McElligott Explains Thursday’s Epic US Stock Reversal

On Thursday afternoon, following a truly absurd reversal on Wall Street that found US equities closing sharply higher despite the onset of a war in eastern Europe, I implored market participants to exercise a modicum of common sense while assessing the situation.

“Please, for your own sanity, stop saying stocks ‘shook off’ a Russian invasion,” I wrote, in a social media message. “Hedges were monetized and some folks decided to play a little offense, which daisy-chained into a squeeze, but to let CNBC and BBG tell it, everyone just decided, midday, that Ukraine is no big deal.”

On Friday, Nomura’s Charlie McElligott echoed that assessment. “God forbid some poor soul sees market headline writers and actually believes the absolute nonsense that some media puts out,” he said, on the way running through what he called “the real stuff.”

As noted here earlier this week, everyone is now a day-trader. Horizons are shrinking, both due to geopolitical headline hockey and the impossibility of taking a long-term view on the macro given inflation ambiguity and the Fed’s forced withdrawal of transparency.

That means no one is “swinging for the fences,” McElligott wrote. Instead, he said, you “hit for singles and doubles.”

That means when short-dated puts (or other downside expressions) work, you monetize them immediately and pivot opportunistically to whatever manifestation of dip-buying fits your investor profile. Then, if that works too, you ring the register and put on additional short-dated hedges.

“This is especially the case when a lot of folks came into [Thursday] looking at tactical ‘buy the war / invasion’ back-test trades,” McElligott said, citing Vietnam, the Gulf War, Afghanistan, Iraq and the Crimean crisis, which, he noted, “all saw higher SPX returns t+6m.”

This is set against a backdrop where dealer hedging flows act as accelerants, selling dips and buying rips. “Everybody’s taking premium out of their downside hedges, so some also then bought upside too for the short-term bounce,” Charlie wrote, reiterating that this is a “short-Gamma environment” with lots of “short-Delta ‘squeeze’ potential” stemming from dealers’ hedges, which get covered as spot rallies away from the downside strikes they’re short.

And so, as I alluded to on social media Thursday afternoon, hedge monetization quickly morphed into an epic squeeze, as the tinderbox we call “markets” was ignited, only this time in the “right” direction.

“Tactical traders further fueled the initial ‘hedge monetization’ rally with highly-convex 0 or 1 DTE ‘upside’ to goose the snapback trade as well, as we squeezed higher over the course of the day,” McElligott wrote, adding that “when you know much of the investing universe got VaR-shocked on the overnight gap marks, and will be ‘mechanically’ de-grossing in a risk-management exercise, there was big potential for ‘covering fodder’ in seriously sized-up Short books [and] covering of dynamic Shorts.”

The figure (above) illustrates what Charlie called an “unprecedented” short-covering event in futures.

Nomura’s S&P futures intraday imbalance monitor registered the biggest “buy pressure” in the history of the bank’s data.

You can go back to your Bloomberg and CNBC headlines now.