Past, Present And Future

The tail is still wagging the dog.

I assume that’s obvious to those who understand the dynamics which explain why stocks do what they do (or don’t do) on a daily basis. For everyone else, the simple version is just that options are dictating cash equities.

A recent FT article cited Barclays in noting that call overwriting funds logged the biggest monthly inflow since 2012 in July. The same linked article cited SocGen’s James Masserio, who said the bank’s trading desk is seeing “an increase in interest from investors looking to overwrite call selling on existing and new stock positions.”

Nomura’s Charlie McElligott reiterated familiar talking points in a Thursday note which mentioned the FT piece. “Yield enhancement and income-generating overwriting flows looking to exploit elevated vol risk premia are stuffing Dealers on market insulating (long) Gamma,” he said, noting that the sum of SPX and SPY $Gamma within 1% of spot now ranks in the 92.4%ile.

By way of illustration, Charlie noted that the “cumulative flows from the ‘Gamma Hammer’ strangle-seller alone have Dealers long ~$3B in Gamma… which means that for a generic 100bps selloff, desks would in theory be in the market buying ~$2.5B of futures.”

If you’re wondering why a given day’s equity weakness never seems to develop into a proper selloff (like some poorly organized disturbance that can’t manage to become a hurricane), that goes a long way towards explaining it. Equities are insulated by what amounts to a mechanical, automatic stabilizer.

Meanwhile, the same juxtaposition between implied/term and realized persists, with the vol complex doomed to extremes by a structural supply/demand imbalance. “Dealers simply cant be short ‘crash’ / ‘tails’ out 1m in any real size, and we have to daisy-chain each other on expensive hedges,” McElligott remarked.

Read more: As August Melts Into September…

He’s still focused on mid-September for a possible local peak in stocks and a (possibly fleeting) window for a pullback on a post-expiry gamma unclench that opens the market up to a wider distribution of outcomes. And just as corporates go into buyback blackouts and the Fed attempts to thread the communications needle at this month’s meeting.

Jerome Powell will need to contextualize the new dots with the (increasingly emphatic) contention that the taper timeline carries no mechanical implications for liftoff timing. Powell routinely reprimands the media for mischaracterizing the dot plot, and this is one time when I’m sympathetic to the plight of journalists. It’s not realistic to ask people to ignore a visual summary of expectations for the price of money when those expectations emanate from the very people who set that price. This month, Powell will presumably engage in the usual attempt to explain away the dots, while simultaneously reiterating that there’s not necessarily a link between the taper timeline and liftoff.

“I think the Fed timing here is particularly meaningful, not because the potential for an ‘official’ announcement of tapering is some massive deal to markets, but more because the potential for movement in the Committee’s economic projections and thus the ‘dots,’ which could cause some Rates upheaval,” McElligott went on to say Thursday.

If any such “upheaval” temporarily subdues the market’s classical conditioning (e.g., the instinctual selling of “rich” vols at the first opportunity or, more simply, the buying of anything that even looks like a “dip”), it “could mean a longer period without the support that comes from [those] short vol flows reflexively swooping in to save the day,” Charlie remarked, adding that for more than a decade, those flows “have acted to reset nascent spikes in volatility and stop the bleeding.”