The flagging fiscal stimulus push in the US and escalating virus lockdowns in Europe are a “double-whammy” for the reflationary impulse inspired recently by rising odds of a Democratic sweep in next month’s elections, but Nomura’s Charlie McElligott said the talking point on the desk was more “simple” Thursday.
“You cannot overstate the Gamma impact on the overall market of those single-name, mega-cap Tech options expiring tomorrow,” he wrote, reiterating points from earlier this week, when evidence of knock-on hedging flows at the index level suggested the dynamics that helped push the Nasdaq into the stratosphere in August (only for big-tech to subsequently correct in September) are back in play.
Charlie continued. “The ‘negative Gamma’ in these monster positions… has them chasing the market to remain Delta hedged, accelerating the swings in both directions this week,” he wrote, in an early Thursday morning note.
Read more: Nomura’s McElligott: It’s ‘Déjà Vu All Over Again’ As August Comes Calling In October
The (potential/unfolding) problem here is relatively straightforward. Dealers may be overhedged after struggling to keep up as tech’s scramble higher into this week’s early upside event “risks” (Prime Day and iPhone unveil) prompted forced buying. Now, they may need to get rid of those hedges.
McElligott reiterates as much. “There is simply so much convexity now just a one day out from expiry in these Calls… that we see the opposite accelerant flow on the way down, with the Delta on these now 1-day options having reversed those prior moves and utterly collapsing.”
Dealers, then, may be sellers into a selloff. What would they be selling? Well, as Charlie puts it, “whatever the preferred hedging mix” was for the folks short those calls. That could be the stocks themselves, or QQQ, or Nasdaq futs, or S&P futures, depending on whether the latter looked “cheap” by comparison.
Remember, QQQ has seen some extremely manic flows over the past month or so.
As Bloomberg put it earlier this week, “the massive cash movements may be a byproduct of building options appetite [as] call open interest in Facebook, Amazon, Netflix, Alphabet, Apple and Microsoft has averaged 12.9 million contracts over the 30 days through Friday, the highest since early 2019.”
“Looking locally today, things would get messy in index on a move down through 3400 (3389 to be exact) in SPX and / or through 284.63 in QQQs, where we estimate that the current index ‘long Gamma’ position for Dealers flips ‘short,'” McElligott says, summing things up.
This comes with the usual caveat that nothing is certain, and there are always countervailing flows. But as we’ve seen time and again, these short-term setups where dealer hedging exacerbates directional moves are well worth keeping apprised of.
I admit I don’t understand the dynamic here. I would have assumed that a lot of the hedging was by large institutional investors and that as expiries approached they would “roll” their hedges into longer dated options. It seems implausible they would leave themselves “naked” even for a short period of time. Even triple (quadruple) “witching Fridays” don’t inspire the sort of awe they used to. Does this imply the options market is swaying more towards traders and the market makers catering to them?
By “this” at the end, I meant McElligott”s analysis.