All of the big moves markets witnessed over the summer had one thing in common.
We’ve been over this before. But we’re going to go over it again. And you’re going to like it.
“Price movements over this summer once again clearly emphasized the spot/gamma/realized vol dynamics”, SocGen wrote, in a September note documenting a crucial dynamic that can always be described as “underappreciated” until everyone understands it. “All the big daily moves (magnitudes larger than 1.5%) occurred when the previous day’s aggregate gamma estimate was negative”, the bank said.
Failing to appreciate this dynamic will leave you scratching your head when downside moves seem exaggerated and marveling at what appears to be inexplicable tranquility in range-bound markets.
Recently, for example, there’s been quite a bit of digital ink spilled documenting “unheard of” calm. Prior to last week’s small decline, the S&P had risen for six consecutive weeks, the longest streak since the halcyon days of 2017. As Bloomberg wrote in a lengthy tribute to “peace”, the index marked 29 sessions without back-to-back daily losses last Monday. Average peak-to-trough moves have collapsed, along with realized vol. and correlations.
There is no “mystery” to most of this, though. Clearly, optimism around the prospect of tariff rollbacks and the notion that an inflection in the macro is just around the proverbial corner combined to push equities to new highs, but if you’re wondering what accounts for spot getting “pinned” as it were, look no further than gamma gravity.
“Extreme’ SPX $Gamma at 94th %ile and $Delta at 99th %Ile continues this ‘feel good’ stasis for stocks up here”, Nomura’s Charlie McElligott writes on Tuesday, adding that the current snapshot shows the dealer ‘Long Gamma’ position wouldn’t flip ‘Short’ “until all the way down in the 3050-3060 range”.
He then revisits the points made here at the outset.
“Intraday movement is squelched by dealers selling strength and buying dips”, he writes, explaining the “negligible” 1-day range in markets.
This acts to tamp down volatility and serves as a kind of automatic check on outsized swings. As Charlie goes on to reiterate, it “creates flows which insulate the market against large drawdowns”.
Again, this is second nature to a lot of folks, but for most “regular” market participants, it’s greek (figuratively and literally). Until it’s something that counts as common knowledge to the general investing public, “underappreciated” will be an apt adjective.
McElligott summarizes the situation as follows:
Grinding higher (albeit range-y) S&P 500 is the perfect virtuous feedback loop for the market to choke on sustained “Long Gamma,” as customers sell Vol to Dealer desks largely via yield enhancement strategies / players—thus what feels like this perpetual pin approx. between the monster $Gamma strikes of 3100 and 3150. An additional boost to Equities comes from the VIX ETN complex, where the insane 99.4 %ile “Net Long Vega” position (rel 2011) continues to mean rebalancing flows which sell UX1 fut to buy UX2—creating extremely outsized “SELL VIX” flows as a “second-order”catalyst for higher stocks.
If you’re looking to explain things, there’s your explanation. (Note: You should consider that latter bit about the VIX ETNs whenever you hear talk of the “record short” in VIX futs.)
As Charlie put it in a recent interview, “you know, I think the most powerful and most meaningful flow in the market is gamma, which, in some ways, is saying that the tail wags the dog with regards to what people think moves the markets actually does not move markets”.