Nomura’s McElligott Saw ‘Potentially Important Inflection’ This Week

Early this week, vol markets witnessed “a potentially important inflection,” Nomura’s Charlie McElligott said, in a Tuesday note.

For months, interest in index upside was minimal while demand for downside skew was insatiable, but on Monday, that dynamic (which has been a fixture in McElligott’s commentary) “showed the first signs of abating,” he wrote.

The figures (below, from Charlie) show the shift. The annotations are his.

After citing what he characterized as a “cathartic release” in vols across equities, McElligott highlighted (literally — it’s in yellow highlighter in the original) the combination/juxtaposition of/between downside put skew coming off and a notable bid for upside call skew. The result: A “clobbering” of overall SPX skew. All of that is illustrated in a straightforward way in the tables (above).

To the extent that did, in fact, represent a durable reversal of the trend, it’s significant, especially when considered in conjunction with the potential for a set of familiar systematic catalysts to lend a helping hand to an equities rally that feels like it could use a pick-me-up.

Over the week and a half since the CPI “shocker,” CTAs and vol control shed some $50 billion in equities exposure and now, both could be poised to act as a tailwind. “CTAs have added +$12.4 billion of Global Equities net exposure versus last week [and] the US Equities Vol Control model shows the strategy now set to add in [the] coming weeks with the resumption of a range-y ‘Short Vol, Long Gamma’ trade,” McElligott said. The vol control add is, of course, contingent on well-behaved markets.

Moreover, Charlie cited “big overwriting flows” and “particularly notable Put selling” in a handful of “rich vol, high growth” tech names, as well as the ongoing “bleed” in VIX ETNs’ net vega position, with VXX shares outstanding down almost 30% since late last month. Clearly, some folks went ahead and monetized long vol positions amid the jitters that accompanied the CPI overshoot.

Taken together, all of the above should create a more stable environment. As McElligott put it Tuesday, it’s “all part of the feedback loop which now has us embedded in a very ‘insulated’ US Equities market.”

This is set against a macro backdrop that’s generally seen as having calmed down over the past several sessions, with Fed speakers keen to emphasize that, for now anyway, “transitory” is still the go-to talking point. The April FOMC minutes’ mention of “upcoming meetings” notwithstanding, the taper discussion is, if anything, just getting underway internally, which means it’ll be months before an effort is made to telegraph any kind of schedule for commencement to the market.

Rates have remained rangebound, which I’ve argued is absolutely key when it comes to short-circuiting any further “shock-downs” in tech, hyper-growth and other manifestations of extreme “froth.”

With breakevens coming off their biggest weekly decline since September and commodities taking a breather, it’s little wonder that, as McElligott put it Tuesday, “directional stuff” in rates is “looking tired.”

One persistent theme here has been the notion that modern market structure may not be able to cope with an increase in macro vol. The corollary is simply that macro calm (or even the appearance thereof) can rekindle and feed various manifestations of short vol, thereby creating an environment conducive to re-leveraging in equities. And around we go until the newfound “stability” once again breeds instability on the way to another shock.