Markets stocks VIX volatility

All Bets Are Off.

"Unimaginable violence" and emergency intervention...

In case it’s somehow not clear enough by the extraordinarily dramatic action in rates, the Fed is now compelled to act in the interest of halting the slide on Wall Street, where stocks are in free fall.

To (again) state the obvious, what traders and other market participants witnessed this week is unprecedented on at least some levels.

Even if the selloff were to stop today, the sheer rapidity of the decline will go down in the history books as one of the most harrowing events ever witnessed in US capital markets. Some readers will doubtlessly dispute that contention, but what’s indisputable are the numbers. This was among the five worst weeks for US equities going back some 70 years.

It is now virtually impossible to imagine that central banks won’t intervene, with the Fed leading the way.

Speculation is now building for, at the least, a weekend announcement.

The likelihood of imminent policy intervention against a purged market that’s now oversold, sets the stage for a potentially explosive environment.

Downside hedges in equities and upside plays on volatility are likely to be monetized, catalyzing what Nomura’s Charlie McElligott on Friday suggested may turn into “violently ‘squeezy’ flows in the equities market”.

If you’re wondering what happened on Thursday (and what is probably happening again on Friday), Charlie calls it a “tangled web of ongoing EXTREME Dealer ‘Short Gamma’ hedging into a meltdown, mechanical and inherently ‘lagging’ systematic deleveraging, and all likely with the additional incremental ‘sell’ flows from the recently 100th%ile asset manager net notional position in S&P futures at $190 billion”.


I’ve spilled gallons upon gallons of digital ink discussing all of those dynamics this week. The bottom line is that between vol.-targeters deleveraging in “passive” fashion (as trailing realized vol. is pulled higher), dealer hedging and CTA de-risking after stocks fell far enough, fast enough, to breach levels previously seen as unreachably low, the tsunami of systematic selling pressure overwhelmed the corporate bid (i.e., buybacks) and pension rebalancing flows.

With retail clearly hitting the exits, it was a wipeout. US equity fund outflows were the largest in nine weeks through Thursday, as $17.7 billion ran screaming from stocks, according to weekly EPFR data compiled by BofA.

On Thursday alone, Nomura’s vol.-targeting model implied an additional $22.6 billion of selling pressure. Once you factor in Friday, the total for the week will likely approximate at least $90 billion for that universe.

On the CTA side of things, McElligott on Friday delivered an update on the situation. You’ll recall that on Thursday morning, prior to the cash open (and, really, on Wednesday as well), Charlie cautioned that the “unthinkable” was suddenly in play.

That wasn’t an attempt to stoke panic – rather, it was just an effort to alert folks to the fact that spot was on the verge of sliding through levels which, when combined with the three-month look-back suddenly getting some ‘loading’ in the model, had put the legacy “100% Long” signal in jeopardy.

So, where are we now? Well, McElligott on Friday writes that although this was “almost impossible to imagine” just a week ago, a break and close below 2,811 in Eminis would flip the model to outright short. The reference was 2,945, so there was still a large cushion, but that was eroded amid another morning “shock-down” on Wall Street.

All of this “speaks to the unimaginable violence and scale of the continued selling [and] de-risking flows in the market in recent days”, Charlie goes on to say, before adding this highly amusing bit of additional color for good measure:

Part of the issue right now is that many investors (hedge funds and the reddit/wallstreetbets retail / day-trader) have “netted-up” into the sell-off in recent days, buying Calls & upside to try and catch a rally in index or their favorite single-names, which all the analogs / backtests tell you that you should be doing; however, they continue getting their hands blown-off, so rallies now are seemingly at risk of being “sold into” on forced de-grossing / “Var-down” behavior.

Now, when it comes to what happens next, you have to think that anybody sitting on downside hedges or upside VIX positions will start to monetize those if for no other reason than to help stanch the bleeding in whatever longs they happen to have.

That, in turn, could get the market back on the “right” (and that’s something of a misnomer, but you get the idea) side of the gamma profile.

“For instance, Dealers [would] have what once were ‘wingy’ S&P / SPY Puts they were short sold back to them as these are monetized, which, in turn, would force them to BUY upside / BUY futures to hedge their synthetic short exposure and likely drive opaque and violent rallies thereafter”, McElligott writes.

Consider all of that in the context of the assumed emergency intervention from the Fed that has STIRs foaming at the mouth. Here’s Charlie one more time:

The fear of this potentially imminent- and likely coordinated- central bank “interventionary” response (let’s call it: this upcoming Sunday night, before the Asian open) will keep markets in a dangerous space, because strategies and traders which are potentially “pressing” shorts 1) either directionally (CTA model now “in play” of outright “short SPX” as noted above) or 2) pressing-shorts to managed “net exposures” or hedge long books, will be exposed to a surge squeeze higher, while investors who have been “grossed-down” by their risk management VaR models won’t be exposed to an “up-trade” in risk and likely feel obligated to “grab into” a short squeeze.

Of course, what makes this even more precarious (assuming that’s even possible) is that China PMI data (not to mention South Korea trade data) are due. Nobody has any idea what the NBS is going to report when it comes to the PMI print, and South Korea’s infection total continues to rise.

Meanwhile, if the market gets hit with news flow that suggests there’s a coronavirus cluster in the US with the potential to morph into a South Korea/Italy/Iran situation, then you can just go ahead and quote Guy Ritchie’s immortal classic, Snatch

All bets are off.


4 comments on “All Bets Are Off.

  1. Great read, thanks a lot Mr. H!
    After following you for the better part of 2 years I can confidently say I understand most of of the “Greek”… 😉
    Having the S&P supporting the theses put forth in realtime sure helps

  2. PaulMiller

    I’m sure the author meant “worst 5 days” vice “worst 5 weeks in opening paragraph.

Speak On It

Skip to toolbar