On Monday’s ‘Absolutely Explosive Short-Covering Rally’

“Fed speakers are lunging around like ‘short Gamma’ traders,” Nomura’s Charlie McElligott wrote, in an especially apt Tuesday quip.

Monday’s concerted effort by officials to emphasize that US monetary policy isn’t on a preset course (highlighted by Raphael Bostic’s one-man, good cop/bad cop act which pitted dovish “Yahoo Bostic” against hawkish “FT Bostic”) didn’t count as a proper “pivot,” per se. Rather, it was a clear indication that the situation is too fluid to be amenable to anything like pre-commitments, which the FOMC doesn’t like anyway, especially when it comes to hawkish shifts.

Fedspeak, McElligott suggested, probably shouldn’t be viewed through the forward guidance lens. Rather, “their commentary is a reflection of extremely high inflation and wages convexity month-to-month,” he wrote Tuesday, emphasizing that policymakers need to preserve “‘max optionality’ for each meeting.” Forward guidance past March is “dead,” he wrote.

When it comes to stocks, it’s about getting nets back up. Monday found funds covering shorts and monetizing hedges, quite possibly chasing a mechanical rabbit up a yellow brick road to nowhere.

Hence what Charlie called “an absolutely explosive short-covering rally,” fueled by the reduction of dynamic hedges and the knock-on impact of put-selling and call-buying. Vols “absolutely cratered,” McElligott remarked, noting that it all fed on itself and was ultimately exacerbated by dealer positioning, as the short gamma dynamic compelled an upside chase into the rally.

On Sunday afternoon, I gently suggested that to the extent Bloomberg stories touting a burgeoning retail fascination with puts were accurate, those could be incinerated in the event spot were to lurch higher, triggering a crash-up, even as the overarching mood ostensibly argues for additional downside.

On Tuesday, McElligott wrote that “the ‘short Gamma, max short Delta’ dynamic was pure fuel for a melt-up, as Dealers had to chase higher prices to stay hedged, hence [the] dreaded accelerant flows which buy into strength.”

The real pain, he said, was “in Downside Puts where Vols were face-melted and then exacerbated in conjunction with the spot rally, which meant substantial ‘Vanna’ impact on Dealer covering of short-hedges as those out-of-the-money Puts lost Delta, bleeding and decaying [and] ultimately forcing owners of downside hedges to close or roll.”