For most of November, market participants enjoyed a “lake placid” environment thanks in part to the gamma “pin” that kept stocks in a “range-y” grind higher.
Nomura’s Charlie McElligott called it a “feel good stasis” as “intraday movement [was] squelched by dealers selling strength and buying dips”.
It was, he wrote last week, “the perfect virtuous feedback loop… as customers sell Vol to Dealer desks [creating] what feels like [a] perpetual pin approx. between the monster $Gamma strikes of 3100 and 3150”.
Despite the “stasis”, the potential always existed for some countervailing force to come along and alter the dynamic. As we put it last week, “one big macro bombshell (e.g., the announcement of new tariffs out of the blue) can change the game overnight”.
Well, the market did, in fact, get a new tariff announcement on Monday, via a bombastic Trump tweet aimed at Brazil and Argentina. That was followed up hours later by a USTR determination that France’s digital tax is unfair and may warrant tariffs on some $2.4 billion in French goods.
Fast forward to Tuesday morning and Trump – who is in London for a NATO pow wow – told reporters that it may be best to wait until after the election to get a trade deal with China done.
This has driven S&P futs some 2.4% lower from the pre-Monday morning tweet highs and it’s now on the verge of imperiling the “virtuous feedback loop” mentioned above.
Nomura’s McElligott is all over it.
“Touching on my constant refrain over the past two years—that being where a ‘macro shock’ acts as catalyst for Dealer Gamma ‘flip’ and/or in conjunction with a Systematic Trend deleveraging impulse— we see a mixed-bag, as our Nomura QIS CTA model shows the majority of Equities futures positions remain ‘in trend’ and ABOVE estimated deleveraging / ‘sell’ levels [while] looking at SPX options, we see the Dealer $Gamma position nearing the potential ‘flip’ level to ‘SHORT GAMMA’ ~ 3073 (spot 3083 last), which would of course beget more selling [to] hedge the lower futures travel”, he writes, in a Tuesday morning note.
In other words, CTAs aren’t yet on the brink of de-leveraging according to Nomura’s model (left pane below), but the dealer gamma “flip” is very close (right pane).
Beyond the “flip” zone, selling can beget more selling, and that has the potential to drive spot lower through key levels that could, in turn, trigger de-leveraging from trend followers. Here’s Charlie:
Back to Equities however, the larger risk today for a “sloppy” move lower in US Stocks would be via Dealer “Greek” exposures via Options positioning, as our analysis of the Dealer Gamma position across consolidated SPX / SPY options is just ~12 handles ABOVE a potential “flip SHORT” level ~3073—but in true “negative convexity” / “short Gamma” fashion, we are accelerating as we turn lower.
After that, all bets are off as the not-at-all virtuous “volatility-flows-liquidity” feedback loop is activated.
Throw in the potential for the massive asset manager long (notional length in futures) to get “monetized” on the way down (i.e., take profits before it’s too late) and you’ve got the potential for something nasty.
Remember, McElligott has called these moves before, specifically in the context of “tariff man”.
For example, on the evening of Sunday, May 5, Trump broke the Buenos Aires truce with a single tweet.
Minutes later, McElligott sent out a client blast warning that depending on how things panned out, SPX/SPY consolidated gamma could flip negative beyond which dealer hedging could exacerbate moves or, as he put it, things “could get sloppy”.
And indeed they did.