“Risk assets remain on razor’s edge”, Nomura’s Charlie McElligott wrote Monday, ushering in the new week with a quick blast documenting the state of play, as it were.
Things are off on something of a sour note. The situation in Hong Kong deteriorated further and China’s credit data for July came up short, raising more questions about political and economic stability, respectively.
When it comes to US equities, McElligott notes that “the situation remains binary into Op-Ex, as we either ‘realize down’ to what the Vol market has been telling us over the past month or all of this ‘crash’ bid / VIX ‘Short Gamma’ bleeds and acts to ‘sling-shot’ US Equities higher on second-order impacts”.
By “realize down”, Charlie means a dive into the 2700s, and by “second-order impacts”, he just means volatility grinds lower, folks see their downside hedges turn worthless and crash protection gets sold.
As far as the prospects for potential downdrafts tied to trade escalations to be turbocharged by dealer desk hedging, the good news is that things don’t look quite as extreme as they did last week. That said, McElligott warns that dealer gamma remains short “and thus hyperactive with the various geopolitical catalysts likely keeping options’ desk hedging very twitchy”.
As far as CTAs go, Charlie chuckles a bit at the “perverse” situation created by last week’s bounce-back. “On the powerful recovery off the lows via heavy post-earnings corporate buyback flows and leveraged funds being short-squeezed into covering, the +100% Long position has been re-established in both SPX and NDX by CTA Trend, which then perversely means we are again in close proximity to further deleveraging ‘sell triggers’ as CTAs struggle with the ‘chop'”. His model shows SPX selling under 2883.
For Charlie, one of the more potentially impactful near-term catalysts remains the “other side” of the 50 Cent VIX positions. He talked at length about this last week.
“With dealers short the Call Wing into this Friday’s expiry, which in-turn has kept S&P Skew extreme as they are forced into holding enormous ‘crash’, IF the global risk dynamic were to even just ‘stabilize’ with no new negative shocks over the course of the week, that Dealer ‘Short Gamma’ in the VIX complex should beget more UX selling on forced-hedging flows”, he writes.
As indicated by the all-caps (in the original), that’s “a big ‘IF'”.