“News” – in scare quotes.
Nobody really believes talks between Bob Lighthizer, Steve Mnuchin and Liu He early next month are going to accomplish anything, let alone set the stage for an imminent lifting of US tariffs and retaliatory duties.
But the headlines are “dictating forced-reduction of crowded ‘risk-off’ hedges”, Nomura’s Charlie McElligott writes on Thursday.
Hot on the heels of yesterday’s risk-on catalyst(s) (i.e., Hong Kong concessions and Boris’s boondoggle) the follow-through triggered by the US-China news is manifesting itself in “one month out VIX futures down over 1.5 vols since Tuesday, UX term structure normalizing again back into upward-sloping fashion from prior inversion, short-dated skew getting hammered as the S&P Put-Wing collapsed and ‘Vol of Vol’ smoked nearly 5 vols, as downside tails get crushed”, Charlie notes.
Given the nature of modern market structure, that easing in the US equities vol. complex has the potential to catalyze further upside for stocks, as trailing realized is dragged lower, “allowing” for and/or dictating re-leveraging from systematic strats.
“In typical ‘second-order’ fashion of the Delta-One / Vol-Targeting market structure we exist within, this easing in the Vol complex will act as further upside catalyst for underlying risk-assets”, McElligott goes on to say, adding that “in the case of VIX, we’d expect to gradually see the return of roll-down players as the curve has again normalized”. So, more short vol. supply and another systematic flow driver.
As far as CTAs go, Charlie flags potential covering in the Russell, where futures are scooting above a key trigger level.
Meanwhile, in the S&P, “gamma gravity” is at work, with “two very large strikes ($4.5B at the 2950 level and $4.4B at the 3000 level)” serving as a tractor beam of sorts. “This is particularly the case with Dealers being Long Gamma from the return of various Vol Sellers”, McElligott goes on to say, referencing the flows from overwriting and yield enhancers he’s been documenting for the last several notes.
This is all in the context of Charlie’s prevailing view, which centers around stocks trading up into mid-September as overwriters roll in-the-money calls, creating large buying of Deltas into expiry, while corporates scramble to squeeze in buybacks ahead of the blackout period.
That then theoretically acts to “force” in the fundamental/discretionary crowd, where nets are extremely depressed. Throw in systematic re-leveraging as outlined above, and you’ve got the potential for a push higher into mid-month.
And then comes the (potential) fall, as some of the bullish catalysts for equities mentioned above roll off (by necessity and by definition vis-à-vis buybacks and expiry) into a possible Fed disappointment.
As far as the Sino-US talks go, Charlie notes the obvious, which is that many see it as “merely ‘face time’ for markets and little more”.