Categories
Commentary

Daily Brief For April 26, 2022

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

What Happened

Overnight, equity index futures auctioned sideways-to-lower ahead of an earnings season that’s set to accelerate.

Concerns that remain include the implications of China’s response to COVID-19, the resolution of the tension between Russia and Ukraine (and the rest of the world for that matter), as well as the intent, by policymakers, to accelerate a pivot to normalization (i.e., rate hikes and beyond).

Graphic: Via Sanford Bernstein. Taken from The Market Ear.

With a larger part of the market moving in sync (as talked about more in the “Technical” section), many strategists suggest the outlook for equities is continuing to worsen and positioning is likely to compound further volatility.

Ahead is data on durable goods and core capital equipment orders (8:30 AM ET), the S&P Case-Shiller U.S. home price index and FHFA U.S. home price index (9:00 AM ET), as well as consumer confidence index and new home sales (10:00 AM ET).

Graphic updated 7:00 AM ET. Sentiment Risk-Off if expected /ES open is below the prior day’s range. /ES levels are derived from the profile graphic at the bottom of 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: “With defensive stocks now expensive and offering little absolute upside, the S&P 500 appears ready to join the ongoing bear market,” Morgan Stanley (NYSE: MS) says.

Graphic: Via Morgan Stanley (NYSE: MS). Taken from The Market Ear. “[T]he accelerative price action on Thursday and Friday may also support the view we are now moving to this much broader sell-off phase.”

“The market has been so picked over at this point, it’s not clear where the next rotation lies. In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison.”

Graphic: Via Bloomberg. “Everyone bearish, but redemptions just starting,” explain Bank of America Corporation (NYSE: BAC) strategists led by Michael Hartnett, adding that the environment of “extreme inflation” and rates shock is just setting in, as the Federal Reserve tightens monetary policy. “75 basis points is the new 25 basis points,” Hartnett said, referring to the scope of future interest-rate hikes.

Adding, Bank of America’s global EPS model predicts negative growth by year-end.

Graphic: Via Bank of America Corporation. Taken from The Market Ear.

Positioning: Monday’s bottoming at $4,200.00, near intraday lows, came as participants sold puts, and the hedging of the consequent volatility compression, thereafter, bolstered a price rise.

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

At this juncture, though positioning appears (a tad) stretched and prices are nearing a lower bound, there may be room for volatility to expand, further.

Per SpotGamma’s Delta Tilt indicator, which “reflects the market approaching a maximum put threshold, [there’s] potential for further hedging that may result in sharp rallies and declines with volatility climaxing around early May (FOMC and potential for Russian Default).”

Graphic: SpotGamma’s Delta Tilt.

This is as options counterparts themselves have hedges (i.e., protective puts) that reduce hedging requirements, so to speak, when underlyings trade down to certain levels. 

SpotGamma explains

“Using this logic, when the downside puts gain value, they may reduce the need to delta hedge. 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.”

So, in summary, participants are pretty well-hedged. Should they begin to monetize protection, that may lower counterparty exposure to positive delta, thus fueling a price rise.

Whether that price has legs is dependent on improvement in the fundamental situation.

Graphic: Via Bloomberg.

Technical: As of 7:00 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the lower part of a 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 $4,272.00 high volume area (HVNode) puts in play the $4,303.75 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,272.00 HVNode puts in play the $4,233.00 VPOC. Initiative trade beyond the VPOC could reach as low as the $4,195.25 regular trade low (RTH Low) and $4,129.50 overnight low (ONL), or lower.

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

Considerations: The market is weak and all major indexes covered by this newsletter are trading below their 20-, 50-, and 200-day simple moving averages.

Additionally, all indexes are below their volume-weighted average prices anchored from the start of this year (or their respective peaks). Further, AVWAPs are a metric highly regarded by chief investment officers (CIOs), among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.

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

The modus operandi is to sell into a flat-to-declining AVWAP. So long as prices are below the below AVWAPs, sellers remain in control and rally attempts are to likely fail, all else equal.

Another important note to make is the market’s poor breadth (via VOLD and ADD). Previously, there were divergences; rate-sensitive areas of the market were sold while more value was bid. Last week, there was a change in tone. All areas of the market were sold, heavily. 

This suggests the potential for a broader sell-off (and this is supported by the U.S. Equity ETF flows graphic included, above).

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Notice the indicator in the top right, weighted S&P sectors (histogram) versus unweighted (blue line). During late last week, participants sold the entire market, heavily (as supported by the difference between the volume flowing into stocks that are up versus those that are down).

What People Are Saying

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 11, 2022

Hey team, you’re going to have to forgive me. Still am traveling through the rest of this month. Therefore, coverage will remain sporadic and less in-depth. Apologies and take care!

What Happened

Overnight, equity index futures were mixed after last week’s liquidation alongside news that the Federal Reserve was interested in sharper interest-rate hikes and balance-sheet reductions to stem inflation. 

China equities were weak on the implications of COVID-19 outbreaks, among other things. 

Some Russian entities entered into effective default, as ruled by markets. The conflict between Russia and Ukraine, that spurred crippling economic sanctions, is ongoing. 

And, in other news, some Bitcoin (CRYPTO: BTC) pundits suggest weakness in risk assets, like technology, may bring down cryptocurrency. 

Crypto prices “do not trade on the fundamentals of being peer-to-peer, decentralized, censorship-resistant digital networks designed for the transfer of money,” explained BitMEX founder Arthur Hayes on correlations with the Nasdaq 100 trading at record highs. 

Crypto “will lead equities lower as we head into the downturn, and lead equities higher as we work our way out of it.”

Ahead is data on NY Fed median 1- and 3-year expected inflation (11:00 AM ET). Fed-speak by Charles Evans (12:40 PM ET). The quarterly earnings season begins this week. Bank stocks to start reporting Wednesday, April 13.

Graphic updated 6:45 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 ruling narrative, so to speak, is concerned with the management of inflation through monetary policies, credit impulse contractions, as well as the implications of Russia’s invasion of Ukraine, China’s COVID-19 actions, and beyond.

Graphic: Via The Macro Compass.

The Federal Reserve’s (Fed) roadmap for shrinking the balance sheet and raising rates was revealed in the recent release of Federal Open Market Committee (FOMC) minutes. 

“The FOMC stayed far too easy for far too long and has belatedly realized their mistake,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC. 

“They are now scrambling to get policy back to neutral as quickly as they can. Once they arrive at something close to neutral, they will have to ascertain over time how far into restrictive territory they have to move to get inflation back under control.”

Graphic: Via Bloomberg.

Moreover, as talked about in past commentaries, quantitative tightening (QT) amplifies the impact of rate hikes.

Per statements by JH Investment Management, through QT, central banks remove assets from their balance sheet. This is “either through the sale of assets they purchased or deciding against reinvesting the principal sum of maturing securities.” 

With that, we note that when bonds rise in value, their yields decline; “when the Fed embarks on bond-buying program[s] to support the U.S. economy, … [it nudges] the prices of these assets higher while pushing yields lower, which also has the effect of driving yield-hungry investors into relatively riskier asset categories that promise high returns.”

As liquidity is removed, this may prompt risk assets to converge with fundamentals.

Graphic: Via Bloomberg. Bonds continue their losing streak. This is amid end-of-quarter rebalancing inflows; “Bonds performed so poorly in the past month that exchange-traded fund investors were forced to buy in record amounts.”

At present, via CME Group Inc’s (NASDAQ: CME) FedWatch tool, participants are pricing in a heightened probability of a half-point hike next month.

Graphic: Via CME Group Inc. FedWatch tool.

Notwithstanding, per Credit Suisse Group AG (NYSE: CS) research, there has been no meaningful breadth disconnect; breadth remains supportive of higher S&P 500 prices.

Via: Credit Suisse research. Taken from The Market Ear.

At the same time, JPMorgan Chase & Co’s (NYSE: JPM) Mislav Matejka sees continued gains in earnings while equity versus credit and bond yields are still supportive of valuations.

Positioning: Keeping this section light, today.

After quarterly rebalances and options expiries, the reduction in counterparty exposure to positive gamma freed indexes (i.e., unpinned), as expected

Why? 

We see counterparties as those participants who take the other side of customer trades. The collapse in realized volatility and the move higher in equity markets solicited counterparties’ decreased (increased) hedging of put (call) options. 

The naive assumption is that counterparties are short (long) put (call) protection. When implied volatility declines and underlyings move higher, counterparties have less (more) exposure to amplified losses (gains). 

To hedge, they sell into strength and buy into weakness, basically.

As participants start to concentrate their bets in shorter-dated expiries, at higher prices, counterparties take from underlying movement in their provision of liquidity. It takes an options expiry, or some exogenous event, to disrupt this balance. 

That happened at the end of last month. Since then, increases in implied volatility and lower underlying equity prices have helped pressure indexes and increase realized volatility.

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

In the best case, the S&P 500 trades higher; activity above the $4,468.75 poor low puts in play the $4,489.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,501.00 VPOC and $4,519.75 overnight high (ONH), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,468.75 poor low puts in play the $4,444.50 weak low. Initiative trade beyond the weak low could reach as low as the $4,409.00 VPOC and $4,395.25 high volume area (HVNode), or lower.

Considerations: 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.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For April 1, 2022

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

What Happened

Overnight, equity index futures auctioned sideways to higher after their late-day liquidation and break from a multi-day consolidation area on technical factors (e.g., options expirations) among other things, potentially, like the increase in personal consumption expenditures.

Broadly speaking, the narrative that investors are showing some concern over the economic outlook, with respect to geopolitical tension and monetary policy, continues to emanate. 

U.S. high-grade bonds shed over 5%, booking the worst quarterly performance since the ‘80s. This is as recession risks have risen more than two-fold. 

Notwithstanding, the Federal Reserve’s (Fed) favorite yield curve metric remains steep; per a Bloomberg commentary, “the gap between the three-month bill rates and 10-year yields is the ‘most useful term spread for forecasting recessions,’ … [and] it currently stands at 186 basis points, versus negative 2 basis points on 2s10s.”

In terms of news, the U.K. will join the U.S. in releasing oil from its reserves to lower prices and reduce its reliance on external partners. This helped ease futures calendar spreads on oil, Reuters’ John Kemp said in a newsletter to followers; the “six-month spread [narrowing] to a backwardation of $9 per barrel, the lowest since before Russia’s invasion of Ukraine.”

Ahead is data on nonfarm payrolls, the unemployment rate and average hourly earnings, as well as labor-force participation (8:30 AM ET). Thereafter, the Chicago Fed’s Charles Evans is scheduled to speak (9:05 AM ET). 

Later is Markit manufacturing PMI (9:45 AM ET), as well as ISM manufacturing index and consumer spending data (10:00 AM ET).

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

What To Expect

Fundamental: The S&P 500 bagged its first quarterly loss in two years as recession probabilities, implied by some yield curves, have risen.

Graphic: Via Barclays. Taken from The Market Ear. “[T]he 1y ahead recession probability implied by the 3m10y curve rises to about 40% a year from now (so for an early 2024 recession), slightly higher than implied by other curves.”

This is as the stock performance, relative to bonds against the lagged spread of 10- and 2-year bond yields, is expected to be weak, according to insights by Pictet Asset Management.

Graphic; Via Pictet Asset Management Ltd. Taken from Bloomberg. “On this basis, stocks’ great outperformance this quarter may end up looking like a head-fake.”

Pictet’s narrative further validates some of the theses shared by institutions like Brevan Howard Asset Management, which is having one of its best years, Morgan Stanley (NYSE: MS), Goldman Sachs Group Inc (NYSE: GS), and Bank of America Corporation (NYSE: BAC).

Adding to the prospects for weaker earnings amid higher costs, among other things, some of these institutions see the potential for the Fed’s terminal rate to reach between 3% and 3.25%.

Graphic: Via Andreas Steno Larsen. “The Fed is now priced to hike to levels above 3% by Dec-2023, … which is the main reason why we have seen a sell-off in all assets with an intensive duration profile over the past 12-15 months … [and has] duration intensive assets … starting to look attractive again from a risk/reward perspective.”

This would hit valuations as higher yields both reduce the present value of future earnings and “hurt those carrying the highest leverage,” potentially playing into a slowdown or recession. 

Graphic: Via S&P Global Inc (NYSE: SPGI) “expects the economic damage [of geopolitics and pricing pressures] to lower U.S. GDP growth to 3.2% this year, matching its preliminary forecast in early March but a full 70 bps lower than its November forecast of 3.9%.”

“Now rates volatility can drive growth volatility and that actually becomes a vicious cycle between the two,” said Christian Mueller-Glissmann of Goldman Sachs. 

“That’s a big difference to the last cycle where growth volatility drove rates volatility.”

Graphic: Via Vanda. Taken from The Market Ear. “The bond market is pricing the 2022 cycle to be remarkably fast. Macro Alf: ‘Remember: sharp changes in borrowing conditions often cause non-linear reactions in a highly leveraged system.’”

However, this is as the dominance of rate-sensitive tech stocks is set to shrink next year amid sector reclassifications, as well as still-stimulative policy and beats of economic expectations that may feed into earnings surprises, later.

JPMorgan’s Marko Kolanoivc explains that (1) “both equity and credit markets have historically fared well at the start of monetary tightening cycles,” (2) “the real policy rate is extremely negative and thus stimulative,” and (3) “not all central banks are tightening.”

Morgan Stanley’s Michael Wilson vehemently disagrees suggesting the recent equity market turnaround “was nothing more than a vicious bear market rally,” and offers participants a clear opportunity to sell at better prices.

Taking all of the above comments and perspectives together, one thing is for certain: this period in history is like no other. It makes sense to pick a timeframe and stick with it. 

Positioning: In the past weeks, according to JPMorgan Chase & Co’s Nikolaos Panigirtzoglou, the supportive “rebalancing flows away from bonds into equities” are no more and, therefore, equities are subject to increased vulnerabilities “if bond yields continue to rise.”

This is after measures of equity implied volatility were crushed heading through the mid-March FOMC and monthly options expiry (OPEX) events, and the options hedging impact of this, at least, was very supportive, as we’ve talked about many times in this newsletter.

Graphic: Via Bloomberg. “The CBOE-VIX index, measuring stock volatility from the options market, unsurprisingly spiked immediately after Russia’s attack. It reached another high three weeks ago. Then the VIX started to fall, and in the two weeks since the Fed unveiled its first rate hike in years, the decline has been almost linear. The ‘fear gauge,’ as it is often known, is now significantly lower than it was a week before the invasion, when markets were priced on the assumption that there would be no war.”

On the contrary, measures of volatility for other assets, like the Merrill Lynch Options Volatility Estimate (INDEX: MOVE), a useful measure of bond market sentiment, are doing the opposite. 

We discussed early last month, what we saw was an increased supply of equity market volatility, as a potential reason for some of these divergences. 

As Bloomberg’s John Authers explained well, it, too, could have been “an aggressive central bank” that prompted a move out of bonds and into equities, and subdued target-date fund rebalancing flows which usually sell stocks and buy bonds.

Graphic: Via Bloomberg.

“[I]t looks as though the contradictions that had built up in the market over the last two years, and in the decade before that, are being put under extreme stress by the double whammy of a newly aggressive Federal Reserve, and the worst geopolitical shock in decades,” Authers adds.

Still, realized volatility continues to trend down which ought to force those (e.g., computer-driven traders) who position (and size equity exposure) based on underlying volatility to load up, again.

Nomura Holdings Inc’s (NYSE: NMR) Charlie McElligott explains that “volatility-targeting funds and trend-following commodity trading advisers, purchased” billions of equity futures which bolstered the price rise of the last weeks.

From a positioning versus buying support perspective, the forward returns distribution is skewed positive but not by a lot; a lot of the supportive options exposure is rolling-off and this could free up (i.e., unpin) indexes for the next leg up or down.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options Indicator shows negative delta trade in the S&P 500 SPY ETF, and this pressured the underlying index.

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

In the best case, the S&P 500 trades higher; activity above the $4,546.00 spike base puts in play the $4,573.25 high volume area (HVNode). Initiative trade beyond the HVNode could reach as high as the $4,583.00 untested point of control (VPOC) and $4,611.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,546.00 spike base puts in play the $4,526.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,515.25 and $4,489.75 LVNodes, or lower.

Considerations: A change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend) occurred.

Continue to monitor for acceptance outside of the balance area. Rejection (i.e., return inside of balance) portends a move to the opposite end of the balance. See the below graphic for more.

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

What People Are Saying

Definitions

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

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

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

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.

Options Expiration (OPEX): Marks change in 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 March 16, 2022

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

What Happened

Stock index futures were higher after positive developments, abroad.

According to some reports, the talks between Russia and Ukraine are making progress. This is while China vows to stabilize markets with a promise “to ease a regulatory crackdown, support property, and technology companies and stimulate the economy.”

On the China news, the Hang Seng China Enterprises Index (INDEX: HSCEI) rose ~13% (in the context of a ~30% 1-month drawdown).

At home, in the U.S., the Federal Reserve is expected to increase rates by a quarter-point, the first since 2018. Markets are pricing up to seven hikes this year.

Ahead is data on retail sales and import prices (8:30 AM ET). The NAHB home builders index and business inventories (10:00 AM ET). As well as the Federal Open Market Committee (FOMC) announcement (2:00 PM ET) and press conference (2:30 PM ET).

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

What To Expect

Fundamental: The 60/40 portfolio is headed for its worst performance since the financial crisis of 2008 as assets are hurt by a mix of slowing economic growth and inflation.

Graphic: Via Morgan Stanley (NYSE: MS). Stocks and bond relationship upended. Adding, per a Bank of America Corporation (NYSE: BAC) survey, participants believe the markets would have to fall 24% (from peak to trough) – $3,636.00 SPX – to solicit a Fed pivot.

Further, this letter has talked about the “bonds down, equities down” phenomenon before. To borrow from letters published over the past two months, in short, over the past 40 or so years, monetary policy was used as a crutch to support the economy. 

Graphic: Via tastytrade. Asset correlations matrix.

This promoted deflation, innovation, and the subsequent rise in valuations.

With rates lifting, that’s a headwind; coupled with participants’ increased exposure to rate and equity market risk, which can play into cross-market hedging and de-leveraging cascades, 60/40 turns into somewhat of a poor hedge.

Why? Let’s back up for a moment.

For an investor to take on additional risk for return, they must receive in excess of the risk-free rate (as provided by the Treasury). This excess is the risk premium.

As Investopedia details well, therefore, “the total return on a stock is the sum of two parts: the risk-free rate and the risk premium.”

Moreover, higher rates and risk premiums increase the required rate of return.

Higher interest rates, basically, decrease the present value of future cash flows, making stocks, especially those that are high growth, less attractive.

So, at higher rates, shares should fall. At lower rates, shares should rise. Some strategists estimate that annual returns for 60/40 will be less than 5% over the next decade, as a result.

Graphic: Via Bloomberg. The FOMC is likely to signal more hikes.

This conversation has me bringing up a conversation I had with Karan Sood, the CEO and Managing Director, Head of Product Development at Cboe Vest Financial LLC.

“Bonds have been giving you really good returns because interest rates have been going down since the 1970s when they peaked at about 11%,” Sood explained to me. 

“That’s changing now; we’re at the zero bound, and it’s unlikely that will be as a strong of a tailwind. Worse, it could be a headwind if interest rates start to rise.”

Graphic: Via Bloomberg. Federal Reserve to raise rates for the first time in years.

In regards to the Federal Reserve’s balance sheet, Bloomberg explains that participants ought to receive updates on the pace of buying, as well as the sale of assets.

“That may include setting out caps on how many billions of dollars worth of Treasuries and mortgage-backed securities will be allowed to mature every month without reinvestment, something that Powell told Congress earlier this month would be discussed at this meeting.”

Graphic: Via Bloomberg. S&P 500 participants proactively price in the Federal Reserve’s intent to cut support. It is monetary frameworks and max liquidity that enabled markets to diverge from fundamentals.

Positioning: Based on a comparison of present options positioning and buying metrics, the returns distribution remains skewed positive.

Graphic: Via Physik Invest. Data via SqueezeMetrics.

Pursuant to the buying support remark, JPMorgan Chase & Co (NYSE: JPM) strategists say pension and sovereign wealth funds, in rebuilding risk-on positions, may boost markets by as much as 10%. 

“It’s the biggest rebalancing since 2020 in terms of buying equities,” JPMorgan strategist Nikolaos Panigirtzoglou said. An inflow of at least $100 billion and as much as $230 billion could trigger gains of between 5% and 10% to global stocks, he said.

Graphic: Via Bloomberg. “[D]eclines have driven down the value of targeted allocations for the world’s biggest funds, many of which hew to a traditional mix of 60% stocks and 40% bonds. To address the shortfall, they have to buy equities.”

At the same time, expected is further compression of volatility (via the passage of FOMC), as well as the removal of customer puts (and associated hedging pressures) via OPEX (options expiration).

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

To note, there is the potential, according to SpotGamma, for some “path dependency,” as “the expiration and/or covering of a large swath of these put hedges may place the market back into an ‘underhedged’ position.” 

In such a case, new demand would add fuel to weakness.

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

Gap Scenarios: 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.

In the best case, the S&P 500 trades higher; activity above the $4,285.25 high volume area (HVNode) puts in play the $4,326.25 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,346.75 HVNode and $4,375.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,285.25 HVNode puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,219.00 VPOC and $4,177.25 HVNode, or lower.

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

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

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

Definitions

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For March 10, 2022

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

What Happened

Overnight, equity index futures auctioned lower practically negating the prior day’s advance. Per the news, Ukraine and Russia failed in their efforts to end the war.

Adding, similar to days prior, areas where there are key technical nuances served as supports and resistances. One may construe this as short-term traders’ dominance in the smaller time horizons while the other time frames are positioning for expansive moves (yet to happen).

To note, key metrics under the hood (SpotGamma’s HIRO, among other things) yesterday, further validated the status quo and short-covering.

Moreover, ahead is data on jobless claims and the consumer price index (8:30 AM ET). Later, participants get data on real domestic nonfinancial debt and wealth (1:00 PM ET), as well as the budget deficit (2:00 PM ET).

Graphic updated 6:40 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Fundamental: The consumer price index (CPI) is to likely accelerate to 7.8% from a year ago.

This forecast varies widely, however, based on economic analysis with respect to the implications of Russia’s invasion of Ukraine and the sanction that resulted after.  

“There’s going to be a lot of noise in the next six months that’s going to be extremely difficult to disentangle,” said Omair Sharif of Inflation Insights LLC. 

“If you thought it was difficult to figure out what used car prices were doing and whether that was transitory, multiply that by a thousand.”

In a mention on energy market volatility, while today’s economy is less dependent on oil (i.e., less likely to kill the expansion), the action in that market (and the responses it may solicit from policymakers, later) is noteworthy.

Graphic: Via Bloomberg. “When families have to spend more money on necessities, they have less to spend on discretionary items and services. Economists at Barclays Plc expect the spike in energy prices to subtract an annualized 0.3 percentage point from consumption growth on average per quarter through the end of 2023.”

Despite a deterioration in the relationship between prices of crude and inflation, oil is “a major input in the economy – it is used in critical activities such as fueling transportation and heating homes – and if input costs rise, so should the cost of end products,” Investopedia says well.

Further, according to Reuters’ John Kemp, fuel oil inventories fell last week to the lowest seasonal level in more than 15 years.

Graphic: Via John Kemp’s “Best in Energy” note. “Distillate stocks were already looking tight and are now on track to become exceptionally tight before mid-year. Distillate inventories are on course for an expected first-half low of 103 million barrels (with a range of 92-114 million).”

“Stocks are on track to hit an even lower seasonal level than 2008 when the distillate shortages helped propel crude oil prices to a record high at the middle of the year,” Kemp says.

Graphic: Via Physik Invest. The CBOE Crude Oil Volatility Index (INDEX: OVX) reveals signs of peaking.

The highest oil prices ~$150/bbl had printed in 2008. As Alfonso Peccatiello of The Macro Compass hypothesizes, “Oil is denominated in fiat currency, and there has been A LOT of spendable money printing over the last 15 years. If you think the market gets as extreme as 2008, the equivalent oil price in today’s USD would be above $250/bbl.”

Given wage growth and the like, consumers likely start “to feel the heat way below $250.”

Graphic: Via Alfonso Peccatiello. “The red line shows the inflation-adjusted crude price: if you expect a proper tight oil environment, >$150-160 is your number. Also, anything above $120 in today’s prices and sustained for a few quarters would likely hit the demand side. 2013-2014 a good example, with the private sector turning defensive in 2015-2016 and China forced to ease big times to shore up the global economy.”

Why mention any of this? Fast moves higher in some of these commodity markets may impact end-consumer prices and behavior, quickly. In a bid to rein inflation – ”very high CPI in 2022, [and] still high in 2023 – central bankers will tighten. 

“The path of least resistance is for the Fed to hike rates from 0% to at least 2% relatively quickly,” Peccatiello explains in a recent post. 

However, the “Last time companies were revising their forward earnings estimates down on a net basis while Central Banks were attempting to tighten monetary policy was mid-2018,” when the markets sold nearly 20%.

Graphic: Via Yardeni Research. Taken from The Macro Compass. “The chart above shows the 3-months average of the MSCI World net earnings revisions: essentially, this metric measures the difference between the number of companies revisiting their forward earnings estimate up versus down.”

With financial conditions tightening, Peccatiello posits the Fed will be receptive to that.

Graphic: Via The Macro Compass. “Credit-default swaps on 5-year US Investment Grade Corporate Bonds are trading at 76 bps at the time of writing: Fed puts (or pivots) became more visible in the past when this measure of credit spreads approached 100 bps.”

Basically, if selling were to continue, the Fed would reassess tightening. At such level of reassessment is the Fed Put, a dynamic we’ve discussed in the past.

Graphic: Via Bank of America Corporation (NYSE: BAC). Retrieved from Callum Thomas.

Chamath Palihapitiya recently posted about this, too. He said: “In 2018, the Fed was concerned about inflation. They were wrong and within a quarter or so, the risk shifted to recession. This chart shows how the equity markets reacted… seems eerily similar.”

“Value then faded and Growth ripped.”

Graphic: Via Morgan Stanley (NYSE: MS).

Positioning: Based on a comparison of present options positioning and buying metrics, the returns distribution is skewed positive, albeit less so than before. 

Graphic: Via JPMorgan, from Bloomberg.

Obviously, the fundamental picture and the market’s responsiveness to news events – given the negative gamma environment – has us discounting these metrics. It’s noteworthy, nonetheless.

For instance, in the face of some positive developments abroad, fundamentally, markets diverged from what participants in the options complex were doing.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator reveals strong put buying and call selling (a bearish negative delta trade) in the context of Wednesday’s rise.

This divergence resolved itself, some, overnight in the broader market (even in the face of a ~7% price rise of Amazon Inc (NASDAQ: AMZN) large index constituent).

I’d be remiss if I did not point out growing bets on drops in the equity market’s pricing of risk (via the CBOE Volatility Index [INDEX: VIXI]). That would occur if indexes likely rebounded.

Graphic: Via SHIFT. There was heavy buying of the 26 VIX put.

Taken together, it’s difficult to get a grasp of where the market wants to head, in the near term. 

What is for certain: the compression of volatility (via passage of FOMC) or removal of counterparty negative exposure (via OPEX) may serve to alleviate some of this pressure. 

Until then, participants can expect the options landscape to add to market volatility.

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

In case of lower prices, according to SpotGamma, the rate at which options counterparties increasingly add pressure on underlying SPX, so to speak, tapers off in the $4,100.00 to $4,000.00 area. Caution.

Graphic: Gamma profile flattens out near the $4,100-4,000 range suggesting less pressure and more counterparty support.

A way to take advantage of this volatility, while lowering the cost of bets, is options spreads. For instance, the Call Ratio (buy 1 call, sell 2 or more further out) can lower the cost of bets on the upside while providing exposure to asymmetric payouts.

Time and volatility are two factors, however, to be mindful of when initiating such spreads. Risk is undefined and if the time to expiry is too long (e.g., in excess of 1-2 weeks), fast moves and increases in volatility may result in large losses. 

For that reason, also, one must be extremely careful with Put Ratio spreads. Consider adding protection far away from your short strikes to cap risk and turn the spreads into Butterflies.

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.

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

Gap Scenarios Potentially In Play: 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.

In the best case, the S&P 500 trades higher; activity above the $4,231.00 regular trade low (RTH Low) puts in play the $4,249.25 low volume area (LVNode). Initiative trade beyond the LVNode could reach as high as the $4,285.75 high volume area (HVNode) and $4,319.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,231.00 RTH Low puts in play the $4,177.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,138.75 and $4,101.25 overnight low (ONL), or lower.

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

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

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

Definitions

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

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

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

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For March 3, 2022

Editor Note: In light of travel commitments, there will be no Daily Brief published tomorrow, March 4, 2022. Thank you for the support and see you next week!

What Happened

Overnight, equity index futures were sideways to lower while commodity and bond products remained bid. Cross-asset volatility measures remain heightened in the face of uncertainties with respect to geopolitical tensions and monetary policy action.

To note, in light of the economic war waged on Russia, participants received positive news from Federal Reserve Chair Jerome Powell who ruled out a 50 basis-point hike.

Moreover, ahead is data on jobless claims, productivity, labor costs (8:30 AM ET), ISM services, factory orders, core capital equipment orders, and Fed-speak by Jerome Powell (10:00 AM ET), as well as John Williams (6:00 PM ET).

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

What To Expect

Positioning: Skipping the fundamentals section and will follow up on (and add to) some notes established in Wednesday’s commentary.

Mainly, cross-asset volatility is spiking as investors are seeking protection against the uncertainties posed by geopolitical tensions and monetary policy action.

Graphic: Via @EffMktHype. “Rate vol through the roof, FX picking up steam while equity vol arguably still cheap in comparison despite being at the high end of its 1-year end.”

As explained, however, the equity market’s pricing of risk (which we can take as being reflected by the CBOE Volatility Index [INDEX: VIX]) is not moving lock-step with that of measures in FX and rate markets.

“The fear in one market tends to feed into the fear of another; regardless of the cause, it seems that equity and bond market participants are not (quite) on the same page,” is the direct quote.

In the subsequent text, I did little to mention the implications of liquidity supply at the index level. This realization came to me while writing some commentary for SpotGamma (who just launched its Hedging-Impact of Real-Time Options indicator or HIRO).

Moreover, the evolving monetary frameworks and intention to take from the max liquidity – which pushed participants out of the risk curve and promoted a divergence from fundamentals – has the effect of removing market excesses that have found their way into volatility markets.

Graphic: Taken from The Ambrus Group’s Kris Sidial. Annual listed option volumes.

Taking a look at the U.S. high yield OAS (option-adjusted spread), participants see a “risk-off” bottom; deteriorating credit conditions are a bearish leading indicator and that’s likely been reflected by the bond market’s pricing of risk (but not equity markets, as noted above).

Graphic: Via St. Louis Fed. ICE BoA High YIeld OAS.

Tempering equity market volatility is likely supply, particularly at the index level, whereas elsewhere, at the single-stock level, underlying components are volatile.

As explained in the SpotGamma note: “We’re using the VIX as a proxy for equity market volatility while underlying components are actually very volatile.” 

“There is a decline in correlation, and this is due to suppressive counterparty hedging of the most dominant customer positioning.”

The dominant positioning at the index level is best explained as follows:

  • Customers have positive directional (delta) exposure to the equity markets.
  • The indexes (in which there are tax advantages, cash-settlement, among other things) provide participants exposure to a diversified and liquid hedge, easy to get in and out of.
  • To hedge positive delta exposure against drops, customers will purchase downside put protection. Puts carry a negative delta and their gains are multiplied to the downside (positive gamma). 
  • To reduce the cost of this hedge, they sell upside call protection (also a negative delta trade). This “offset” so to speak can be initiated as a ratio to the protection carried on the downside (e.g., 2 calls for 1 put, and so on), and this feeds into skewness, also.

Options counterparties, who are on the other side of this customer activity, have positive exposure to direction. 

In selling a put, the dealer has positive exposure to the direction (meaning the position makes money, all else equal, with trade higher), but their losses are multiplied with movement to the downside (negative gamma). 

To hedge this put exposure, all else equal, they must sell into weakness and buy strength.

On the call side, however, the counterparty has positive exposure to delta and gamma (meaning gains are multiplied to the upside).

To hedge this call exposure, all else equal, they must buy into weakness and sell strength.

When, in the normal course of action, protection decays (given that time and volatility trend to zero), counterparty positive delta exposure decreases.

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.”

This solicits the buy-back of short futures hedges (static negative delta against dynamic positive delta options exposure) that can support the market.

As we’ve seen, a feature of falling markets is the demand for protection. When this protection is monetized (or decay ensues), options counterparties add to the market liquidity (i.e., buying back short futures hedges).

A feature of rising markets is the supply of protection (and more active hedging of call options). 

Further, as markets rise, volatility falls. Participants’ demand for yield drives participants further out the risk curve (i.e., they sell more volatility) and this can solicit even more supply.

Pictured: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

As explained in the SpotGamma note: “The counterparty is left carrying more positive exposure to delta and gamma (meaning gains are multiplied to the upside). As time and volatility trend to zero, the sensitivity of these options to underlying price (gamma) increases.”

“When gamma increases, counterparties add more liquidity (i.e., sell [buy] more into strength [weakness] against increasing [decreasing] positive delta exposure).”

Amidst this most recent leg higher, volatility has fallen (some) and the heavily-demanded put protection amidst earlier trade lower has solicited decreased hedging. The buyback of hedges has bolstered sideways to higher trade.

Pursuant to that remark, however, participants are still adding to their negative delta options exposure. They’re doing this via call sales (downward sloping HIRO line, below).

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator.

Moreover, given the build in open interest in options at higher strike prices – through naive assumptions and data collected from HIRO, among other measures – we surmise options counterparties are tending to add to the market liquidity and this is stabilizing.

Graphic: Updated 3/2/2022. There is rising interest in options at higher strike prices.

“As the highly-demanded put protection decays, dealers have less exposure to positive delta. To re-hedge this, dealers buy back (cover) existing short (negative-delta) futures hedges,” SpotGamma further explains. “At the same time, as markets trend higher, … the additional interest in options participants supplied on the call side solicits increased hedging.”

From above, we surmise counterparties are long and therefore tend to sell (buy) into strength amid increasing (decreasing) positive delta exposure. 

As short-dated activity clusters in the area just north of the most recent week-long consolidation area, and this protection decays, dealer exposure to positive delta (gamma) falls (rises). 

“Taken together, dealers add to the market liquidity. When there is rising liquidity, volatility (a measure of how ample liquidity is) falls.”

It is options market activity and associated hedging – the supply of liquidity – that’s tempering equity market volatility relative to that of rates and FX.

Graphic: Via SpotGamma. “There’s been a big pop in put volumes for the higher yield bond ETFs: JNK, HYG, and LQD. This syncs with the idea this sell-off is based mainly on rates with a side of geopolitics.”

Hope that better explains index-level volatility and the decline in correlation by constituents.

As an aside, these forces are, too, amplified by the general trend toward “passive” investing. This is a topic for another time, though.

Graphic: Per Nasdaq, “we’ve seen patches of retail selling of stocks that have mostly lasted for less than a week (blue bars in Chart 2). Interestingly, ETFs (yellow bars) remained net buy every single day, albeit at lower levels than usual in the last week of January.”

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

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

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

In the best case, the S&P 500 trades higher; activity above the $4,395.25 high volume area (HVNode) puts in play the $4,415.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,438.00 key response area and $4,464.75 low volume area (LVNode), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,395.25 HVNode puts in play the $4,346.75 HVNode. Initiative trade beyond the $4,346.75 could reach as low as the $4,285.50 HVNode and $4,227.75 overnight low (ONL), or lower.

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

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.

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

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For March 2, 2022

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

What Happened

Overnight, futures were mixed. The equity indices auctioned sideways to higher, in line with most commodity products. Bonds were lower, as was the VIX, an implied volatility measure.

Pursuant to the VIX remark, volatility measures in the rates, foreign exchange, and commodity markets are surging amidst geopolitical uncertainties and monetary policy action.

Ahead is data on ADP employment (8:15 AM ET), Fed-speak by Charles Evans (9:00 AM ET), James Bullard (9:30 AM ET), and Jerome Powell (10:00 AM ET). Later, is a release of the Beige Book (2:00 PM ET).

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

What To Expect

Fundamental: Cross-asset volatility is spiking as investors look to protect against Russia-Ukraine and monetary policy action, among other things.

Graphic: Via @EffMktHype. “Rate vol through the roof, FX picking up steam while equity vol arguably still cheap in comparison despite being at the high end of its 1-year end.” Please note the spike in rate and FX vol versus equity vol (which is sideways to higher, mostly).

Very interesting is action in the rates market where there was a “5-sigma upward shift in MOVE on 3/1/22. [This] has happened 13 times prior in the last 22 years,” said one commentator.

Graphic: Via @EffMktHype. Merrill Lynch Option Volatility Estimate (INDEX: MOVE).

Taken together, the bond market’s pricing of risk – reflected by the Merrill Lynch Option Volatility Estimate (INDEX: MOVE) – is not in line (or moving in-step) with equity market risk, via the CBOE Volatility Index (INDEX: VIX).

The fear in one market tends to feed into the fear of another; regardless of the cause, it seems that equity and bond market participants are not (quite) on the same page.

Moreover, this is in part beyond a decline in liquidity (the variable that’s been connected with the creation of wealth through higher asset prices over time), and has much to do with participants “de-risking” amidst a wide distribution of potential outcomes, another commentator explained

These fears are in the face of emerging risks to growth (given Russia-Ukraine and beyond); the question is whether there is a dovish surprise and this lends to assuaging participants of fear.

Graphic: Via @EffMktHype. “Forward OIS have coalesced since end-Jan and started to aggressively price out rate hikes.”

Taking a look at the U.S. high yield OAS (option-adjusted spread), participants see a “risk-off” bottom; deteriorating credit conditions are a bearish leading indicator. 

Will there be further deterioration that feeds into an eventual repricing of equity market risk? Or, will there be a pullback on hawkishness like the market has started pricing?

Graphic: Via St. Louis Fed. ICE BoA High YIeld OAS.

Positioning: Pursuant to the remarks made on equity implied volatility, March 1, 2022, was “the first day since late January that the options market [was] pricing up volatility a noteworthy but not extreme amount (on a closing basis).”

This is, per SpotGamma, amidst participants’ heightened demand for downside (put) protection; in purchasing protection, traders indirectly take liquidity as counterparties hedge exposure in the underlying.

The effects of this hedging are more notable given reticence on the part of counterparties.

“Essentially, with markets swinging there is a hesitance amongst liquidity providers to step in. This creates an environment in which the absorption of orders deteriorates,” SpotGamma explains. “Given this, the hedging of options exposure further amplifies market moves.”

A heightened VIX, in the face of an equity market that is not trading much weaker, is a clear reflection of this so-called reticence.

Pictured: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

Going forward, bearing in mind the continued passive buying support alluded to in past commentaries, if participants were to be assuaged of their fears, that would likely coincide with less(er) demand for downside protection and compression in volatility.

The implications of this? Reduced demand for protection coincides with less counterparty negative gamma exposure (as counterparty put buying [a negative delta, positive gamma trade] coincides with the addition of liquidity [purchase of underlying, a positive delta trade]). 

In counterparties being less exposed to losses on the downside (via reduced negative gamma exposure), their (re)hedging may bolster attempts higher (i.e., open the door to the upside).

The likelihood of this dynamic coming to fruition is low(er), up until the passage of the Federal Open Market Committee event March 15-16, 2022, and options expiration (that same week).

Graphic: Fear and demand for protection concentrated in shorter-dated contracts most sensitive to changes in implied volatility and direction results in pressure from hedging. The compression of volatility likely coincides with support of attempts higher (as this removes pressure).

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

In the best case, the S&P 500 trades higher; activity above the $4,285.50 high volume area (HVNode) puts in play the $4,346.75 HVNode. Initiative trade beyond the $4,346.75 HVNode could reach as high as the $4,398.50 overnight high (ONH) and $4,415.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,285.50 HVNode puts in play the $4,227.75 overnight low. Initiative trade beyond the ONL could reach as low as the $4,177.25 HVNode and $4,137.00 untested point of control (VPOC), or lower.

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

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

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

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.

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

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

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

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

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

Rates: Low rates have to potential to increase the present value of future earnings making stocks, especially those that are high growth, more attractive. To note, inflation and rates move inversely to each other. Low rates stimulate demand for loans (i.e., borrowing money is more attractive).

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics. 

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 28, 2022

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

What Happened

Overnight, equity index futures auctioned lower in light of an escalation of geopolitical tensions between Russia, Ukraine, and the rest of the world.

Western powers imposed harsh sanctions including the exclusion of some Russian lenders from the SWIFT messaging system “that underpins trillions of dollars worth of transactions,” globally.

As the Russian ruble lost ⅓ of its value and costs of insuring Russian government debt rose, the Bank of Russia (BoR) doubled its key interest rate to 20% and imposed some capital controls to take from the risk of a potential run on banks. Policymakers also banned foreign security sales.

The odds of an aggressive lift-off in interest rates by the Federal Reserve declined, accordingly. The market is now pricing in under six hikes for 2022 as crisis opens room for policy mistakes.

Ahead is data on trade in goods (8:30 AM ET), Chicago PMI (9:45 AM ET), and Fed-speak by Atlanta Fed President Raphael Bostic (10:30 AM ET).

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

What To Expect

Fundamental: As of February 27, 2022, there are reports that with its invasion of Ukraine, “Moscow was frustrated by the slow progress caused by an unexpectedly strong Ukrainian defense and failure to achieve complete air dominance.”

Graphic: Via Bloomberg, locations of Russian controls and attacks.

At present, Russia has only committed 50% of its available firepower to the war and solicited the involvement of neighboring allies. Still, even at 50%, it’s rough.

Russian markets, to put it simply, are in turmoil as a result of this conflict. Its policymakers, to stem the bleed, have banned foreigners from selling assets.

Graphic: Via Topdown Charts, Russian assets are imploding.

Accordingly, sentiment is as bad as it was in 2020, 2016, the period spanning 2008-2009, as well as the period just after the topping of the tech-and-telecom bubble. 

Graphic: Via Topdown Charts, “sentiment basically as bad as the COVID crash.”

In light of the world’s response to this conflict, Russia, too, has heightened its nuclear readiness.

Moreover, over the weekend, Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar, in gauging the implications of conflict and sanctions, explained that excluding Russia from SWIFT may lead to missed payments and overdrafts similar to that experienced during March of 2020.

“Banks’ inability to make payments due to their exclusion from SWIFT is the same as Lehman’s inability to make payments due to its clearing bank’s unwillingness to send payments on its behalf,” he noted.

“The consequence of excluding banks from SWIFT is real, and so is the need for central banks to re-activate daily U.S. dollar funds supplying operations.”

In light of this, some have advanced a narrative around a potential run on Russian banks.

However, former BoR official Sergey Aleksashenko, in an alarmed yet less pessimistic take on CNBC, suggested a “low likelihood” of a run on the ruble.

Further, in light of the deceleration at home in the U.S., Pozsar concludes that “the Fed’s balance sheet might expand again before it contracts via QT (quantitative tightening).”

Graphic: Alfonso Peccatiello of The Macro Compass. He says “YTD: 2022 hikes priced in up from 3 to 6-7. Curves big-time flatter. Inflation expectations 10 bps lower. Real yields higher 40-50 bps. Credit spreads wider. Cyclical growth impulse fading away. Not a risk-on environment.”

Interactive Brokers Group Inc’s (NASDAQ: IBKR) Chief Strategist Steve Sosnick adds: “The tide of money is still positive, and it should provide a cushion for nervous markets as long as that remains the case. But when we consider that monetary conditions are supposed to be changing, volatility should persist if the monetary tide actually ebbs as expected.”

Perspectives: “​​Geopolitical catastrophes tend to be worse than believed in the short term but less than believed in the long term,” Ophir Gottlieb of Capital Market Laboratories notes

Similarly, JPMorgan Chase & Co’s (NYSE: JPM) head of global equity strategy Mislav Matejka says that “If one is selling on the back of the latest geopolitical developments now, the risk is of getting whipsawed.”

“Historically, [the] vast majority of military conflicts, especially if localized, did not tend to hurt investor confidence for too long, and would end up as buying opportunities.”

Graphic: Via Tier1Alpha. Taken from The Market Ear

Positioning: Strong passive buying support persists in the face of a lower liquidity, negative-gamma, high-volatility regime.

Graphic: Via Bloomberg. Taken from The Market Ear.

Adding, in light of the liquidation into last Thursday’s open (after which there was a large reversal), the VIX futures term structure, though in backwardation, was not as steep as in past moments of true panic.

IBKR’s Sosnick explains that “Even though VIX futures [were higher on Thursday morning] across the board and the curve has further steepened, neither the spot level nor the curve are yet demonstrating panic.” 

“I interpret the message of the market to be that we should continue to expect volatility – remember that volatility encompasses moves in both directions – but not to expect that a major bottom was put into place in recent sessions.”

With realized volatility is heightened and implied volatility not performing, so to speak, @darjohn25 explains, try to avoid “any short gamma on all short-dated tenors—you want to own the short term stuff for the foreseeable future.”

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

Gap Scenarios Potentially In Play: 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.

In the best case, the S&P 500 trades higher; activity above the $4,285.50 high volume area (HVNode) puts in play the $4,345.75 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,371.00 VPOC and $4,395.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,285.50 HVNode puts in play the $4,227.75 HVNode and overnight low (ONL) area. Initiative trade beyond the HVNode/ONL could reach as low as the $4,177.25 HVNode and $4,137.00 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.

What People Are Saying

Definitions

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

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

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

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

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

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 is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 25, 2022

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

What Happened

Overnight, equity index futures auctioned sideways, providing some more validation to Thursday morning’s reversal fueled by aggressive short-covering.

Geopolitical tensions and monetary tightening are the two major narratives news outlets are assigning to the volatility. 

The U.S. and its allies applied more sanctions on Russia for its invasion of Ukraine and markets are still pricing around six quarter-point rate hikes by the Fed.

Ahead is data on personal income, consumer spending PCE inflation, core inflation, disposable income, durable goods orders, and core capital equipment orders (8:30 AM ET), University of Michigan sentiment, inflation expectations, and pending home sales (10:00 AM ET).

Graphic updated 6:35 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. 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: Must keep it short, today.

Per JPMorgan Chase & Co’s (NYSE: JPM) Marko Kolanovic, “While Equities are down year-to-date due to rising rates, we note that historically the initial volatility around rate liftoff didn’t last and equities made new all-time highs 2-4 quarters out.”

“The start of policy tightening is usually a confirmation that the cycle has legs, rather than the signal of its end. As we don’t see the yield curve inverting or real yields reaching problematic levels this year, it is premature to talk about end-of-cycle worries.”

Graphic: Via Haver. Retrieved from The Market Ear. Macro conditions are more supportive than during the Global Financial Crisis.

Pursuant to Kolanovic’s remarks, Andreas Steno Larsen of Heimstaden explains that bond yields remain governed by demographics, and this is good news for tech.

“I still think that inflation and bond markets will be governed by other structural trends over the medium term,” he said. “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: Based on a variety of metrics, some of which were pointed to in yesterday’s commentary, there were no clear signs of capitulation

For instance, one of the largest ETF products that track the Nasdaq 100 (QQQ) “has seen persistently illiquidity (daily range / $ volume). There was not much volume (participation) behind the move in price. The 1-week return distribution gets pretty wild.”

Graphic: Via @HalftersPower.

Similarly, “1 Month relative volume (today’s volume / 1-month average) on SPY today (1.66) doesn’t have a capitulatory look to it. Bottoms in the past year occurred at 2+.”

Graphic: Via @HalfersPower.

There was, however, a massive covering of short (negative delta) exposures. The gap lower presented participants a “gift” and many took it as an opportunity to monetize downside bets.

Despite metrics pointing to continued accumulation, and buying support, equity products are in negative gamma wherein the hedging of put-heavy exposures results in whip-saw action (i.e., options counterparties hedge in a manner that exacerbates moves to upside and downside).

Technical: As of 6:30 AM ET, Friday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a balanced 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 $4,249.25 low volume area (LVNode) puts in play the $4,290.25 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,332.75 high volume area (HVNode) and $4,358.75 minimal excess high, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,249.25 LVNode puts in play the $4,177.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $4,137.00 untested point of control (VPOC) and $4,101.25 overnight low (ONL), or lower.

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

Definitions

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

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

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

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

Excess: A proper end to price discovery; the market travels too far while advertising prices. Responsive, other-timeframe (OTF) participants aggressively enter the market, leaving tails or gaps which denote unfair prices.

About

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

Capelj is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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

Categories
Commentary

Daily Brief For February 18, 2022

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

What Happened

Overnight, equity index futures auctioned back up into range after a spike lower from multi-day balance. The overnight response, higher, happened after Russian Foreign Minister Sergei Lavrov agreed to meet U.S. Secretary of State Antony Blinken for talks in Europe next week.

Ahead is data on existing home sales and leading economic indicators (10:00 AM ET), as well as Fed-speak by Christopher Waller (10:15 AM ET), John Williams (11:00 AM ET), and Lael Brainard (1:30 PM ET).

In observance of Washington’s Birthday, markets are closed Monday, February 21, 2022.

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

What To Expect

Fundamental: Given the persistence of mechanical responses to key levels, visually-driven, weaker-handed participants (which seldom bear the wherewithal to defend retests) carry a heavier hand in recent price discovery.

The takeaway is that the larger, other time frame (OTF) participants are waiting for more information before committing to substantial expansion of range via large sales or buys.

Information the OTFs are seeking to process and position themselves in accordance with are (but not limited to) geopolitical tensions and contractionary monetary policy.

Thursday’s commentary went in-depth on the implications of more severe Fed-action. Mainly, to slow inflation and rid the market of excesses, “a Volcker moment” is needed a strategist said.

Graphic: Via MacroTrends & Cboe Options Institute. “Value stocks started to outperform when the Federal Reserve (under Greenspan) communicated their intent to tighten policy. Value fell out of favor in the middle of 2007 following a UST yield curve inversion and looser monetary policy (under Bernanke).”

The Ambrus Group’s Kris Sidial, and others, expressed their differing sentiments on the issue, given that equities are so intertwined with consumer savings.

“There is no way the fed looks to use additional volatility as a policeman,” he explained. “It’s one of those things that sounds ok in theory but will not work in real-world applications.”

As Moody’s Corporation (NYSE: MCO) puts well, “This cycle is unlike any recent one and, while there are a ton of reasons to be optimistic about the U.S. economy’s near-term prospects, there are also reasons to worry that a recession isn’t far off on the horizon.”

Graphic: Via St. Louis Fed. Taken from Cboe Global Markets Inc (BATS: CBOE). “In fact, a dynamic where short-dated bond yields are higher than longer-dated bonds can reinforce an economic slowdown. The cost of capital is perhaps the most important component for evaluating so many other market relationships. Any investment that involves borrowed money becomes more expensive when the cost of capital increases. More is spent on interest payments. Higher rates incentivize saving (as opposed to consumption) which impacts businesses and the economy as a whole.”

“If the Fed is forced to raise the fed funds rate above its neutral rate to tame inflation, the stage will be set for recession. Also, some Fed officials believe they are falling further behind the curve, which could lead to a more aggressive tightening cycle, a recipe for an economic downturn in 2023 or 2024.”

Based on this sentiment, investors have already bet – via the eurodollar futures contract – on the Fed reversing its tightening course in late 2023. The current baseline calls for four 25-basis point rate hikes this year.

Graphic: Via Bloomberg. “In the eurodollar futures markets, the spread between the December 2023 and December 2025 contracts has dropped further into negative territory on Monday — implying a near-25 basis point cut in the federal funds benchmark over this 24-month timeframe.”

“We, therefore, think that the more likely path is a longer series of 25-basis point increases in the target range for the fed funds rate and we may need to add an additional rate hike to our baseline forecast in March,” Moody’s says in response to more hawkish pricings as a result of market focus on comments by hawkish regional Fed presidents.

Graphic: Via TS Lombard. Taken from The Market Ear. “Flattening is normal when the Fed is tightening. Looking at the past eight hiking cycles, almost every segment of the curve has flattened on average without immediately triggering a recession.”

On that note, Mark Haefele, chief investment officer at UBS Group AG’s (NYSE: UBS) Global Wealth Management arm says that “Despite the recent volatility, it’s important to remember that we are still in an environment of robust economic and earnings growth.”

Graphic: Via Bloomberg. “If market dysfunction is reflected in tighter conditions, then this chart shows we’re nowhere near stressed levels — after all, central bank policy globally is historically loose.”

“Our base case we expect upside for equity markets over the balance of the year.”

Positioning: Passive buying flows persist alongside a drop in bearish sentiment readings.

Graphic: Via EPFR, Barclays PLC (NYSE: BCS), and Bloomberg. Taken from The Market Ear

This action is in the face of a collapse in margin debt.

Graphic: Via Tier1Alpha. Taken from The Market Ear. “Margin debt is a big part of the puzzle, but even more important is the “delta” of the margin debt. The YoY % change of FINRA margin debt looks slightly scary.”

In the credit markets, investment-grade spreads are at some of their widest levels since 2020. Per Bloomberg, put option (bets on the downside) open interest in corporate bond ETFs is at an all-time high.

“Rotate into credit now,” Chris Sheldon, the co-head of credit and markets at KKR, explained, taking a contrarian view. “As the rate volatility plays through the market segment, we think high yield could become more attractive very quickly.”

On the single-stock and index-level, options positioning suggests participants should continue to brace for volatility. Participants’ demand for protection (negative delta exposure) has left counterparties (dealers taking the other side and warehousing risk) adding negative delta exposure linearly (via stock and futures sales) to hedge.

To note, owning an option offers someone positive exposure to gamma or convexity (to have profits multiplied if the direction is correct, all else equal). On the other side, though, participants who are short gamma or convexity may have their losses multiplied if incorrect.

Making some naive assumptions on the build-in interest in options strikes at lower prices, we may surmise that dealers are exposed to increased negative gamma exposure. 

To hedge this, if volatility were to remain unchanged, dealers must sell (buy) into weakness (strength) to hedge increasing (decreasing) negative gamma exposure. If volatility rises (drops), then more stock and futures must be sold (bought/covered).

Pictured: SqueezeMetrics highlights implications of volatility, direction, and moneyness.

The monthly options expiration (OPEX) will coincide with the removal of lots of put-heavy exposures. This will decrease the dealers’ positive exposure to delta and make gamma exposures less negative. 

Therefore, absent some exogenous event that increases demand for protection, again, there is the potential for strength, post-OPEX. That’s when that real-money buying, alluded to above, may resolve in higher prices.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,415.00 untested point of control (VPOC) puts in play the $4,438.00 key response area (balance boundary and high volume area). Initiative trade beyond the key response area could reach as high as the $4,464.75 low volume area (LVNode) and $4,485.00 regular trade high (RTH High), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,415.00 VPOC puts in play the $4,401.50 spike base. Initiative trade beyond the spike base could reach as low as the $4,367.25 regular trade low (RTH Low) and $4,332.75 high volume area (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

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

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

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

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

Options Expiration (OPEX): Traditionally, option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire) and the reduction dealer gamma exposure. In recent history, this reset in dealer positioning has been front-run; prior, there was an increase in volatility after the removal of large options positions and associated hedging.

Balance (Two-Timeframe Or Bracket): Rotational trade that denotes current prices offer favorable entry and exit. Balance-areas make it easy to spot a change in the market (i.e., the transition from two-time frame trade, or balance, to one-time frame trade, or trend). 

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

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 is also a Benzinga finance and technology reporter interviewing the likes of Shark Tank’s Kevin O’Leary, JC2 Ventures’ John Chambers, FTX’s Sam Bankman-Fried, and ARK Invest’s Catherine Wood, as well as a SpotGamma contributor developing insights around impactful options market dynamics.

Disclaimer

Physik Invest does not carry the right to provide advice.

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