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‘Spastic Spooz’: An (Implicit) Short Gamma Odyssey

"Hello Dave".

On Tuesday, JPMorgan’s Marko Kolanovic suggested that after October’s abysmal performance in U.S. equities, stocks could be in for a “rolling squeeze higher”.

That was at roughly 10:15 on Tuesday morning. Since then, stocks are up more than 2.5%. My guess would be you won’t hear much from the bearish peanut gallery, let alone from any newly-minted Kolanovic critics, on that point.

Read more

Marko Kolanovic: October’s ‘Rolling Bear Market’ Could Morph Into A ‘Rolling Squeeze Higher’

Anyway, part of the rationale for Marko’s call was re-risking from systematic investors whose exposure to equities plunged in October. “Volatility targeting strategies’ equity holdings are similar to February lows, and many CTAs are outright short or out of equities”, Marko wrote, before suggesting that if “volatility [were] to decline into year-end, [it] should prompt systematic investors to re-build equity positions to the tune of ~$100 billion.”

That was but one of several factors Kolanovic cited and obviously, re-risking from the systematic crowd won’t happen all at once, but in the context of that call, the following excerpt from Nomura’s Charlie McElligott is notable (this is from his Thursday note):

This U.S. Equities “gap higher” (S&P minis +4.8% since Monday night’s low-tick) ultimately has forced incremental Systematic fund RE-leveraging in U.S. Equities—the Nomura Trend CTA model shows SPX positioning now “+60% Long” from “+31% Long” two days ago; Russell to “+60% Long” from “-100% Max Short” last week; and Nasdaq to “+60% Long” from just “+31% Long” yesterday.

As ever, we would remind folks that if you’re going to flag the impact of these flows during selloffs, you have to also be mindful of how they contribute on the upside. That’s something the likes of McElligott and Kolanovic have no trouble doing (indeed, that’s their job), but I’d be willing to bet that most readers have noticed a remarkable propensity over the past year or so for bearish commentators (bloggers and otherwise), to scream from the rooftops about systematic de-risking only to go completely quiet when it comes to systematic re-risking.

In his Thursday missive, McElligott also touches on what he calls “a hotly-debated topic now in the business”. That topic: The propensity/ability of funds that were torched last month to go on the “offensive” and thereby provide an incremental bid for equities going forward. This is an extension of the discussion around the egregious hit discretionary funds took in October.

“The underperformance/shock drawdown within the U.S. Equities fund space weakens the basis for performance-chasing mentality into year-end as sentiment pivots to defense from offense, with little-to-no ammo across the generic fundamental/discretionary Equities space”, McElligott wrote in his Wednesday note.

Well, on Thursday, he picks back up on that debate on the way to positing a theory about what’s been going on over the past several sessions.

“SPX continue to trade like there’s an implicit and incremental source of short gamma in the market [and] that short gamma source would likely be contained within the fundamental universe, both HF and MF, who are not actually short option delta per se, but are increasingly likely to act as forced buyers the higher we travel”, Charlie writes, before making the obvious connection with the October narrative as follows:

This is occurring after the 1) “mass de-gross / cutting of nets” and 2) enormous reduction of “market” factor risk exposure of the past month. “Beta” market-neutral was -10.9% in Oct despite including yday’s +2.9% rally—nonetheless the sixth worst month for the factor since 2010—as crowded portfolio positioning “long high beta / short low beta” was liquidated.

McElligott is basically – and he says this – arguing that with macro funds and trend followers re-risking, building exposure and just generally getting long, hedge funds are getting left further in the dust.

“They’re de facto getting shorter the higher the market moves in their absence”, Charlie says, adding that in his mind, “they are ‘dynamically hedging’ with spastic trading in Spooz as opposed to options due to their richness right now.”

So there’s a handy explanation for you if you’re inclined to characterize the last couple of days as “spastic.”

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4 comments on “‘Spastic Spooz’: An (Implicit) Short Gamma Odyssey

  1. My new goal in life after I retire is to actually and fully understand what u write

  2. Pingback: A menudo uno encuentra su destino justo donde se esconde para evitarlo. – Global Macro Statistical Arbitrage Fund

  3. Yvonne keep reading the posts and u will get it sooner the be able to retire earlier!!! Basically it is all about outperforming a benchmark and keeping your job. So even if fundamentals are bearish in a PMs mind they need to be cognizant of the benchmark and if they underperform they end up living in their parents basement. The pressure to perform is so great that they almost have to chase performance or risk a career ending mistake. So if everyone owns AAPL and money flows come in they have to buy, value, growth, momentum guys everyone then justify it with a story. As long as it goes up and you are overweight u win but if something tips the balance everyone has to get out. Fundamentals become a rear seat passenger to the flows driver. The short term focus is why many funds underperform. These guys view risk as volatility rather than future cash flows and valuations. It works until it doesn’t and they zig when they should zag. The market was riskier at the end of Aug than it is now (not to say the fundamental risk is that different still elevated due to wage pressures, late cycle, fiscal position, tariffs, etc) but these guys were longer then then they are now. Be smart, think rational, focus on risk and reward, fundamentals, valuations and you will do well. Hope this helps.

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