There’s scope for a short-term pullback following options expiry.
That’s the message from Nomura’s Charlie McElligott on Thursday, and it’s a familiar refrain. In addition to being a recap of a warning he’s delivered on any number of occasions over the past few weeks, the dynamic that could facilitate a prospective drawdown is a recurring theme.
After cataloguing a variety of factors which have conspired to create what he calls “more opacity” around the “‘true’ nature of the Street Gamma profile”, Charlie reminds you that June serial/quarterly Op-Ex is “always significant”.
“Despite the absolute notional rank being rather ‘mehhh‘ at just 36th %ile since 2013, there is a particularly large %age amount of this aggregate $Gamma set to drop-off”, he writes, reiterating points discussed in these pages on a number of occasions recently (see the last paragraph here, for example).
Specifically, Nomura’s estimates show “nearly a 42% decline once the front expiry clears”, McElligott says Thursday, before giving you some context. “[That’s] a meaningfully larger drop-off than standard expiries in the ~upper teens-20% range and serials being 30%’s”, he notes.
This opens the door to “messier” price action and potentially wider ranges for equities going forward.
McElligott writes that it “fits the historical sequencing ‘up into but lower out-of‘ June Op-Ex”. The figure shows S&P seasonality when the four-week trade into expiry is positive.
In addition to that, there are a trio of factors which could exacerbate things – and I emphasize “could”.
First, Charlie notes that the impact of overwriters rolling options is set to evaporate. Second, we’re approaching buyback blackouts around earnings. Finally, it’s worth considering what the impact of quarter- and month-end fixed-weight rebalancing might be, given that stocks have outperformed bonds recently.
All of this is, of course, tactical, and isn’t meant to be a comment on any longer-term, macro thesis.
But, when you have these kinds of setups where the technical backdrop leaves the market vulnerable to larger trading ranges (as the gamma “pin” loses some of its influence) and supportive flows (e.g., buybacks) fade into negative flow catalysts (in this case possible rebalancing out of stocks and into fixed income), it means that any selloff tied to macro “shock” catalysts has the potential to be amplified.
And in 2020, there are no shortage of potential macro “shock” catalysts.