Nomura’s McElligott ‘Rubbernecks’ Tuesday’s Crash, Says ‘Flow Risk’ Is Materializing

While idly watching Tuesday’s burgeoning train wreck in US equities, I wondered whether an update from Nomura’s Charlie McElligott was imminent.

In fact (and this is true), I actually delayed a trip to the local barber (there’s only one here on the island, it’s a fairly long drive and he’s usually busy) on the assumption that Charlie would likely produce something in relatively short order.

Sure enough, McElligott was out with a quick note on Tuesday called “Rubber-necking a pile-up” that finds Charlie reiterating many of the points he made on Sunday evening about what could transform the tariff tweet tantrum into an honest-to-God rout.

Essentially, McElligott argued that the buildup of a large notional asset manager long in US equity futs (roughly half of which is “in the money” by virtue of being added during the rally) could be at risk of “aggressive monetization”.

Read more: This Is Either ‘Epic Poker-Playing Or A Raging Miscalculation’

That hypothetical profit taking combined with CTA selling below trigger levels and dealer hedging dynamics (on a flip into negative gamma territory) could create a “supply/demand” imbalance, which, if it “tipped over”, would be ugly.

Long story short, Charlie thinks we have reached that tipping point.

“It currently looks as if as we are seeing this supply ‘tip’ into realization, now with both SPX and RTY through their CTA deleveraging levels, while too we estimate that we are now in ‘negative Gamma’ territory in SPX / SPY and QQQ options landscape”, he writes, adding that this comes as the VIX curve inverts “and forces short vega covering from systematics.”

(Bloomberg)

If you’re looking for evidence to support McElligott’s suggestion that asset managers are monetizing and CTAs are deleveraging, consider the following additional color and visual:

Look at this chart to show the magnitude of the Futures over Cash notional today: currently INTRADAY (obviously will look different by end of day with Cash close), the excess Futures notional of S&P, Nasdaq and Russell above the combined Cash notional (and adjusting ‘roll’ days, defined as the first future traded notional-second fut traded notion) is supportive of the view that today’s trade is absolutely driven by futures deleveraging–and perhaps indicative that this is indeed both the 1) Asset Manager monetization of “Longs;” 2) our estimate that CTA Trend models may be reducing their “Long” and of course 3) dealer Gamma hedging activity.

On the surface anyway, this looks to be another instance of McElligott having “nailed it” in terms of outlining the dynamics that could ultimately conspire to pull the rug out.

Things could always turn around later in the week, but as things stand, the market’s Monday, Matrix-esque bullet-dodge has morphed into a bloodbath.