Heisenberg Report

Nomura’s McElligott: ‘Violent’ Virus Contagion Flips Dealer Gamma Profile, Prompts ‘Massive Stop-Outs’ In Treasury Shorts

Risk assets started the new week in all kinds of trouble, as the initial, knee-jerk moves coming off the weekend were not faded.

In fact, US equity futures fell further. European stocks followed Japanese equities lower, as markets appear to be on the edge of panic amid the proliferation of the Wuhan epidemic, which showed no signs of abating over the weekend.

10-year yields, which fell to the lowest since prior to the October announcement of the “Phase One” trade deal in the earliest of early trading Monday, continued to fall. S&P futs were down nearly 3% from Friday’s pre-cash-open levels at the overnight lows.

Our initial reaction was to emphasize the move in Treasurys as perhaps the most notable part of this virus-scare move. Early Monday, Nomura’s Charlie McElligott underscored the point.

“The 2020 resumption of the ‘Everything Duration’ rally violently escalates to start the week as the Coronavirus contagion snowballs, with the already brutal short-squeeze in USTs experienced last week now blowing through stop-losses and seeing UST futures across the curve at best levels since Fall ’19, with risk-assets sharply lower on negative global growth impact fears”, he wrote, alluding to a discussion last week around bond shorts at a time when bonds have refused to selloff.

He then updates the numbers from Friday’s COT / TFF data, citing colleague Ryan Plantz. There was, it turns out, “even more aggressive Spec selling of Duration in the last weekly reporting period”, which makes this action in rates especially painful.

(Bloomberg, Nomura’s Plantz)

As far as equities are concerned, McElligott has some potentially distressing news: We may have reached the dreaded “flip zone”.

“This Coronavirus ‘black swan’ has shocked-out the ‘extremes’ recently seen in SPX / SPY consolidated options positioning, with prior 95%ile + $Gamma- and $Delta- positions now acting as a source of significant ‘de-risking supply'”, he writes.

Last week, Charlie noted that for the time being, markets were still insulated from shocks, but that may be about to change.


That isn’t what you want to see. It suggests we could witness the type of selling-begets-selling dynamic that’s defined so many of the harrowing routs witnessed over the past several years.

“Our Dealer Gamma analysis actually shows that the Dealer Gamma position has now pivoted NEGATIVE on the move in futures below 3263”, McElligott says. “The lower we go from here, Dealers have to (perversely) ‘short more’ into the down-move to dynamically hedge”.