Two days into a week that should’ve been quiet if you forget about the seasonal dearth of liquidity and what that can mean for volatility, markets have impressed on the lively side.
“China’s Blackstone” is in trouble, the PBoC is panic-cutting, Russia is panic-hiking and tumult in Argentina only adds to the now palpable sense of angst across emerging markets. In the US, the economy is still running too hot for comfort (the Atlanta Fed GDPNow estimate for Q3 is tracking a ridiculous 5%) and that leaves equities vulnerable to a “good news is bad news” trade.
Given the somewhat discordant atmosphere, it’s worth reiterating that US shares are arguably one downdraft away from… well, from a larger downdraft.
“A clean break lower risks seeing more systematic deleveraging in light of topped-up long positioning accumulated over the compressed vol environment since March’s regional banks crisis,” Nomura’s Charlie McElligott said.
Regular readers are by now familiar with the situation. Vol control cohorts have added exposure such that they’ll be larger sellers on any kind of sustained spot movement than they will be buyers in an unchanged market — it’s a highly asymmetric setup.
And yet, thanks in part to the proliferation of 0DTE options, close-to-close price changes still look relatively benign, even as Tuesday was a bit more interesting. “We have now seen four of the top 10 all-time 0DTE options volume days (both absolute and as percentage of overall SPX options volume) occur since August 4,” McElligott wrote.
Associated flows “feed the intraday gaps and overshoots in both directions,” he went on, noting that because anything in-the-money (i.e., your winners) needs be monetized by EOD, you get reversal flows later in the session. That’s part and parcel of the recent intraday “chop.”
In the same note, Charlie suggested the S&P really needed to avoid making new one-month lows. Alas, it didn’t.
“A push to new one-month lows in spot likely drives a fresh bout of index downside gamma grabbing that can then dictate dealer hedging accelerant flows which expand vol, which will then too risk kicking-off systematic unwinds,” McElligott said, noting that “any move larger than 1%” risked “good-sized” selling from vol control.
I mention all of this because, again, things are already lively this week, and should they get any more interesting into thin August markets, the potential exists for fireworks.
McElligott also highlighted another paradox of the short-dated options frenzy. “The willingness to short -1% puts keeps arresting deeper spot equities selloffs to an extent,” he wrote, before cautioning that it “also increases the likelihood that when it does break,” a 1% selloff turns into a 3% slide.
“It ain’t voodoo,” Charlie joked. That’s true, but it is Greek, figuratively to the uninitiated and literally to the ordained.
