The Real Reason For Monday’s ‘Biblical’ Stock Reversal

Monday morning was the first time clients had to “outright sell stuff,” Nomura’s Charlie McElligott wrote Tuesday, as US equities continued to careen wildly about.

Portfolio VaR, he wrote, “just absolutely blew out.”

That, in turn, dictated mechanical deleveraging, which eventually gave way to tactical considerations for the discretionary crowd, who started playing offense, selling puts and buying calls (or selling vol and buying dips, if you like).

Headed into the week, the setup in the vol space was defined by huge demand for protection. McElligott described a “violent” grab for downside late last week, noting that “between old hedges and new hedge demand, last Friday was the largest single-day of Put volume in history.” That continued early Monday, when vol-of-vol escalated materially (figure below).

That matters in the context of the post-OpEx landscape. Despite the gamma roll off, the new puts “kept the Dealer position near ‘max short Gamma vs spot'” in US majors and related ETFs, Charlie wrote. That’s dry kindling. It opens the door to a “selling begets selling” dynamic or (and this is crucial) an upside crash.

Note the italics I used. As McElligott reminded folks, “short gamma cuts both ways.” Too often, that simple idea is lost in the media’s penchant for attributing crashes to mechanical flows and rallies to “dip-buyers.”

The above also meant the extreme negative delta in QQQ and IWM was “preserved” (if you will), setting the stage for a squeeze in the event spot managed to bounce. (Which it did.)

McElligott went into considerable detail, but he summed it up concisely. “Like always, the combustible, tried-and-true mix of client conditioning to ‘sell the vol rip’ / ‘buy the spot dip’ alongside ‘max short Dealer Gamma vs spot’ but paired with extreme ‘short $Delta’ was the perfect recipe for a biblical ‘crash-up,'” he wrote, adding that “as Put sellers began furiously selling (as spot rallied away from their strikes), Dealers bot back short hedges, which cratered the value of downside Puts and further accelerated the Dealer ‘short hedge’-covering, while the rapid loss of value in Puts then incentivized additional monetization of downside, and [all] as the client upside Call buying was occurring, creating more Deltas to buy.”

That’s the story of Monday’s reversal. And that’s why it’s not particularly helpful to read mainstream media market wraps during times like these. Financial journalists (bless them) are compelled to provide perfunctory recaps amenable to a wide audience. It’s not that they’re incapable, it’s that they have a mandate to write for public consumption, which isn’t always consistent with veracity. So, you get half the story if you’re lucky. On Monday, most of the coverage simply wasn’t accurate at all.