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Gamma Gravity And Vol. Math Following The Trump-Xi Trade Détente

"...it will be hard for vol NOT to come in after the event."

Although it’s never a great idea to count the proverbial chickens before they hatch, Saturday evening’s news that the U.S. and China have struck what amounts to an interim deescalation agreement on trade is ostensibly positive for risk sentiment heading into the new trading week.

Depending on who you ask, “consensus” (and I use that term loosely there as it’s hard to form a “consensus” around anything that Trump is involved in) headed into the G20 was that the two sides would at the very least attempt to try and improve the optics around the situation.

Although Goldman (for instance), suggested that the “most likely” outcome was further escalations, they put the the subjective odds on that at just above 50% with a “pause” scenario coming in a “close second”.

Long story short, what we got on Saturday evening is a “pause” – the tariff rate on the $200 billion in Chinese goods that were taxed at 10% from September 24 will not be raised to 25% at the turn of the year. There will be no additional tariffs for at least 90 days while the two sides negotiate a laundry list of issues including, of course, IP theft and forced technology transfer. China has reportedly agreed to buy a “substantial amount” of U.S. goods including agricultural product from U.S. farmers, so I suppose we’ll be watching this chart going forward:

Soybeans

(Bloomberg)

All of this leads one to wonder what was wrong with Steve Mnuchin’s original, similar deal struck with Chinese Vice Premier Liu He back in May.

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In any case, this counts as a thawing in relations as the stalemate has for now been broken. Obviously, Trump could renege at any moment, but absent an inflammatory tweet between now and when trading gets going, you’d be inclined to think there’s scope for risk assets to build on last week’s gains.

You’re reminded that U.S. stocks logged their best week since 2011 on the heels of Jerome Powell’s dovishness and the November Fed minutes, which tipped a “flexible” committee that may consider altering the language in the statements going forward to reflect the notion that there is no “preset” policy path, where that means hikes could be paused at any time depending on the incoming data.

SPX

Headed into the G20, we spent quite a bit of time discussing the dynamics that could turbocharge any trade-related relief rally, including tightly clustered CTA levels and the potential for systematic buying to push assets into key strikes, triggering gamma effects that would in turn accelerate things further.

In a Friday note, Wells Fargo’s Pravit Chintawongvanich provides a bit of color around the options side of this equation.

“A breakthrough in trade this weekend is unlikely, but the bar is low for a positive market reaction”, he notes, adding that “with event premium this high, it will be hard for vol NOT to come in after the event.”

The key bit from Chintawongvanich’s note is the discussion of the “tremendous” (an apt descriptor, given that Donald Trump is involved) amount of buying in short-dated calls.

“There is large open interest in SPX Dec 7th upside calls, especially at the 2750, 2770, 2800, and 2850 strikes”, Chintawongvanich reminds you, before reiterating that if the market is pushed into those strikes, “dealers become short gamma and will have to buy S&P on the way up, potentially exacerbating the move.”

Wells

(Wells Fargo)

Crucially, Chintawongvanich notes that the very fact of the G20 being out of way will bring down vol. “Looking at the curve, we can calculate implied vol as of Dec 3 to see where vol would be without this weekend included [and] Dec 2750 calls would be 1.1 vols lower”, he writes. And that’s just the mechanical impact – that is, it doesn’t account for any prospective relief rally.

Vol

(Wells Fargo)

Again (and this should go without saying, let alone without us saying it multiple times in the same post), this could all be derailed with a couple of wild tweets, but what we would say is that Powell may have at least mitigated “tweet risk” for the time being.

Also bear in mind that this is now a shortened trading week due to the the national day of mourning for President Bush.

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