These ‘Crucial’ Levels Matter Most In News-Driven Market

In early February, one bank’s equity derivatives team suggested market participants were assigning too much weight to Fed rhetoric and not enough to Ukraine headlines when it came to explaining the previous month’s volatility trends.

At the time, a Russian incursion was still a hypothetical, but some of January’s more volatile episodes coincided with a marked uptick in news stories documenting Vladimir Putin’s military buildup on Ukraine’s borders.

SocGen’s Vincent Cassot and Jitesh Kumar suggested conflict news flow contributed more to market angst than some traders and investors might have realized.

Fast forward six weeks and Putin’s incursion is no longer a hypothetical. It’s now very difficult to discern an explanation for a given session’s price action because i) the inflation nexus means Fed policy and the war are inextricably linked, and ii) options positioning and related hedging flows became the only thing that mattered from one session to the next at the onset of the conflict.

In a new note, Cassot and Kumar underscored that latter point.

“The beginning of the Russian war in Ukraine increased investor concern, and we saw some dramatic volatility in the aftermath,” they wrote, flagging the intraday range for European equities which, at one juncture, became wholly farcical. They continued, noting that an “aggregate dealer option gamma framework continues to define the bifurcation point between laminar and turbulent volatility flows quite well.”

The charts (below) illustrate the dynamic quite clearly. Negative gamma territory opens the door to a wider distribution of outcomes which, in turn, is conducive to higher volatility.

“All the large moves on S&P 500 and Eurostoxx 50 have been coincident with a negative aggregate gamma regime,” Cassot and Kumar went on to say. “In fact, during periods of aggregative negative gamma, the indices saw both larger intraday moves, as well as an elevated level of implied volatility.”

Remember, that matters for liquidity. Generally speaking, volatility is inversely correlated to market depth. As the former rises, the latter deteriorates. Impaired liquidity means even larger swings, raising the odds of systematic de-leveraging.

In headline-driven environments, that so-called “doom loop” can be just as pernicious as the nickname conveys. “Watching these aggregate gamma levels will continue to be crucial at a time when prices are being moved around by geopolitical newsflow,” SocGen went on to say.

On the bright side, there’s an argument to be made that things could be going far worse for stocks. “If one had known in early December that a war would break out on European soil, 10-year Treasury yields would rise 107bps, the price of front-month Brent would rise 75% and the market would price in a further ~six Fed hikes in 2022, the expected value of volatility would arguably have been significantly higher!”, Cassot and Kumar exclaimed.

As for recommendations, SocGen had some, but conceded upfront that “strong convictions are not easy to find in such uncertain times.”

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One thought on “These ‘Crucial’ Levels Matter Most In News-Driven Market

  1. Interesting charts. So gamma transition zone can be roughly approximated as a squiggly MVA? If recent buyers are in the black, gamma tends to be positive? Ultra naive way of looking at it, but looking at it does raise the question.

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