflected in index put options activity that has translated “to an uptick in open interest at $3,900.00 and $3,950.00” in the S&P 500, per SpotGamma, -Gamma has increased.

Graphic: Retrieved from Bloomberg. Via Goldman Sachs Group Inc (NYSE: GS). “Broadly, hedge funds’ net leverage, a gauge of risk appetite that measures the industry’s long versus short positions, sat in the 24th percentile of a one-year range, Goldman data show.”

If you take the statements about +Gamma above and reverse them, the opposite happens. With less +Gamma in the market, the result is less dislocation and index movement that is more in line with its wilder underlying components, hence the measured whipsaw, yesterday.

Anyways, today there’s a “$2.1 trillion options expiration” that will clear the deck of some of that sticky +Gamma we talked about earlier. Per SpotGamma, dealers are likely to react in a manner that “allows the market to move more.”

Graphic: Retrieved from Bloomberg. Via Goldman Sachs Group Inc (NYSE: GS).

One could construe that as bearish but it may pay more to not do so. The market is trading in a period during which there’s less liquidity. That may mean this hedging, for one, may result in continued support. The Holiday period pulls forward Delta buyback linked to options’ decay with respect to the passage of time (Charm). Therefore, per SpotGamma, weakness after expiration likely is contained.

“The potential for more violent downside (i.e., new YTD lows) increases into the end of the month and early December due to the large December options expiration.”

Graphic: Retrieved from SpotGamma.

For that reason, with “[l]​​ow skew and vol-of-vol,” entering trades that are convex and change non-linearly with respect to changes in underlying implied volatility (IVOL) and direction, are attractive.

That’s because of the following dynamics:

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma). When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga). If there is a large enough change in direction (RVOL) or IVOL, you may make money.

Graphic: Retrieved from Banco Santander SA (NYSE: SAN).

Technical

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

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,027.00, $4,069.25, and $4,136.75. 

Key levels to the downside include $3,965.25, $3,923.00, and $3,871.25.

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

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

Definitions

Volume Areas: 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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For November 16, 2022

Physik Invest’s Daily Brief is read by over 1,200 people. To join this community and learn about the fundamental and technical drivers of markets, subscribe below.

Subscribe
Graphic updated 7:15 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of this letter. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) with the latter calculated based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Click to learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

There will be no Daily Brief published on Thursday, November 17, 2022.

Positioning

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to enter into such trades including protective collars (i.e., sell call, buy put), as stated in yesterday’s letter and explicitly discussed by the likes of Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott. 

To quote McElligott: The “legacy ‘short skew’ trade that’s been the key US equities vol theme of 2022 is now at risk of its own ‘regime change’ reversal, too. This is, then, especially interesting when considering that ongoing VIX call [or] call spread buying … generally some pretty ‘tail-y’ stuff that is beginning to get loaded into.”

Graphic: Retrieved from The Ambrus Group’s Kris Sidial. This is “gutter low vol.”

Entering trades that change non-linearly with respect to changes in implied volatility (IVOL) and direction (Delta) exposes participants to convexity (Gamma).

A simple way to think about this is if the market was to shock lower by one, all else equal, the derivative’s value would change in excess of that. On the other hand, if one was short static (not dynamic) Delta, meaning they profit from that movement lower, profits realized would be one for one with the change in the underlying.

Graphic: Retrieved from Banco Santander SA (NYSE: SAN).

So, given the flat skew we mentioned earlier, it is attractive in price to hedge against the downside. Whether that downside materializes, is another story.

Graphic: Retrieved from Goldman Sachs Group Inc (NYSE: GS). Equity skew is so depressed in the US that one could buy a multiple of the calls they sold in the S&P 500, elsewhere.

Food For Thought:

This is amidst the responsiveness near key technical areas provided in past letters. It suggests traders with short time horizons are very active and anchoring to key areas, such as $4,000.00 in the S&P 500. These same participants will often lack the wherewithal to defend retests, and big participants (some of whom move by committee) seldom respond to those technical inflections. 

Graphic: Retrieved from SpotGamma.

According to SpotGamma, a provider of data and written analyses on the options market, data shows the “$4,000.00 strike continu[ing] to dominate both in terms of position sizing” with calls, at that level most likely “being sold, which has helped maintain $4,000.00 resistance.”

The sale of IVOL leaves counterparties with long (+Delta) exposure to be hedged through sales (-Delta) of the underlying. As the market trades higher, these options, which are very close to current market prices, have a lot of Gamma, meaning they are very sensitive to changes in the price of the underlying (or convex and non-linear to direction). That means these options can go from having little value to a lot of value, quickly.

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

If the market is below $4,000.00 and trading higher, while at $4,000.00 there is a lot of this trade going on, then the counterparty will sell the underlying to offset gains in their options while the reverse happens if the market is trading down, as SpotGamma data showed, yesterday. When the market traded lower, positive Delta was firing off, which is supportive, hence the mean-reversion back to $4,000.00 into the close.

Graphic: SPY HIRO. Retrieved from SpotGamma’s Twitter. Posted 11/15/2022 at 1:42 PM ET.

A quick check of how sticky these areas may be, look at the level of positive Gamma.

As traders bet against the market movement, counterparties take on more exposure to positive Gamma. In hedging this positive Gamma, the counterparty does more to reduce market movement.

Couple this mean-reversion-type activity with the structural Delta buyback linked to the passage of time (Charm) and compression of volatility (Vanna), these conditions do more to bolster continued relief, as put forth by Goldman Sachs Group Inc.

Another consequence, as picked up by individuals online including Darrin John, the S&P 500’s realized volatility (RVOL) “is so high” with “a basket of 500 of the ‘best’ stocks in the US [wildly] swing[ing] +5% in a single day,” while the S&P 500 is relatively mute, as your letter writer sees it.

In general, something has to give. If there are forces that are pinning the S&P 500, all the while there are arbitrage constraints connecting the components and all, then correlation must break and dispersion must increase. In short, this is a trader’s market; data shows managers tend to “outperform the worst by more during periods of lower correlation,” as does “higher dispersion.”

Should traders continue to hone in on key areas, and add to the interest and volume near those areas, then the market is likely prone to more of the same. Expect pinning and sideways to up. If there were to be a decrease in positive Gamma exposures, that likely opens the door to more movement. Likewise, if traders’ bets are concentrated elsewhere (higher or lower), that can open the door to relief. A catalyst for that may be something fundamental.

The Key Takeaway:

Recent happenings mimic that of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).” 

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

Simple trades to protect (or capitalize on this) include collars, as stated earlier, as well as calendars. If you expect RVOL on the index level, at least, to be mute, then sell short-dated exposure and use those proceeds to purchase farther-dated exposure (e.g., sell weekly put to buy monthly put).

Why? 

When you think there is to be an outsized move in the underlying, relative to what is priced, you buy options (+Gamma). When you think there is to be an outsized move in the implied volatility, relative to what is priced, you buy options (+Volga). If there’s a large change in direction (RVOL) or IVOL repricing, you may make money. 

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of IVOL to levels where there would be more stored energy to catalyze a rally,” as we saw after elections and CPI … 

Graphic: Commentary published by Kai Volatility.

… alongside the Dollar’s (INDEX: DXY) weakness which is easing the burden on margins and global funding.

Per Morgan Stanley (NYSE: MS), “simple math on S&P 500 earnings from currency is that for every percentage point increase on a YoY basis, it’s [] a 0.5 hit to EPS growth.”

Graphic: Retrieved from Bloomberg.

Technical

As of 7:15 AM ET, Wednesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of prior-range and -value, suggesting a limited potential for immediate directional opportunity.

Our S&P 500 pivot for today is $4,000.25. 

Key levels to the upside include $4,027.00, $4,069.25, and $4,136.75. 

Key levels to the downside include $3,965.25, $3,913.00, and $3,871.25.

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

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

Definitions

Volume Areas: 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 writes options market analyses at SpotGamma and is a Benzinga journalist. 

His past works include private discussions with ARK Invest’s Catherine Wood, investors Kevin O’Leary and John Chambers, the infamous Sam Bankman-Fried of FTX, former Bridgewater Associate Andy Constan, Kai Volatility’s Cem Karsan, The Ambrus Group’s Kris Sidial, the Lithuanian Delegation’s Aušrinė Armonaitė, among many others.

Contact

Direct queries to renato@physikinvest.com or Renato Capelj#8625 on Discord.

Disclaimer

Do not construe this newsletter as advice. All content is for informational purposes.

Categories
Commentary

Daily Brief For September 16, 2022

The daily brief is a free glimpse into the prevailing fundamental and technical drivers of U.S. equity market products. Join the 900+ that read this report daily, below!

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Graphic updated 6:50 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

Administrative

A longer note so stick with me!

Updates are pending for the above dashboard. Exciting! Beyond this, the newsletter is getting a revamp in other parts. If you have any feedback on what should be changed, please comment!

Also, I am going to refer everyone to a conversation between Joseph Wang and Andy Constan, as well as some updates Cem Karsan of Kai Volatility made (HERE and HERE). That is, in part, a primer for what we will be talking more about, soon.

Fundamental

Talked about yesterday was the prospects of contractionary monetary policy reducing inflation and growth. BlackRock Inc (NYSE: BLK) strategists, even, put forth that a “deep recession” is needed to stem inflation. In short, “there is no way around this,” they claim.

Graphic: Retrieved from The Market Ear. FedEx Corporation (NYSE: FDX) sold 20% on warning about the global economy.

From thereon, we talked about how rates rising would “bring private sector credit growth down,” as well as “private sector spending and, hence, the economy.”

Based on where rates are at, the market may still be too expensive.

Graphic: Retrieved from Bloomberg via Michael J. Kramer. “What is amazing is how expensive this market is relative to rates. The spread between the S&P 500 Earnings yield and the 10-Yr nominal rate is at multi-year lows.”

On the other hand, some argue inflation peaks are in. ARK Invest’s Cathie Wood suggests “deflation [is] in the pipeline, heading for the PPI, CPI, PCE Deflator.” 

Tesla Inc’s (NASDAQ: TSLA) Elon Musk added that he thinks the Federal Reserve (Fed) may make a mistake noting “a major Fed rate hike risks deflation.” Musk suggested the Fed should drop 0.25%, basing his decision on non-lagging indicators, unlike the Fed.

That’s not in line with what CME Group Inc’s (NASDAQ: CME) FedWatch tool shows. Through this tool we see traders pricing an 80% chance of a 0.50-0.75% hike, all the while quantitative tightening (reducing Fed Treasuries and mortgage-backed securities holdings) accelerated on September 15. 

UST and MBS will roll off (which could turn into “outright sales”) at a pace of $95 billion per month, now, increasing competition for funding among commercial banks, and bolstering borrowing costs, as explained, below.

Graphic: Via Physik Invest. Data compiled by @jkonopas623. Fed Balance Sheet data, here. Treasury General Account Data, here. Reverse Repo data, here. NL = BS – TGA – RRP.

According to Bank of America Corporation (NYSE: BAC), since 2010, nearly 50% of the moves in market price-to-earnings multiples were explained by quantitative easing (QE), the inverse of QT, through which the Fed (or central banks, in general) creates credit used to buy securities in open markets, MarketWatch explains.

Graphic: Retrieved from the Federal Reserve Bank of Richmond. “The Fed Is Shrinking Its Balance Sheet. What Does That Mean?”

The “purchases of long-dated bonds are intended to drive down yields, which is seen enhancing appetite for risk assets as investors look elsewhere for higher returns. QE creates new reserves on bank balance sheets. The added cushion gives banks, which must hold reserves in line with regulations, more room to lend or to finance trading activity by hedge funds and other financial market participants, further enhancing market liquidity.”

Graphic: Retrieved from Bank of America Corporation (NYSE: BAC) via MarketWatch.

The liability side of the Fed’s balance sheet is what “matters to financial markets.” 

Thus far, “reductions in Fed liabilities have been concentrated in the Treasury General Account, or TGA, which effectively serves as the government’s checking account” to run the day-to-day business.

Given that we’re talking about balance sheets, here, Fed liabilities must match assets. Thus, a rise in the TGA must be accompanied by a decline in bank reserves (which are liabilities to the Fed). This, as a result, decreases the room banks have to “lend or to finance trading activity by hedge funds and other financial market participants, [which] further [cuts into] market liquidity.”

With the Treasury set to increase debt issuance, boosting TGA, it will effectively take “money out of the economy and put[] it into the government’s checking account.” The linked reduction in bank deposits and reserves bolsters “repurchase agreement rates and borrowing benchmarks linked to them, like the Secured Overnight Financing Rate,” per Bloomberg.

Graphic: Retrieved from the Federal Reserve Bank of New York. “The Secured Overnight Financing Rate (SOFR) is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities.”

Adding, this may play into “an additional tightening of overall financial conditions, in addition to the increase in the main fed funds rate target that the central bank intends to continue boosting.”

This will “put more pressure on the private sector to absorb those Treasurys, which means less money to put into other assets” that may be riskier, like equities, said Aidan Garrib, the head of global macro strategy and research at Montreal-based PGM Global.

Positioning

As of 6:50 AM ET, Friday’s expected volatility, via the Cboe Volatility Index (INDEX: VIX), sits at ~1.44%. Net gamma exposures decreasing may promote generally more expansive ranges.

Graphic: Via Physik Invest. Data retrieved from SqueezeMetrics.

Given where realized (RVOL) and implied (IVOL) volatility measures are, as well as skew, it is beneficial to be a buyer of options structures.

This is as there’s been a lot of speculation, particularly on the downside (put options), setting the stage for a more volatile and fragile market environment, says Kai Volatility’s Cem Karsan.

“On the index level, people are not well hedged,” a departure from what the case was heading into and through much of 2022. It’s the case that heading into 2022, traders were well hedged. Into and through the decline, traders’ monetization of existing hedges, as well as counterparty reactions, “compressed volatility” realized across US equities, as explained on July 15, 2022.

This made for some attractive trade opportunities seen here.

Graphic: Retrieved from The Market Ear. “VIX has decoupled from cross-asset volatilities.”

Now, given that the go-to trade is to sell stock and puts, short interest has grown, as have other risks, associated with this activity; essentially people are “los[ing] faith in convexity and risk premia’s ability to work,” as a result of “poor performance of vol,” and, the reaction to their “pain and financial loss,” is setting the stage for tail risks heading into the Q1 and Q2 2023.

The sale (purchase) of the front (back) expirations will bolster market pinning; as SpotGamma puts forth, “the positive impact of put closers and rolls, as well as decay,” is easing the market drop. However, this “positioning likely compounds drops and adds to volatility,” in the future.

To quote: “Though the removal of put-heavy exposures can boost markets higher, too add, the positive impacts are dulled via the demand for put exposures at much lower prices.”

Graphic: Retrieved from SpotGamma.

These particular options, which are at much lower prices, “are far more sensitive to changes in direction and IVOL,” as I explained in a SpotGamma note. These options can go “from having very little Delta (exposure to direction) to a lot more Delta on the move lower,” quickly.

Graphic: Via Mohamed Bouzoubaa et al’s Exotic Options and Hybrids.

“If we maintain that liquidity providers are short those puts, a positive Delta trade, then those liquidity providers [will sell] futures and stock, a negative Delta trade to stay hedged.”

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

Technical

As of 6:50 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher.

Any activity above the $3,909.25 MCPOC puts into play the $3,935.00 VPOC. Initiative trade beyond the latter could reach as high as the $3,964.75 HVNode and $4,001.00 VPOC, or higher.

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

Any activity below the $3,909.25 MCPOC puts into play the $3,857.25 HVNode. Initiative trade beyond the latter could reach as low as the $3,826.25 and $3,770.75 HVNodes, or lower.

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

Considerations: A feature of this 2022 down market was responsiveness near key-technical areas (that are discernable visually on a chart). This suggested to us that technically-driven traders with shorter time horizons were very active. 

Such traders often lack the wherewithal to defend retests and, additionally, the type of trade may be indicative of the other time frame participants waiting for more information to initiate trades.

That’s changing. The key levels, quoted above, are snapping far easier and are not as well respected. That means other time frame participants with wherewithal are initiating trades. 

Those are the participants you should not fade.

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For June 22, 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!

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What Happened

Overnight, equity index and commodity futures were sideways to lower all the while bonds and volatility were bid. 

This is after participants, based on metrics included later in the letter, took the advance as an opportunity to sell at higher prices. Demanded was protection, and this bid implied volatility.

Big headlines include China sending warplanes near Taiwan after the U.S. rejected its strait claims. The Taiwanese Foreign Minister Joseph Wu wrote that the threat was “more serious than ever.” This is, also, ahead of Taiwan and U.S. officials talking about arms sales.

In other news, Congress was called on to pass a $0.184 per gallon gasoline tax holiday. Growth in job postings slowed as Q2 GDP forecasts have been revised lower, Chinese manufacturing orders declined by 20-30%, U.K. inflation hit a 40-year record, and sellers of homes are cutting prices in some of the hottest markets while the demand for adjustable-rate mortgages surges.

Ahead, the Federal Reserve’s (Fed) Patrick Harker speaks at 9:00 AM ET. Then, Jerome Powell testifies to the Senate Banking Committee at 9:30 AM ET. Later, Charles Evans speaks at 12:50 PM ET, followed by Harker and Barkin, again, at 1:30 PM ET.

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

What To Expect

Fundamental: For what it is worth when it comes to talking of theory and the economy, ARK Invest’s Cathie Wood has been spot on, in many ways.

Somewhat pursuant to our detailed analysis on May 18, 2022, which talked about the impact of reduced liquidity and credit on the real economy and asset prices, Wood explained that the U.S. fell into a recession during the first quarter.

Read: Daily brief for May 18, 2022.

“If massive inventor[ies] bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year,” she said. Last year, though badly timed, Wood said that inflation would be on its way out due in part to excess inventory which would be reflected in commodity prices.

Read: Walmart Inc’s (NYSE: WMT) inventory glut to reduce in a “couple of quarters” and how Target Corporation’s (NYSE: TGT) oversupply problem should scare all retailers.

Graphic: Via Bloomberg. “The hot commodities rally is cooling off fast as recession fears again ground and cloud the outlook for demand.”

“If inventories and stock prices are leading indicators for employment and wages, … then fears of cost-push inflation a la 1970’s should disappear during the next six months.”

To put it briefly, as we’ve talked about in the past, the recent market rout is a recession and the direct reflection of the unwind of carry. It is the manifestation of a deflationary shock, and today’s sentiment and reducing demand for goods, among other things, reflect this.

And, with that, after a period during which capital was misallocated, the Fed is not in a position to control price stability “without bringing down the markets,” per Kai Volatility’s Cem Karsan.

Read: Kris Abdelmessih’s Moontower #148 on prevailing macroeconomic perspectives.

In light of these efforts to control price stability, to remain is a continued reach for cash (or bank deposits) and the sale of non-cash assets.

Graphic: Via Redfin Corporation (NASDAQ: RDFN).

“Bonds are not acting as a hedge and appear to be becoming less ‘money’ like due persistent declines in price and elevated rate vol,” as Joseph Wang, who was a trader at the Fed, puts it.

Bank deposits are to drain about $1 trillion or so by year-end, prompting investors to “continue to lower their selling prices to compete for the cash they want.”

Graphic: Per Bloomberg, “[E]very $1 trillion of QT will equate to a decline of roughly 10% in stocks over the next 12 months or so.”

If it provides any solace, per comments by Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, the Fed, which “can only deal with nominal [and] not real chokepoints,” is likely to change course.

This is as “nominal balance sheet and liquidity trends will, at some point, clash with the realities of a garden variety of supply chain issues.”

Likewise, Andreas Steno Larsen explains that bond yields remain governed by demographics, and this is good news for stocks, in general.

“Just look at the growth rate of the working-age population (10 years forward) versus the term premium of US Treasury bonds. The current bond bear market is not standing on structural pillars.”

Graphic: Via Andreas Steno Larsen. “Bond yields remain governed by demographics over the medium-term. Low(er) for longer.”

Positioning: To preface, I encourage everyone to check out the Daily Brief for June 17, 2022.

Moving on. So, last week, we had a large monthly options expiration (OPEX). After this, liquidity providers’ re-hedging flows supported the market.

Over the weekend, into Tuesday’s U.S. close, equities, then, traded higher. The rally, however, was not confidence-inspiring and was indicative of short-covering.

Per SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator, participants took the relief rally “as an opportunity to hedge/sell,” as I wrote for SpotGamma, yesterday.

Graphic: SpotGamma’s combined HIRO reading for the S&P 500 (INDEX: SPX) and SPDR S&P 500 ETF Trust (NYSE: SPY). Trade was responsive (i.e., buy dip, sell rip) up until 2:00 PM ET when demand for negative delta (i.e., put buying, call selling) outweighed that for positive delta.

This ultimately showed up in broad measures of implied volatility. As The Ambrus Group’s Kris Sidial said: “[I]n the final hour, spot [and] vol up.”

This plays into decreased odds for a far-reaching rally. Participants are positioned out in strikes that are lower and the activity in those strikes plays into a change in tone with respect to the non-linearity and strength of volatility and skew with respect to linear changes in asset prices.

As Karsan spoke to, last week, the spikes in short-dated -sticky skew – the “first we’ve seen since [the] secular decline began” – hints at a “critical change in dealer positioning.”

“We’re transitioning to a fat left tail, right-based distribution,” Karsan adds. 

So why does any of this matter?

There still appears to be a heavy supply of options, particularly those with less time to maturity, and skew remains poor-performing (hence comments in prior letters on the benefit of buying into implied skew convexity should volatility reprice).

Graphic: Via Charles Schwab Corporation-owned (NYSE: SCHW) TD Ameritrade’s Thinkorswim. Note historical or realized volatility (RVOL) versus that which is implied (IVOL).

Basically, participants are hedged and volatility remains well-supplied. 

If there was to be forced selling or demand for protection by a greater share of the market in ways not recently seen, then the repricing of the aforementioned structures would be a boon for those who own them.

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

Options have a “non-zero second-order price sensitivity (or convexity) to a change in volatility,” as Mohamed Bouzoubaa et al explain well in the book Exotic Options and Hybrids.

“ATM vanillas are [not] convex in the underlying’s price, … but OTM vanillas do have vega convexity … [so], when the holder of an option is long vega convexity, we say she is long vol-of-vol.”

In other words, by owning that protection – e.g., butterfly and back spreads – you are positioned to monetize on a continued non-linear repricing of volatility. The difficult part is cutting the decay of those spreads when nothing happens.

Read: Trading Volatility, Correlation, Term Structure and Skew by Colin Bennett et al. Originally sourced via Academia.edu.

As an aside, despite the bearish tilt in positioning, there has been a notable uptick in index call buying per UBS Group AG (NYSE: UBS), presumably so that participants don’t miss out on a vicious reversal, should one transpire.

Graphic: Via UBS Group AG.

Adding, the “high starting point” in IVOL makes it possible to put on zero- and low-cost bets that deliver asymmetric payouts in case of violent and short-lived reversals. 

Read: Daily Brief for May 13, 2022.

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 inverse of a back spread).

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 $3,696.00 low volume area (LVNode) puts in play the $3,722.50 LVNode. Initiative trade beyond the LVNodes could reach as high as the $3,735.75 and $3,770.75 high volume areas (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,696.00 LVNode puts in play the $3,675.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,639.00 RTH Low and $3,610.75 HVNode, or lower.

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

Considerations: Gap scenarios are in play, today.

Gaps ought to fill quickly. Should they not, that’s a signal of strength; do not fade. Leaving value behind on a gap-fill or failing to fill a gap (i.e., remaining outside of the prior session’s range) is a go-with indicator.

Auctioning and spending at least 1-hour of trade back in the prior range suggests a lack of conviction; in such a case, do not follow the direction of the most recent initiative activity.

Definitions

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.

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 13, 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!

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What Happened

Overnight, futures for commodities, the equity indexes, and bonds were weak. There was no salvation in different assets. Instead, the realized correlation, across markets, tightened.

This is on the heels of inflation data updates that have traders pricing a 50-50 odds for a 75 basis point interest rate hike in July, after a 50 basis point hike this month.

That said, Ben Bernanke, who is a former Federal Reserve (Fed) Chair, said monetary policy leaders may be able to sidestep a big recession, expressing hopes that improvements in supply chains, among other things, would help rein inflation.

In other news, Chinese military officials warned their U.S. counterparts to avoid the Taiwan Strait and dismissed the need for the United Nations to review labor standards in the Xinjiang region.

This is as Britain’s economy unexpectedly shrank and Russia claims it has destroyed U.S. and European weapons stores in Ukraine. Additionally, despite OPEC+’s modest output gains, the average price of a gallon of gas rose to over $5 per gallon in the U.S. 

This output shock is likely to last into 2023 with gas potentially reaching as high as $6-$7.

Interestingly, as an aside, power grid operators in the Midwest are suggesting rolling blackouts in the coming years. This is just as power use in the South hit all-time records.

Ahead is data on inflation expectations (11:00 AM ET). This week’s focus is on the Federal Open Market Committee’s (FOMC) monetary policy decisions and large derivative expirations.

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

What To Expect

Fundamental: The CPI report was released Friday. 

Expected was an 8.2% rise year-over-year (YoY) and 0.7% month-over-month (MoM). Core CPI (which excludes food and energy) was to rise by 5.9% YoY and 0.5% MoM, respectively.

Officially, the headline number rose to 8.6%, and, the same day, consumer sentiment dropped to record lows while expectations for inflation (5-10 years from now) jumped 0.3%.

Graphic: Via All-Star Charts. Taken from the Weekly S&P 500 ChartStorm.

As Bloomberg’s John Authers put it well, the report’s details “were if anything even more alarming. There’s no way around it; this was a bad report.”

Graphic: Via Schroders plc (OTC: SHNWF). Taken from the Weekly S&P 500 ChartStorm. “Everyone’s (current) favorite economic data report was out this week and it showed annual CPI inflation running at an 8.6% clip. On this chart that would imply a P/E ~11x (Current P/E is ~20x).

Subsequently, a key part of the U.S. yield curve turned upside down while traders priced more tightening by September (i.e., two 50 basis point hikes and one that is potentially 75 basis points), selling nearly everything but the U.S. dollar.

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

Early last week, after commentaries resumed, we talked about the reach for cash amid poor safety in fixed income and stock price declines.

Ultimately, to quote Joseph Wang who was a trader at the Fed, 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 McClellan Financial Publications. “These bonds move a lot more like the stock market than like T-Bonds. What makes them even more interesting is that they tend to be terribly sensitive to liquidity, both good and bad.”

“Inflation is eating margins, eating consumer demand, and causing the dramatic monetary tightening we are witnessing. None of this is good for stocks,” said James Athey of Abrdn. 

“There is still much downside to come.” 

Positioning: In short, prior-mentioned supply and demand dynamics resulted in divergences between the volatility that the market realizes (RVOL) and that which is implied (IVOL).

Graphic: Via Robson Chow, founder at Tradewell. The SPDR S&P 500 ETF Trust (NYSE: SPY) “is off ~5% in two trading sessions and implied volatility is still below realized volatility.”

Basically, participants are hedged and volatility remains well-supplied, due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

Consequently, the market’s descent has been orderly and not exacerbated by the demand for hedges and associated repricings of volatility.

This was expected, per Kai Volatility Cem Karsan’s commentary published in December 2021.

Graphic: Commentary published by Kai Volatility.

Accordingly, for “divergences in RVOL and IVOL to resolve, it would likely take forced selling,” as I explained in a recent SpotGamma commentary.

This is similar to the happenings of the Global Financial Crisis when, according to The Ambrus Group’s Kris Sidial, “vol slowly [ground] until the eventual October 2008 move (i.e., Lehman).”

“The markets were understanding that there was a change going on, especially in credit. But that risk was discounted until it was forced into realization.”

In light of this, on June 8, we talked about long 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).

Why would you do that?

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.

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

Ultimately, “liquidity providers’ response to demand for protection (en masse) would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

More on these dynamics later this week.

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

In the best case, the S&P 500 trades higher; activity above the $3,808.50 HVNode puts in play the $3,836.25 LVNode. Initiative trade beyond the $3,836.25 LVNode could reach as high as the $3,863.25 LVNode and $3,911.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,808.50 HVNode puts in play the $3,768.25 HVNode. Initiative trade beyond the $3,768.25 HVNode could reach as low as the $3,727.75 and $3,688.75 HVNode, or lower.

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

Definitions

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

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

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!

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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 24, 2022

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

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What Happened

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

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

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

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

Graphic updated 6:15 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

What does this mean?

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

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

Graphic: Via Millbank Dartmoor Portsmouth.

How to play?

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

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

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

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

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

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

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

Graphic: Via SpotGamma.

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

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

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

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

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

Such traders often lack the wherewithal to defend retests.

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 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!

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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 9, 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!

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What Happened

Overnight, equity index, commodity, and bond futures were all lower while yields, and implied volatility metrics we monitor were bid.

This is as new fundamental data did little to disrupt the Federal Reserve’s (Fed’s) course to hike rates and reduce the size of its balance sheet, as well as the odds of further slowing as a result of actions to curb the spread of COVID-19 abroad, and geopolitical conflict.

Goldman Sachs Group Inc (NYSE: GS), among others, cut their equity market forecasts. Presently, they see an economic contraction playing into the S&P 500’s test of $3,600.00.

Notable is the market’s retest of a very key technical area ($4,055.75 in the E-mini S&P 500). This area, last week, likely solicited responsive buying by technically-driven market participants who often lack the wherewithal to defend retests, just days before the Fed’s decision on policy.

Now, the market is set to open below those key technical areas and that is the worst outcome.

Ahead is data on wholesale inventories (10:00 AM ET), as well as inflation (11:00 AM ET).

Graphic updated 6:35 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Positioning: Last week’s letters went in-depth on the implications of volatility divergences, the post-Fed rally, responses to key technical levels, and beyond.

On Friday, May 6, 2022, this letter essentially remarked the following:

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.

Graphic: Via MarketWatch. “[B]ack-to-back swings in the internals on the scale seen this week are rare, with the last one occurring close to the COVID lows in stocks of March 2020. Indeed, investors had never seen a swing in internals as severe as Thursday’s before the financial crisis of 2008-09.”

How do you know whether the risk is worth the reward? 

A naive measure like the Cboe VVIX Index (INDEX: VVIX), which measures 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.

Graphic: Updated May 6, 2022. The VVIX via Physik Invest.

We’re not there yet and the market remains well-hedged, as SpotGamma explains well:

“From an options perspective, participants would have to demand en masse protection (buy puts, sell calls) for liquidity providers to further take from market liquidity (sell into weakness) and that volatility skew to, essentially, blowout (e.g., Corona crisis, Meme mania, and the like).”

Pursuant to those remarks, SpotGamma sees markets reaching a lower limit near the $4,000.00 SPX area. At that juncture, the rate at which liquidity providers add pressure in their hedging activities flattens as they, too, have hedges.

Graphic: Via SpotGamma. Updated April 27, 2022.

“In turn, dealers may be able to advantageously reduce delta hedging (sell less), and supply markets with more liquidity (buy more stock). This could serve to reduce volatility.”

Noting, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma.

Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

This is amid what is a front-running of the bullish flow associated with the delta decay of options with respect to changes in volatility (vanna) and time (charm), among other factors.

In other words, it is participants’ increased awareness of the implications of options and OPEX that has resulted in a front running. According to SqueezeMetrics, “People didn’t know about the OpEx week effect (in this case, largely charm). Now everyone and their mother knows about it.’”

So what?

Charm is a measure of an options delta’s change with respect to the passage of time. As time passes, delta “bleeds” as options decay. 

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.”

As most participants, at least at the index level, own protection, the counterparties to this trade are short protection. These counterparties, therefore, have positive exposure to delta (i.e., as index falls [rises], position loses [makes] money) and negative exposure to gamma, or delta (directional) sensitivity to underlying price changes (i.e., as the index moves against short option exposure, losses are multiplied). 

Moreover, given the growth of options volumes, participants’ heavy demand for protection matters more, to put simply. Counterparties, in light of this recent drop, pressured markets with their hedging. The decay (and eventual expiry) of this protection marks options deltas down.

Graphic: Via Bloomberg. Rising put volumes coincide with early 2022 market sell-off.

To re-hedge, counterparties buy back short stock and futures hedges. This supportive action is what has been front-run. The bullishness of the event can happen in the days and weeks prior.

Technical: As of 6:35 AM ET, Monday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a negatively skewed overnight inventory, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $4,055.75 low volume area (LVNode/gap boundary) puts in 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 (MCPOC), or higher.

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

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

Considerations: Last Tuesday, we discussed the response to a key technical level ($4,055.75).

Specifically, the E-mini S&P 500 probed $4,056.00 before staging a sharp reversal and closing higher. This was noteworthy as it told us a lot about who was gaining the upper hand.

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

Such traders often lack the wherewithal to defend retests.

Moreover, heading into last week’s Federal Open Market Committee (FOMC) event, large participants (who often move by committee) de-grossed and hedged resulting in poor reliability of our technical levels.

In the days leading up to the event, these larger had little to do with respect to repositioning. 

The market’s tests of key technical areas solicited responsive buying by these short-term traders, and this played into a rally that continued through FOMC. Post-FOMC, the market quickly succumbed to the initiative selling by longer time frame participants.

All else equal, Monday’s regular trade is expected to start somewhere below a key technical area that solicited strong responsive buying by shorter timeframes. 

Given capital constraints and tolerances, shorter timeframes may fuel an acceleration of the prevailing downtrend.

What People Are Saying

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.