Categories
Commentary

Daily Brief For May 17, 2022

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

What Happened

Overnight, equity index futures were higher. The S&P 500, in particular, probed the high end of the low-volume (gap) area it broke into on May 9, 2022.

The key is to monitor whether the S&P 500 is able to sustain the prices it discovered overnight. If so, then the odds that participants are, indeed, hammering out a bottom are heightened.

Ahead is data on retail sales (8:30 AM ET), industrial production and capacity utilization (9:15 AM ET), the NAHB home builders’ index, and business inventories (10:00 AM ET).

Fed-speak is scattered. At 9:15 AM ET, the Philadelphia Fed’s Patrick Harker speaks on health care. At 2:00 PM ET, Fed Chair Jerome Powell is interviewed by the WSJ. At 2:30 PM ET, the Cleveland Fed’s Loretta Mester talks at an inflation conference. And, lastly, at 6:45 PM ET, the Chicago Fed’s Charles Evans speaks.

Graphic updated 6:50 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: Out of all the news, it was noteworthy when Elon Musk broke with the prevailing opinion to declare the U.S. was facing a tough recession that would last up to 18 months. 

This is on the heels of a large “misallocation of capital,” he says, caused by the government printing “a zillion amount of more money than it had.”

Musk cautioned companies to watch their costs and cash flows, the latter of which we talked on the importance of in cycles where monetary conditions are tighter and there is less money to be had for corporates who are taking “the long view” and “competing on eyeballs and growth,” per Kai Volatility’s Cem Karsan who this letter’s writer spoke with last summer.

As Karsan puts it, over the last four decades, monetary policy was a go-to for supporting the economy. Money was sent to capital and that promoted deflation, ultimately creating “a disinterest and unimportance to cash flows.”

“Monetary policy has a velocity of almost zero, it goes directly to ‘Planet Palo Alto,’ and Palo Alto creates new technologies,” Moontower’s Kris Abdelmesih puts well in a summary of Karsan’s macro thesis.

“They’re sophisticated, futuristic people. They provide new self-driving cars and things getting delivered to your doorstep. They create supply … [and] does not increase demand. And so it is deflationary.”

Over the last years, in light of talk to address increasing inequality, money was sent to labor, so to speak, and that promoted inflation.

Moreover, today’s contractionary monetary policy is a blunt tool and is not equipped to “address the main problem which is a lack of supply to absorb the demand.”

Please read Moontower’s full write-up, here.

That’s sort of in accordance with comments we quoted Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar making, yesterday. Essentially, “the Fed is pursuing demand destruction through negative wealth effects,” as the “central banks can only deal with nominal” chokepoints.

By that token, we must “[c]onsider at least the possibility that the extreme volatility and lack of liquidity [we] see in markets is by design, and the Fed will not be deterred by it, but rather that it will be emboldened by it in its singular pursuit of price stability.”

With even President Biden endorsing the closure of the “wealth window,” Karsan believes corporations will have to worry about making money again.

“These cycles are a lot shorter than the monetary supply-side cycles but they tend to be very bad for multiples and great for economic growth.”

With that in mind, there is no escape. Even the traditional bond-stock relationship – the 60/40 framework – is at risk of being upended.

Graphic: Via Andy Constan of Damped Spring Advisors. “Zero rate hikes in 2023. Clearly, a recession is being priced in.” Per Bloomberg, a Bank of America Corporation (NYSE: BAC) survey puts the Fed put (a pivot) at $3,529.00 in the S&P 500.

Positioning: Measures of implied volatility came in. That’s significant since participants have a lot of exposure to put options.

Further, we see liquidity providers being short those puts. As volatility continues to come in, the exposure of those options to direction (delta) compresses. 

As a result, liquidity providers will taper some of their negative delta short stock and futures hedges to that positive delta put position.

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.”

Those delta hedging flows with respect to changes in volatility (vanna) are on top of what has historically been a front-running of the bullish flow associated with the delta decay of options, particularly with respect to time (charm), into options expirations (OPEX). 

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

Notwithstanding, though proxies for buying and this hedging of existing options positioning, at the surface, appear to point to positively (skewed) forward returns, we have concern over the level at which from implied volatility is dropping from, and the general divergence between the volatility realized and implied, talked about yesterday.

Basically, as SpotGamma says, there’s not as much “stored energy to catalyze a rally.” 

SqueezeMetrics adds

The Cboe Volatility Index (INDEX: VIX) compressing, while dealer gamma exposure is “more negative than it’s been in years is not how you get sustained rallies–it’s how you get energy for bigger downside moves.”

Therefore, we continue to focus on participating in upside with as little debit risk as possible, via the use of complex strategies, further validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Technical: As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, will likely open in the upper part of a positively 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 $4,083.75 overnight high (ONH) puts in play the $4,119.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,148.25 and $4,184.25 high volume nodes (HVNodes), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,083.75 ONH puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $4,013.25 micro composite point of control (MCPOC) and $3,978.50 LVNode, or lower.

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

Considerations: A push-and-pull between the largest of S&P 500 weights.

For instance, Apple Inc (NASDAQ: AAPL) is clinging to its prior trend.

Graphic: Via Bloomberg.

All the while products like Amazon Inc (NASDAQ: AMZN), are trading into key supports.

Graphic: Via Bloomberg.

We continue to monitor our market internals and (large) changes in positioning (e.g., open interest builds at higher prices further out in time) that will provide further validation to this most recent S&P 500 reversal.

Graphic: Market Internals as pioneered by (a mentor of mine) Peter Reznicek. Current reads of breadth (top charts), in particular, are uninspiring. An advance you do not short has an advance-decline line that’s pegged at +2,000, coupled with a Tick (bottom left) that has trouble closing below 0 for nearly the entirety of a session. Caution.

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.

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 16, 2022

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

What Happened

Overnight, equity index futures auctioned lower after a failed attempt to solicit strong buying on a break of Friday’s regular trade high. 

Coincidentally, after a test of an anchored volume-weighted average price level, some measures from China had traders concerned about global growth, and that fed into a risk-off sentiment and probe further into Friday’s range.

Moreover, ahead is data on Empire State Manufacturing (8:30 AM ET).

Today, we add light context to our narratives with an aim to elaborate further in letters later this week. Take care!

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: Data from China shows contraction in light of COVID-19 troubles.

Graphic: Via Bloomberg

Bloomberg’s John Authers explains that a contracting China “would be a deflationary force for the rest of the world.”

Graphic: Via Stenos Signals. “China imports vs. Commodities – the most important macro chart in the world right now.”

Andreas Steno Larsen, of the Stenos Signals letter, recently talked about this “lack of economic activity in China,” as well as “slowing demand in the West,” both of which are to “lead inflation expectations lower.”

Graphic: Via CrossBorder Capital. “Latest weekly Fed liquidity injections and the S&P 500. Bigger the bull, the harder they fall? Fed trying to crash [the] economy to kill inflation [and] Wall Street is the victim.”

Notwithstanding, the Federal Reserve (Fed) remains on track “to deliver substantial QT and rate hiking,” all the while investors “hold a relatively risk-friendly position in equities and credits.”

Graphic: Via Societe Generale SA (OTC: SCGLY). Taken from The Market Ear.

Steno Larsen explains: “That disconnect [between sentiment and exposure to risk] will have to wane before I truly dare to re-add risk asset exposure to my list of recommendations.”

Graphic: Via @TheBondFreak. University of Michigan Sentiment.

Pursuant to that remark, Authers notes that the latest Chinese data emboldens the risks of a recession which Credit Suisse Group AG’s (NYSE: CS) Zoltan Pozsar explains is not enough.

“[T]he risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects, and signs of a recession might not mean immediate rate cuts to ramp demand back up.”

“Rallies could beget more forceful pushback from the Fed – the new game.”

Graphic: Via @TheBondFreak. “2/10s spread has delivered its message. The long end is beginning to trend lower. NOW…it’s time to start watching the 3m/10yr spread, which will likely invert as the Fed continues with its rate hikes to kill demand, cause a recession, but “us” from inflation.”

Per Goldman Sachs Group Inc (NYSE: GS), baseline forecasts assume “no recession” and imply the S&P 500’s P/E ends unchanged at 17x. 

“A recession would see the index fall by 11% to $3,600.00 as the P/E drops to 15x.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear. A recession brings S&P 500 to $3,600.00.

Positioning: Early on Friday morning, we approached trade too optimistically but, to our credit, we focused on participating with as little risk as possible, via the use of complex strategies, as validated by quoted research.

Graphic: Via Goldman Sachs Group Inc. The VIX’s “high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Heading into Monday’s regular trade, little has changed and indexes are holding well, relative to some constituents.

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

Kai Volatility’s Cem Karsan hypothesizes: “If a meaningful [volatility] event has happened within the last year, participants are more likely to be prepared for the move. So the ‘2nd event’ dramatically underperforms [implied volatility] skew expectations.”

“Take Jan/Feb 2016, Oct-Dec 2018, &…Sep 2020? All these ‘2nd Events’ ended up being as meaningful as their 1st events, if not more, for markets, but were much more orderly [and] accompanied by poor [volatility] performance.”

Graphic: Via Bloomberg. “For all the recent declines — the S&P 500 is down more than 13% from its high on March 29 — stress indicators also aren’t at levels seen during comparable slumps. Fewer than 30% of the benchmark’s members have hit a one-year low, compared with nearly 50% during the growth scare in 2018 and 82% during the global financial crisis in 2008.”

Given the aforementioned supply and demand dynamic, we continue to observe “divergence in the volatility (movement of underlying equity market up and down) realized, versus that which is implied by options activity,” SpotGamma says. 

Graphic: Via @HalfersPower. “1 day return distribution when QQQ ROC[1] > 3.7%. Historically you can expect the weakest relative mean forward returns, and second-highest mean realized volatility amongst deciles.”

For “divergences in volatility realized and implied to resolve, it would likely take forced selling. Liquidity providers’ response to demand for protection would, then, likely exacerbate the move and aid in the repricing of volatility to levels where there would be more stored energy to catalyze a rally.”

All else equal, SpotGamma adds, there is no catalyst to rally until the May 20, 2022 options expiration (OPEX). Till then, rallies are subject to failure.

Graphic: Via SqueezeMetrics. Updated May 13, 2022. “VIX compressing to 30 on a modest pre-market rally with dealer gamma exposure more negative than it’s been in years is not how you get sustained rallies—it’s how you get energy for bigger downside moves.”

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.

In the best case, the S&P 500 trades higher; activity above the $4,013.25 micro composite point of control (MCPOC) puts in play the $4,036.00 regular trade high (RTH High). Initiative trade beyond the $4,069.25 high volume area (HVNode) could reach as high as the HVNode and $4,119.00 untested point of control (VPOC), or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,013.25 MCPOC puts in play the $4,3978.50 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,943.25 HVNode and $3,899.00 VPOC, or lower.

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 13, 2022

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

What Happened

Overnight, equity indices probed higher, above Thursday’s trade, which established a new swing low. The Cboe Volatility Index (INDEX: VIX) fell while yields were bid and commodities mixed.

Today, we’ll get into some key narratives including crypto turmoil and financial conditions, as well as a validation of some of our trade theses.

Ahead is data on import prices (8:30 AM ET), University of Michigan consumer sentiment and inflation expectations (10:00 AM ET), as well as Fed-speak by Neel Kashkari (11:00 AM ET).

Take care and watch your risk.

Graphic updated 6:40 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: In the news, panic in the cryptocurrency markets eased and Tether (CRYPTO: USDT-USD), the world’s largest stablecoin, backed by commercial paper and U.S. Treasuries, climbed back to par.

JPMorgan Chase & Co’s (NYSE: JPM) Teresa Ho said there would be little impact on traditional funding markets while, according to Barclays PLC’s (NYSE: BCS) Joseph Abate, redemptions in Tether, which has a market value just shy of $90-100 billion, would only “cause meaningful strains in money markets should they exceed half of the stablecoin’s total holdings.”

Graphic: Via Bloomberg.

Also in the news are rising interest rates (e.g., mortgage rates up to ~5.30%) and a weak equity market (e.g., S&P 500 lower ~20%), among other things, feeding into a tightening of financial conditions (which is how monetary policy impacts the economy).

Graphic: Via Bloomberg.

“Financial conditions for households and businesses wanting to borrow or raise capital tightened again last week and are the most restrictive since the first wave of the pandemic in 2020 and before that 2012,” Reuters’ John Kemp said.

Graphic: Via John Kemp.

This is as inflation has become “deeply embedded,” spreading from the energy and raw materials-intensive merchandise sector to services.

Graphic: Via John Kemp.

“Rapid service sector price increases usually signal the imminent arrival of a recession,” Kemp said, pointing to decisions by some public companies like Uber Inc (NYSE: UBER), Twitter Inc (NYSE: TWTR), and Amazon Inc (NASDAQ: AMZN) to slow growth and cut labor forces as a validation of slowing momentum.

Graphic: Via Bloomberg. “I think we’re primed for a big distressed supply surge,” said Phil Brendel, a distressed debt analyst for Bloomberg Intelligence. “Everyone gets comfortable and complacent on credit and then when it turns, you tend to see these massive spikes.”

The accelerated selling of equities (~$6.2 billion), bonds (~11.4 billion), cash (~$19.7 billion), and some commodities (~$1.8 billion in gold), over the last week, per Bank of America Corporation’s (NYSE: BAC) Michael Hartnett is capitulation. 

“The definition of true capitulation is investors selling what they love,” Hartnett said, gauging the prospects that stocks have hit a near-term bottom. “Fear and loathing suggest stocks are prone to an imminent bear market rally, but we do not think ultimate lows have been reached.”

Positioning: In past commentaries, we talked about ways to play a returns distribution that is skewed to the upside (albeit, with large negative outliers).

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

The following Goldman Sachs Group Inc (NYSE: GS) remark is a validation of what we’ve discussed:

“Even though the VIX’s reaction to recent spot downside has been mild, its high starting point leaves vol high overall, and we like strategies with a short volatility bias, including put selling and 1×2 call spread overlays.”

Graphic: Via Goldman Sachs Group Inc. Taken from The Market Ear.

Mainly, zero- and low-cost bets ($0.00-$1.00 debit to open) that deliver asymmetric payouts (sometimes in excess of $10.00 credit to close) in case of violent and short-lived reversals. 

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

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

As stated before, width and timing are everything. 

Too much time or too narrow may result in asymmetric losses when the demand for upside bets further out in price and time bids the skew that you’re short, relative to the at-the-money volatility you own.

Ten to fifteen days to expiration and 500-1000 points wide, in the Nasdaq 100 (INDEX: NDX), one of the hardest hit of the indexes, work well. 

An easy check is whether the spread prices for a debit or credit to close if the underlying moves to the long strike of the spread, all else equal.

Debits (which may run as low as $0.00, depending on trade location) can be offset with credits from put sales.

Graphic: Chart of the Nasdaq 100 (INDEX: NDX).

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

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume node (LVNode) puts into play the $4,011.00 untested point of control (VPOC). Initiative trade beyond the VPOC could reach as high as the $4,069.25 high volume area (HVNode) and $4,119.00 VPOC, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,978.50 LVNode puts into play the $3,943.25 HVNode. Initiative trade beyond the HVNode could reach as low as the $3,899.00 VPOC and $3,862.75 LVNode, or lower.

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

Considerations: Gap scenarios are 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.

Definitions

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 12, 2022

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

What Happened

Overnight, equity index futures auctioned lower, mostly, alongside most commodities and crypto.

Notable is how orderly the selling has been, particularly in the equity space. That’s due in part to suppressive volatility selling, as well as passive flows supporting the largest index constituents.

The fundamental narrative has changed little. Chief among participants’ worries are growth and inflation, the monetary response to the two, as well as chokepoints not limited to supply chains.

Ahead is data on jobless claims and the producer price index (8:30 AM ET), as well as Fed-speak by Mary Daly (4:00 PM ET).

Graphic updated 7:15 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: In Wednesday’s morning letter, we talked about the expectations for annual inflation to have peaked and month-on-month inflation to have risen a small amount.

Per Bloomberg, “the broader CPI rose 0.3% from the prior month and 8.3% on an annual basis, a slight cooling but still among the highest readings in decades.”

Stocks were sold, after, on the limited change to the broader fundamental outlook. The hardest hit was growth and technology, including cryptocurrency. 

“Now that central banks are unwinding monetary support, growth stocks’ valuations have further to fall,” Citigroup Inc (NYSE: C) strategists including Robert Buckland said

Notwithstanding, “any stabilization in nominal yields should eventually help to stabilize real yields and hence equity valuations.” 

This is because higher rates play into bigger discounts on future profit.

Graphic: Via Bloomberg.

Positioning: Orderly selling continues.

Despite falling about the same distance (peak to present low) during the equity market rout of 2020, selling, this time around is steady and there is no panic, and that’s partly the result of there being “plenty of put-buyers, but nearly as many sellers,” according to SqueezeMetrics.

Accordingly, using off-exchange short sales as a proxy for buying activity, we see implicit buying support, and that’s due in part to “passive flows” which ultimately end up “supporting the largest stocks,” hence the index’s strength versus smaller (and much weaker) constituents.

Taken together, some metrics this letter often looks to for insight into the potential distribution of future returns, carry less weight; it’s odds and when the largest stocks succumb to fundamental weaknesses, for lack of a better way of expressing it, that likely takes the indexes with it.

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

Moreover, with the S&P 500’s break of $4,000.00, an area around which there is a lot of open interest, particularly on the put side, “increases capitulation risk” in the case participants start reaching for protection and indirectly taking from market liquidity as liquidity providers sell into weakness to hedge.

Notwithstanding, later this month is a large options expiration (OPEX), and expected is the roll-off of a large amount of put-heavy negative gamma. Per Pat Hennessy of IPS Strategic Capital, returns one to two weeks prior are skewed bullish.

Ways to participate in upside, while limiting downside, markedly, were discussed on May 10. Making money is one thing. Not losing money is another.

Lose less when wrong. Make more when right.
Graphic: @pat_hennessy breaks down returns for the S&P 500, categorized by the week relative to OPEX. 

Technical: As of 6:45 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, outside of prior-range and -value, suggesting a potential for immediate directional opportunity.

In the best case, the S&P 500 trades higher; activity above the $3,907.75 micro composite point of control (MCPOC) puts in play the $3,943.25 high volume area (HVNode). Initiative trade beyond the $3,943.25 HVNode could reach as high as the $4,011.00 untested point of control (VPOC) and $4,069.25 HVNode, or higher.

In the worst case, the S&P 500 trades lower; activity below the $3,907.75 MCPOC puts in play the $3,862.75 LVNode. Initiative trade beyond the $3,862.75 LVNode could reach as low as the $3,816.75 and $3,780.75 LVNodes, or lower.

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

What People Are Saying

Definitions

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

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

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

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

About

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

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

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

 Disclaimer

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

Categories
Commentary

Daily Brief For May 11, 2022

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

What Happened

Overnight, index and commodity futures were bid while yields and the Cboe Volatility Index (INDEX: VIX) came in, little.

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

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

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

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

What To Expect

Fundamental: Shortened commentary, today.

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

Graphic: Via Bloomberg.

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

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

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

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

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

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

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

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

Accordingly, hedging flows with respect to time and volatility may, then, bolster sharp rallies.

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

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

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

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 10, 2022

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

What Happened

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

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

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

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

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

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

Graphic updated 6:25 AM ET. Sentiment Neutral if expected /ES open is inside of the prior day’s range. /ES levels are derived from the profile graphic at the bottom of the following section. Levels may have changed since initially quoted; click here for the latest levels. SqueezeMetrics Dark Pool Index (DIX) and Gamma (GEX) calculations are based on where the prior day’s reading falls with respect to the MAX and MIN of all occurrences available. A higher DIX is bullish. At the same time, the lower the GEX, the more (expected) volatility. Learn the implications of volatility, direction, and moneyness. SHIFT data used for S&P 500 (INDEX: SPX) options activity. Note that options flow is sorted by the call premium spent; if more positive, then more was spent on call options. Breadth reflects a reading of the prior day’s NYSE Advance/Decline indicator. VIX reflects a current reading of the CBOE Volatility Index (INDEX: VIX) from 0-100.

What To Expect

Context: We continue to build out the narrative.

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

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

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

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

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

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

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

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

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

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

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

What’s going on? 

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

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

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

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

Why does this matter?

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

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

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

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

As The Ambrus Group’s Kris Sidial sums well: 

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

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

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

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

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

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

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $3,978.50 low volume area (LVNode/gap boundary) puts in play the $4,055.75 LVNode/gap boundary. Initiative trade beyond the $4,055.75 could reach as high as the $4,119.00 untested point of control (VPOC) and $4,153.25 regular trade high (RTH High), or higher.

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

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

Definitions

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

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

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

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

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

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

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 9, 2022

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

What Happened

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

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

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

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

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

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

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

What To Expect

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

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

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

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

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

A naive measure like the Cboe VVIX Index (INDEX: VVIX), which measures the volatility of volatility, has a mean below 100 and a high correlation with the Cboe Volatility Index (INDEX: VIX) during times of stress.

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

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

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

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

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

Graphic: Via SpotGamma. Updated April 27, 2022.

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

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

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

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

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

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

So what?

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

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

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

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

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

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

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

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

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

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

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

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

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

Such traders often lack the wherewithal to defend retests.

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

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

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

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

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

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

 Disclaimer

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

Categories
Commentary

Daily Brief For May 5, 2022

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

What Happened

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

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

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

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

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

Ahead is data on jobless claims, productivity, and unit labor costs (8:30 AM ET).

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

What To Expect

Fundamental: The Fed is raising rates and reducing the size of its balance sheet in light of the economy’s “strong underlying momentum,” as Nordea Bank (OTC: NRDBY) research puts it, a hot labor market and elevated inflation.

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

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

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

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

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

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

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

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

Graphic: Via Reuters.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,260.25 overnight low (ONL) puts in play the $4,303.00 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,337.00 untested point of control (VPOC) and $4,393.75 high volume area (HVNode), or higher.

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

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

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

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

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

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

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

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

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 4, 2022

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

What Happened

Overnight, equity index futures were quiet, auctioning sideways-to-higher, ahead of updates on monetary policies.

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

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

Today’s economic calendar includes, also, a release of the Automatic Data Processing Inc’s (NASDAQ: ADP) employment report (8:15 AM ET), international trade balance (8:30 AM ET), S&P Global Inc’s (NYSE: SPGI) U.S. services PMI (9:45 AM ET), and the ISM services index (10:00 AM ET). 

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

What To Expect

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In the best case, the S&P 500 trades higher; activity above the $4,157.00 untested point of control (VPOC) puts in play the $4,195.50 regular trade high (RTH High). Initiative trade beyond the RTH High could reach as high as the $4,247.00 VPOC and $4,279.75 overnight high (ONH), or higher.

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

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

What People Are Saying

Definitions

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

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

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

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

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

About

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

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

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

Disclaimer

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

Categories
Commentary

Daily Brief For May 3, 2022

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

What Happened

Overnight, equity index futures were sideways, inside of the prior range, after exploring much lower, Monday. Measures of implied volatility, bonds, and most commodities were bid.

This is alongside news that Russia is dodging default, the necessity for the Fed to drop inflation down to 4% by year-end per Citadel’s Ken Griffin, the U.S. Treasury’s intent to scale back sales of longer-term debt, falling earnings estimates, Taiwan preparing to fend-off a potential invasion as Beijing ordered officials to find ways to fight against western sanctions, similar to those used against Russia, among other things including Fitch trimming China’s 2022 growth forecast.

Also, near risk-free, inflation-protected I bonds will pay 9.62% through October, the Treasury said, and here’s more on the Citigroup Inc (NYSE: C) trader that’s behind a European crash.

Ahead is data on job openings and quits, as well as factory and core capital goods orders (10:00 AM ET).

Read on for coverage on the fundamental and technical position of the market, as well as ways to position for future trade.

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: The Federal Reserve (Fed) is expected to raise its target overnight rate by about 50 basis points and provide updates on quantitative tightening (QT).

Graphic: Via CME Group Inc’s (NASDAQ: CME) FedWatch Tool. Market participants expect a near-100% chance the fed moves its target rate to 75 or 100 basis points.

The expectations of the aforementioned have played into a tightening of financial conditions which, as Columbia Threadneedle’s Gene Tannuzzo explains, “reduces demand and ultimately slows inflation.”

Graphic: Via Bloomberg. “Tighter financial conditions are the mechanism that reduces demand and ultimately slows inflation,” said Tannuzzo, the firm’s global head of fixed income. “If financial conditions don’t tighten and inflation remains high, in their eyes, they need to hike more.”

The key is the update on QT. As Bloomberg’s John Authers puts it well, “what the Fed does with its balance sheet at the margin [] matters for asset prices, and there is little or no lag.”

Graphic: Via Crossborder Capital Ltd. Taken from Bloomberg.

The Fed’s liquidity reductions, thus far, have played into the market’s troubles since the start of the year. This is as QT has an impact on the “ability to roll over or refinance investments.”

Graphic: Taken from The Market Ear. “46% of non-earnings driven market cap changes were explained by Fed balance sheet expansion since GFC.”

Perspective: JPMorgan Chase & Co (NYSE: JPM) strategists note that investors’ fears are unwarranted. The U.S.’s economic expansion has not been derailed. 

“Worries about China’s growth outlook, a negative take on the Q1 earnings reporting season, concerns about higher bond yields and further tightening of financial conditions from a strong dollar, all appear to have soured equity and credit investors’ sentiment,” the strategists said. 

“We find these fears overblown.”

Positioning: Comments from yesterday’s morning letter remain valid, today.

Participants’ bets on the direction are concentrated in negative delta (long puts, short calls). The exposure is short-dated and extremely sensitive to changes in implied volatility and direction.

Graphic: Via Goldman Sachs Group Inc (NYSE: GS). Taken from The Market Ear. “Retail Investors buyers of 0-1 DTE (days-to-expiry) puts are largest on record.”

Those options carry a lot of gamma and are exposed to the potential for asymmetric or convex payouts. This is not good for those who are on the other side.

In hedging a short put, for instance, a positive delta and negative gamma trade, counterparties sell underlying if there is weakness or jumps in implied volatility. If the underlying trades higher, or dips in volatility, the counterparty will buy the underlying, all else equal.

Taken together, in such an environment, the counterparty leans toward taking liquidity and this exacerbates underlying movement if there’s a thinning liquidity environment, SpotGamma says.

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

In other words, hedging matters more in such an environment. This was clear during Monday’s trade when a bout of put selling and light call buying appeared in both the SPDR S&P 500 ETF Trust (NYSE: SPY) and Invesco QQQ Trust Series 1 (NASDAQ: QQQ).

This, ultimately, too, fed into the compression of volatility at the short-end of the term structure, yesterday. To re-hedge, counterparts likely bought into the market’s weakness and bolstered the near-vertical reversal, and close higher.

Graphic: SpotGamma’s Hedging Impact of Real-Time Options (HIRO) indicator for SPY. A rising blue and orange denote put selling and call buying, respectively.

The odds of follow-through, to the upside, come back to the fundamental situation and Fed announcements this week. Should fears with respect to monetary policy be assuaged, then volatility can compress and that, alone, will spur a buy-back of those underlying short hedges.

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

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

In the best case, the S&P 500 trades higher; activity above the $4,123.00 untested point of control (VPOC) puts in play the $4,176.00 overnight high (ONH). Initiative trade beyond the ONH could reach as high as the $4,247.00 VPOC and $4,279.75 ONH, or higher.

In the worst case, the S&P 500 trades lower; activity below the $4,123.00 VPOC puts in play the $4,055.75 low volume area (LVNode). Initiative trade beyond the LVNode could reach as low as the $3,978.50 LVNode and $3,943.25 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.

Considerations: Most interesting was Monday’s response at a key technical level ($4,055.75) outlined in the morning letter.

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

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

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

Adding, the Federal Reserve’s meeting this week concludes with statements to be shared on Wednesday. For weeks heading into this event, (larger) participants (that move by committee) have de-grossed and hedged. For that reason, the reliability of our technical levels took a hit.

Graphic: Via JPMorgan Chase & Co (NYSE: JPM). Taken from The Market Ear. Per Bloomberg, “Hedge funds tracked by Morgan Stanley have also cut their net leverage — a measure of risk appetite that takes into account long versus short positions — to a two-year low.”

In the very near term, until more fundamental information is revealed, these technical-driven traders may play a larger role in the volatility. These traders, given capital constraints and tolerances, often trigger sharp moves in their entry and exit on news. Caution on whipsaw.

How I’m Playing: Presently, the market is stretched to the downside and participants are leaning, heavily, one way.

Graphic: Via SpotGamma, “Put vs Call gamma suggests stretched positioning.”

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

Consider zero- or low-cost bets that deliver asymmetric payouts in case of reversals.

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

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

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

For those spreads that are not zero cost, debits can be offset with credit sales (on the put side) in products that have shown relative strength like the S&P 500 (INDEX: SPX). This, inherently, carries more risk. Read more about these strategies, here.

Please note that the above is NOT a trade recommendation or advice.

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.

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.