Way back in September, SocGen’s derivatives strategists reminded folks that most large daily moves in stocks (where “large” means magnitudes bigger than 1.5%) since May came “when the previous day’s aggregate gamma estimate was negative”.
It’s a crucial point, and one which, to quote Donald Trump on Frederick Douglass, is “an example” of something that’s “done an amazing job and is getting recognized more and more, I notice”.
Jokes aside, this really is important. “Price movements over [last] summer once again clearly emphasized the spot/gamma/realized vol dynamics”, SocGen wrote, in September, documenting a crucial dynamic that it’s always fair to describe as “underappreciated” until everyone understands it.
Last week, on January 27, Nomura’s Charlie McElligott warned that thanks to the move lower in equity futures occasioned by the coronavirus scare, his dealer gamma analysis suggested dealers’ positioning had pivoted negative. That raised the risk of markets succumbing to the type of selling-begets-selling dynamic that’s defined so many of the harrowing routs witnessed over the past several years.
“The lower we go from here, Dealers have to (perversely) ‘short more’ into the down-move to dynamically hedge”, Charlie wrote.
Subsequently, the situation got a bit less dicey as stocks rebounded, but it’s probably safe to say that spot loitered precariously close to the flip zone, something which may have exacerbated some of the big swings last week.
In a Monday note which focuses primarily on the Chinese policy response to the burgeoning epidemic (which you can read all about here and here), McElligott notes that SPX/SPY consolidated options positioning shows $Gamma and $Delta are “now negative”, with dealers “incrementally” back in “small” short gamma territory. Here’s an update on the “flip” chart which has become something of a mainstay:
To the point above, what we wanted to drive home in this quick update is the following chart, which reinforces the idea that this dynamic has a ton of explanatory power, something that folks familiar with this discussion know all too well, but is still largely Greek (figuratively and literally) to wider audiences.
As Charlie writes, a “gamma change ‘impulse’ was again concurrent with [a] large SPX move”.
Meanwhile, updating his famous CTA model, McElligott gives you some granulars on the impact of the look-backs.
“Despite the overall signal for the SPX position remaining ‘+100% Long’ as of this morning (because all three time horizons with any ‘loading’ or ‘weighting’ are all still ‘buy’ signals), the short-term 2w window has in fact flipped ‘Short’ on account of the recent impulse move lower [and] the jump higher in trailing realized vol.”, he says, adding that the gross exposure in the SPX futures position has “thus been deleveraged from the two year ‘high’ of 60.3% made last week, now reduced to this morning’s 49.8% position”.
All in all, Charlie describes the current situation as “stable”, but with “more event risk tonight to keep things edgy”.
By that, he means Bernie risk in Iowa.