It goes both ways.
Several weeks back, I attempted to emphasize that although dynamics associated with systematic flows and modern market structure grab the most headlines when they can be blamed for exacerbating selloffs, they also contribute to melt-ups and, in some cases, upside “crashes.”
Since last month’s OpEx, stocks have oscillated. The post-expiry “unclench” collided with a hodgepodge of macro catalysts, and the ensuing swings drove a spike in realized vol, which tipped the Jenga tower for a vol control universe that spent the summer accumulating exposure thanks to a market that moved ever higher on small-ish daily gains.
Recall that equities logged a series of peaks despite a lengthy stretch without a 1% move higher (figure below).
The spell finally broke last month. The high-to-low in S&P futures was -6.2%. On Nomura’s models, the de-allocation from CTAs in global equities was $135 billion since the start of September. Vol control de-risking in US equity futures was nearly $100 billion over (roughly) the same period.
But coming back to my point, the bank’s Charlie McElligott on Thursday noted that “rips like [Wednesday] and more into today show you that the market is trading ‘short Gamma and short Delta’ and that goes both ways.” “So, they’re grabbing Delta to the upside now with the same violence that we traded to the downside,” he remarked.
US equities accelerated higher Thursday morning following a deal between Mitch McConnell and Democrats. The debt ceiling can was kicked to December, when it’ll be reargued.
The stage is set for a possible resumption of the virtuous loop. Although at least one bank was quick to suggest that dip-buying “failed” this time around, that assertion won’t hold if stocks manage to make new highs in relatively short order. A resumption of familiar dynamics could very well get us there.
McElligott on Thursday cited the “delta positive dynamics of hedge monetization, resumption of Vol selling, and downside puts going OTM” as factors which can “further feed the virtuous cycle where rVol resets lower, and leads to lagged re-allocation / re-leveraging thereafter from systematic Risk Control and Target Vol strats.”
Meanwhile, call skews are back from the dead, suggesting some folks are going on offense — if tentatively and with the caveat that the usual list of downside metrics still exhibit extreme historical ranks. Speaking to the “crash-up” accelerants, Charlie wrote Thursday that the big move in spot flipped the gamma profile in SPX/SPY, or at least brought it near neutral (figure below). QQQ was “finally nearing long Gamma ‘insulation’ again” as well, with $366.52 the level to clear.
Although he was careful to enumerate the risks, McElligott also listed three possible “final nails in the coffin” for the equities selloff.
The debt ceiling can-kick “matters, as it accelerated the obvious ‘short Gamma / short Delta’ dynamic in the marketplace,” he wrote, adding that the big rally in the Hang Seng on Thursday suggests traders are “sniffing out” PBoC intervention.
Finally, earnings season is upon us stateside. “Revisions have turned largely negative, which is actually a back-test ‘positive’ for stocks on the lowered bar,” McElligott said.
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