People finally get it. Or so it seems.
Market participants are trying to front-run pullback “windows” created by the post-OpEx “unclench.”
That was one takeaway from the latest by Nomura’s Charlie McElligott, who wrote Thursday that “clients now try to get ahead of this Dealer-driven flow and begin to de-risk” beforehand. (How clever of them.)
The reference was to the options expiration cycle, and the extent to which the dynamics that can keep spot “pinned” (e.g., hedging flows which insulate equities from large moves) periodically roll off, opening the door to a wider distribution of outcomes thereafter.
That appeared to happen last month, when de-risking occurred the week prior, only to see the tide turn dramatically in favor of the bulls thanks (in part anyway) to the resumption of vol-selling. As McElligott put it on August 23, “the feedback loop reversed yet again from ‘vicious’ to back to ‘virtuous.'”
Since then, I’ve casually mentioned that the setup from a “cascade” event is still mostly in place. McElligott put some numbers to it on Thursday.
“The upcoming quarterly Index / ETF options expiration next week is set to be a whopper, because nearly 70% of the S&P options Delta and Gamma is front-month for the serial Op-Ex which, despite [a] modest pullback from all-time highs, remains ‘mongo,'” he wrote.
As was the case last month, it’s conceivable that equities will melt-up into one of the strikes with the most “gravity” into expiration, “but the risk,” Charlie said, “is that you ‘unclench’ after that.”
If more clients are indeed starting to understand this (and by “understand” I mean folks have belatedly realized these dynamics are potentially tradable events and are thereby starting to act on them as the message is finally “socialized”), then some de-risking could occur prior to the full “unclench.” That seems to assume that a wider distribution of outcomes post-expiry necessarily entails a drawdown when it’s actually directionally agnostic. But between various “peak growth” narratives, positioning extremes among the systematic crowd and the general sense that “something’s gotta give” (consider how long it’s been since we saw a 5% pullback, for example), “down” feels more likely than “up,” at least into month-end.
McElligott on Thursday reiterated that this particular pullback window also captures buyback blackout commencement for financials as earnings season looms. He called the proximity to the September FOMC (which, of course, comes with a new SEP and dots) “critical,” as the long shadow of the Fed meeting “could act to limit” the same “‘short vol’ flow muscle-memory” that turned the tide for equities last month when, for a fleeting moment, a selloff looked to be afoot.
In the meantime, Charlie wrote that “spot US Equities index continues to be a story driven by the options market, where we currently see S&P futs banging around the 4,500 strike which now houses the largest $Gamma on the board.” The tail is wagging the dog.
It’s “more of the same (long) gamma stuffing of the Dealer community,” he added, noting that “short-dated Realized Vol has resumed its collapse after the mini-fireworks around the August Op-Ex.”
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