US equities labored under the tyrannical overhang of “huge VWAP-style selling pressure” during Wednesday’s choppy session, a burdensome state of affairs that served to snuff out rallies and “mush nascent market bids.”
That’s according to Nomura’s Charlie McElligott who, on Thursday, delivered an entertaining play-by-play recap of equities’ somewhat maddening attempts to muddle through a pre-FOMC week characterized by deafening policymaker radio silence.
McElligott described incessant Wednesday sell flows, which overwhelmed dip-buying and the knock-on impact of options trades positioning for a post-Fed rally. “Piling on to the downside supply, we also saw the CTA model go outright ‘-100% Short’ in Russell [Wednesday] on the break through 2,092,” he wrote, in the course of reiterating that the prior session saw the model flip short Nasdaq, a rarity.
Read more: Stocks Saw Billions In Systematic Selling During Tuesday Rout
From here, McElligott sees some scope for a counter-trend rally.
Why? Well, first, he noted that new demand for downside is lacking. “Despite [Wednesday’s] really ugly price action… Vols and Skew were both lower across major index options,” he wrote Thursday, adding that quite a bit of the forthcoming gamma roll off is in downside hedges. Those are in-the-money “and increasingly likely to be monetized the longer we don’t break down,” he said, with the caveat that they aren’t rolled.
Notably, the negative delta in QQQ and IWM decreased slightly on Wednesday, despite the big move lower in spot. “Extreme ‘negative / short Delta’ across all option expiries is at risk of becoming a combustible ‘fuel’ for a mechanical squeeze if spot rallies,” Charlie went on to write.
Extra impetus for a squeeze could come from CTAs. Cover triggers for new “shorts” in tech and small-caps sit just above spot in the Nasdaq 100 and the Russell 2000.
Meanwhile, as earnings roll in and the Fed comes and goes, event risk will clear, and buyback flows will resume, perhaps helping balance out the supply-demand overhang mentioned here at the outset.
There are, of course, any number of caveats, not least of which is the condition that S&P futures need to stay above their own CTA sell trigger level. It would help, too, if the benchmark can sustainably reclaim the 100-DMA.
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