You may not put much stock in Donald Trump’s “Phase One” trade deal with Beijing or in the idea that risk assets should be inclined to trust any kind of positive narrative around Brexit, but as Nomura’s Charlie McElligott writes on Wednesday, “the injection of last week’s ‘positive macro catalysts’… has kicked off a +5.0% rally in SPX in nine days after the initial -5.6% move in Spooz from September 19 through October 3”.
It’s worth remembering that this isn’t all about a “rational” response to what, at least on the trade front, is little more than an agreement to keep talking (and even that may be in jeopardy, depending on the Trump administration’s willingness to bend on more tariff relief and Congress’s actions regarding support for pro-democracy demonstrators in Hong Kong).
Rather, this recent move to the upside is in no small part attributable to the collision of two ostensible macro catalysts with what McElligott reminds you was “an investor thesis which was largely ‘long worst-case scenario, short good news'”. This is part and parcel of the theme that’s pervaded Charlie’s recent daily missives, and he’s out reiterating it on Wednesday.
“What is behind this sling-shot move in US Equities?”, Charlie asks. Again, anyone who’s followed his daily musings over the past three weeks knows the answer – it’s August all over again in certain respects.
“Just as we envisioned, the ‘accelerant flow’ has come in the form of second-order impacts across the VIX-universe, ‘daisy-chaining’ in three critical ways”, he writes, before listing them as follows:
- Due to the outsized Oct “VIX Call Wing” buyer who has the Street “short Gamma” in VIX upside, there is a significant amount of VIX futures / VIX upside for sale into this morning’s VIX settlement from Dealers who had to hedge the “crash” they were short, and are now choking on the “decay” implications.
- This said, the most notable VIX options “decay” input over the past few sessions (on the UX1 move from 20.25 just 6 days ago to yesterday’s “low tick” of 13.50) is once-again the enormous impact of the VIX ETNs (which remain so “Long Vega”), as these products and their rebalancing mechanisms completely overwhelm market capacity into their “rolls” from front-month to second-month. The “roll volume” of these Short Term VIX ETNs is far beyond market capacity to digest, and is “the” largest reason that we have seen UX1 print its “local lows” on the day ahead of VIX expiry for each of the past seven months, however before then again seeing VIX grind higher thereafter.
- And finally, what do these outsized “rolls” then do as further VIX complex “knock-on”? They create a massive steepening in the VIX futures curve, which then acts as a “signal” for Systematic “roll-down” players to re-enter the trade in size and further pressure the front-end.
(BBG w/ Charlie’s annotations)
And so, the puking of hedges into this week’s “power decay” helped catalyze a veritable melt-up in equities.
This now has us back on the “right side” of things – McElligott notes that SPX/SPY consolidated Gamma profile is long again.
As for CTAs, spot is just below levels that would trigger further re-leveraging, on Nomura’s QIS model.