The dollar is down modestly, gold up significantly, and Treasury yields are unchanged this morning. But US equity markets are screaming higher, panic-bid since the cash markets opened…
The surge in stocks has been going on for 3 days now, with the cash market open being the dominant source of buying pressure…
The narrative for today’s surge is that headlines from the PBoC pledging to support the economy with “appropriate” money growth are driving gains (except that doesn’t explain why stocks barely budged until the cash market opened).
It would appear that the S&P is rebounding back to the remaining upside Gamma at 4475 ($2.7B) and 4500 ($6.8B) beyond that, supported lower at 4450 ($3.8B)
As we detailed last week, the Tue / Wed / Thu risk waterfall originating out of the US Equities Vol space came tantalizingly close to developing into a real move, -2.8% from hi to lo in ES over 3.5 days last week, as Dealers struggled to managed the loss of their long Gamma into expiration as we sold lower through big expiration strikes, versus their short Vega position, which was being squeezed in a pretty painful fashion.
So, what turned the tide off the lows Thu and again Fri… and today?
Nomura’s Charlie McElligott has some answers: The same bulletproof conditioning that has been established over the past decade-plus: selling of “rich vols” into nascent volatility spikes (i.e. UX1 over 22 and VVIX flirting with 130s) as rVol “crashed up” to implieds (ESA 5d realized went from 2.9 to 18.3 quickly), along with monetization of hedges almost immediately, as the feedback loop reversed yet again from “vicious” to back to “virtuous”
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Thursday afternoon as stocks were again fading and tilting down the earlier lows, there was a critically-important sale of what ended up being nearly 15k Nov ES 3600 Puts with another 5k behind out loud (yes, options on futures—traded at the Merc), which approx coincided with the local afternoon low in Spooz…and from there, we rallied back to aforementioned 4400 strike by cash close
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The more important observation about this trade is that it supplied the market back some of its “short crash,” which of course has been creating the ongoing “demand > supply imbalance” tension within the Vol complex which I keep harping about…with an additional kicker of the MM buying futures too against the ‘long Puts’ position they now held, helping spot turn higher at a crucial turning point
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From there, Vols eased back further through Friday, as the inability for Equities to hold lower saw more capitulation of folks who were dynamically hedging (i.e. futures shorts being covered), while we rallied further into strikes that still held some Gamma into Friday’s p.m. expiration as they picked-up Delta again
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And all as we saw additional “short vol” flows from the “Gamma Hammer” Friday as well (27aug 4335/ 4490 sgl paper sold @19.7, 1161xput 1124xcall // sepPM 4200/4540 sgl paper sold 1161p x 1122c @42.75)
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Already today, more of the same, yet another profile sale of “rich Vol” early into the session: Sep 4250p paper sold 2800x @ 20.2 200mm delta, 825k vega
All of which leaves us with an S&P which has gone over 11 months without a -5% drawdown, and 289 days remaining over the 200dma (91st %ile, occurred 16 x’s since 1929).
Historically, the type of gamma flip (from positive to negative) that we saw last week into Op-Ex has suggested the “window for movement” around the monthly Op-Ex could indeed “open,” and deliver “lower” and “chop” for a few days thereafter:
BUT, as the Nomura strategist explains, despite these inputs aligning, the “short vol” kneejerk – along with the trained “monetization” behavior of hedgers – killed the move, and before Vol Control de-allocation stood a chance to occur this week, despite the readiness to cut on any meaningful pullback due to the recent loading of exposure in conjunction with such a low absolute level of trailing realized Volatility
So what happens next?
Here is what McElligott suggests the Vol Control activity “naively” projects (current conditions held static) – which as stated last week, there is almost no way to “add exposure” locally over this next 1w…
…but that is irrelevant right now, because the thing that matters here is getting an actual “drawdown” which could set a VC deleveraging in-motion… and currently, that is increasingly unfeasible in an environment where Vols are being puked indescriminately per the muscle-memory of traders in the “Fed Put / Financial Repression” era of “short vol as yield enhancement”.
Will Powell puncture that conditioned-response-bubble on Friday?
