The S&P closed above 5,300 for the first time on Wednesday as investors cheered a relatively benign read on core price growth, while a marked deceleration in US retail sales suggested the American consumer’s tired, a key ingredient in the “last mile” recipe.
The next question for equities is whether we’re now primed for a return to a melt-up dynamic, which is to say the sort of invigorating, if sometimes frightening, environment where fear of the right-tail manifests as insatiable demand for upside optionality which in turn creates a spot up, vol up conjuncture.
If you ask Nomura’s Charlie McElligott, the answer’s probably not. “My ‘feel’ is that investors [are] far more comfortable overwriting and selling upside optionality than [they were] at the start of the year [when] they FOMO-chased into rally exposure,” he said Wednesday, describing positioning as “far cleaner” versus a few months back, with longer nets.
That latter bit matters. A lot. Market participants aren’t as under-exposed. They’re capturing this upside, or at least enough of it to spare them the painful experience of having to grab for exposure in calls.
“Point being, I think we are losing some of that juice in the crash-up trade… because traders are more willing again to sell upside gamma versus that Q1 fear of being short” into the melt-up, Charlie went on.
He added a notable caveat, though. Have a look at the figure below.
“Start of day” was the start of May 15, prior to the US CPI release. “Spot now” was 11 AM ET — so, two and a half hours after the CPI and retail sales reports.
“We see dealers in a market-insulating long gamma pocket, as ‘vol is a sale’ [but] you are now too seeing spot SPX pushing up and close to a short gamma location for dealers, into some upside strikes between 5300-5400,” McElligott wrote.
Why does that matter? Well, dealers are short that (those upside strikes) to clients. So, in the event the S&P were to accelerate hard through 5,300 and keep going, you could see a kind of “buyers higher” situation develop, where everyone’s compelled to chase and dealer flows are contributing to the upside move.
Note that this is for “illustration purposes only,” so to speak. The equity vol landscape changes in real-time, so the snapshot above is just that: A snapshot in time. But it gives you a sense of where the “acceleration points” (if you will) are, both on the downside and upside outside of the proverbial “pocket.”
