A ‘Big Change’ In Hedging Focus. And Don’t Forget About Tesla

Every box was checked.

The worst-case, “science fiction” election outcome didn’t play out, even as some of the various theories floated by Donald Trump’s attorneys were described by the courts which heard them as bordering on SciFi. Vaccine readouts from Pfizer and Moderna were about as good as it gets, and the regulatory process for clearing them was expeditious. Finally, although the situation was characteristically fraught, the subjective odds of a lame duck stimulus deal began to increase earlier this month. Oh, and pro-cyclical seasonality held up.

With that checklist completed, volatility compressed as hedges were unwound. So, here we are, with 10-day realized very near the lows seen in late-August/early September when implied was beginning to rise alongside spot, as the footprints of the flow catalysts behind the summer tech melt-up started to make themselves more evident.

The whole post-election conjuncture was conducive to a beneficial feedback loop, as dealer flows helped tamp down volatility. With vol moving lower, mechanical re-leveraging from the vol-control universe was triggered. Those “second-order” flows totaled some $25 billion over the past two weeks, on Nomura’s estimates.

So, what’s changed? Or, in other words, why are you reading this?

Well, as Nomura’s Charlie McElligott wrote Tuesday, clients’ hedging focus has shifted. “For the past few weeks, it had been about fear of missing the ‘Crash-UP,’ as evidenced particularly by the upper 90th%ile Call Skews in economically-sensitive Cyclical ETFs,” he wrote, before noting that “over the past two days, we have now begun seeing grab instead for ‘Crash-DOWN.'”

He cited call skew going offered, SPX 1m put skew “now suddenly” in the 87th%ile, 2m in the 84th %ile, and 3m in the 88th %ile.

“Lack of Dealer balance sheet on account of bank/broker risk management and PNL protection into calendar year-end,” means desks are “unable to be short optionality in size,” McElligott went on to say, writing that “hedging anything is going to move the market and/or cost a pound of flesh.” That’s evident in vol of vol.

Although Charlie reiterated that post-Op-Ex, the door will be open to a wider distribution of outcomes, he also said Tuesday that aggregate $Gamma “has already dropped notably and [is] currently down to just 25th%ile since 2013, with some likely monetization of upside winners.”

Oh, and don’t forget about Tesla inclusion. “Index followers will buy Tesla and sell the other stocks in a size we’ve never seen before,” Kevin Muir said Monday. “I still believe Tesla heads lower into the actual index inclusion, but its strength has left me gasping for air, so I have lost all credibility in that vein,” he added, referencing an ill-fated Tesla short.

“However, let’s assume there will be lots of longs waiting to plug the coming Tesla bid (whatever the price), so on the whole, we probably see some supply come to market over the next week [and] when you combine it with the selling of all the other stocks that are needed to pay for Tesla, there is a decent chance the stock market suffers some serious indigestion,” Kevin added.