Weekly Brief | June 20, 2021
Weekly commentary for U.S. broad market indices.
Too Lazy; Didn’t Read: As the market enters into a seasonally weak period, participants have noticed a divergence appear across the broader market. A breakdown in individual sectors – financials and transportation, for instance – and breadth, policy tightening concerns, outflows, elevated skew, put/call ratios, and degrossing on risk-taking (e.g., speculative activity in so-called meme stocks), in conjunction with the passage of Quadruple Witching, may portend increased volatility.
Market Commentary
Key Takeaways: Index futures diverge. Risk-off sentiment returns.
Fears over inflation and taper sparking movements.
Ahead: GDP, Home sales, PMI, Claims, Fed speak.
Indices sideways to lower; growth, tech stay strong.
What Happened: Last week, U.S. stock index futures diverged.
The Nasdaq 100 traded relatively strong, in comparison to the weaker S&P 500, Russell 2000, and Dow Jones Industrial Average. This action comes as the Federal Reserve signaled a faster-than-expected pace of policy tightening (learn more about the impact of policy tightening, here).
At the same time, in conjunction with the divergence in major indexes, participants saw sectoral breakdowns, a concern that may portend increased volatility after ‘Quadruple Witching’ Friday, or the rebalancing of benchmarks, as well as the expiration of stock index futures, stock index options, stock options, and single stock futures.
In light of the event, participants found it very difficult to discover prices. That’s according to Matt Tuttle, the CEO at Tuttle Capital Managment LLC.
“When you get one of these events, you get noises around share movements,” Tuttle said by phone. “It messes up the information that we’re seeing.”
Adding, this Quadruple Witching Friday may throw a wrench into the recent bullishness.
Much of the advance, since the election, came in light of a historically bullish period for markets, amid increased mobility and reflation, supportive structural flows, as well as the pricing in of positive earnings expectations.
Now that the reaction to earnings was lackluster, in addition to the passage of a large derivative expiration and move into a seasonally weak period, the odds of volatility are substantially higher.
Why? Most funds are committed to holding long positions. In the interest of lower volatility returns, these funds will collar off their positions, selling calls to finance the purchase of downside put protection.
As a result of this activity, options dealers are long upside and short downside protection.
This exposure must be hedged; dealers will sell into strength as their call (put) positions gain (lose) value and buy into weakness as their call (put) positions lose (gain) value.
Now, unlike theory suggests, dealers will hedge call losses (gains) quicker (slower). This leads to “long-gamma,” a dynamic that crushes volatility and promotes momentum, observed by lengthy sprints — like the one the market is currently in — followed by rapid de-risking events as the market transitions into “short-gamma.”
“‘Equities stable on hawkish Fed guidance’ is the wrong read here,” Nomura’s Charlie McElligott notes. “Equities are stable for the same reason they’ve been chopping for weeks: markets continue choking on an oversupply of gamma from vol sellers!”
The implications of this volatility supply can be summed up with the below graphic.
Given that OPEX will lead to a drop in gamma exposures, the market will, in the simplest way, be subject to more movement in its attempt to price in changing financial conditions.
Options Expiration (OPEX): Option expiries mark an end to pinning (i.e, the theory that market makers and institutions short options move stocks to the point where the greatest dollar value of contracts will expire worthless) and the reduction dealer gamma exposure.
“The extremely low SPX realized volatility is consistent with the possibility that 18-Jun has left ‘the street’ long index gamma, in which case realized volatility could pick up once positions are cleaner,” Rocky Fishman of Goldman Sachs said.
What To Expect: In the coming sessions, participants will want to focus their attention on where the S&P 500 trades in relation to the $4,153.25 high volume area (HVNode).
Volume Areas: A structurally sound market will build on past areas of high volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low volume area which denotes directional conviction and ought to offer support on any test).
If participants were to auction and find acceptance into areas of prior low volume, then future discovery ought to be volatile and quick as participants look to areas of high volume for favorable entry or exit.
That said, participants can trade from the following frameworks.
In the best case, the index trades sideways or higher; activity above $4,153.25 puts in play the HVNodes at $4,177.25 and $4,199.25. Initiative trade beyond $4,199.25 could reach as high as the $4,227.75 HVNode, $4,235.00 Point Of Control (POC), and $4,258.00 overnight high (ONH).
POCs: POCs are valuable as they denote areas where two-sided trade was most prevalent. Participants will respond to future tests of value as they offer favorable entry and exit.
Overnight Highs (Lows): Typically, there is a low historical probability associated with overnight rally-highs (lows) ending the upside (downside) discovery process.
In the worst case, the index trades lower; activity below $4,153.25 puts in play the $4,122.25 HVNode. Thereafter, if lower, participants should look for responses at the $4,069.25 HVNode and $4,050.75 low volume area (LVNode).
News And Analysis
Economy | Big shift in so-called “dot-plot” that tracks rate projections. (Moody’s)
Economy | Housing boom moderates on lower building permit authorizations. (S&P)
Economy | Capital gains – a century-old tax break gets a rush of attention. (WSJ)
Economy | Supply crunch risks are extending into 2022, stocking inflation. (WSJ)
Economy | New Chinese regulation requires recovery, resolution plans. (Moody’s)
Markets | Troubled companies take pages from AMC playbook, selling stock. (WSJ)
Markets | Brace for huge oil volatility one U.S. trading group suggests. (REU)
Economy | U.S. bank loan-to-deposit ratios fall and pressure margins. (S&P)
Economy | U.S. economic recovery doesn’t have to follow herd immunity. (Moody’s)
Economy | The U.S. distress ratio continued its downward trend last month. (S&P)
Economy | Global structured finance – charting the recovery from COVID-19. (S&P)
Economy | The MBA is predicting another decline in new home sales. (MND)
Markets | Bond market in midst of repricing, but not the kind we’re used to. (MND)
What People Are Saying
Innovation And Emerging Trends
FinTech | Owning the paycheck is the key to financial technology success. (TC)
FinTech | Mark Cuban says ‘banks should be scared’ of crypto-based DeFi. (CNBC)
FinTech | Outlook: How the API economy is reinventing financial services. (CBI)
FinTech | Analysis: Big differences between a digital dollar and a CBDC. (BBG)
FinTech | Cryptocurrency lode of $100B stirs worries over hidden danger. (BBG)
FinTech | Axis-Z is working hard to bring virtual reality (VR) tech to trading. (BZ)
FinTech | OVTLYR’s platform helps investors take advantage of volatility. (BZ)
FinTech | Liti Capital allows investors tokenized access to litigation finance. (BZ)
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.