One apple (which in this case means one bad session for Apple) might’ve spoiled the bunch on Thursday, but in the interest of keeping readers apprised as to what’s going on behind the proverbial curtain, I wanted to quickly highlight a notable shift in the equities options space mid-week.
The post-CPI stock rally brought out the vol-sellers and stoked demand for upside equity exposure, according to Nomura’s Charlie McElligott, who described a turn for the “constructive,” amid what’s otherwise been a slow-burning, multi-week pullback.
Recall that the new year dawned with investors showing little, if any, “fear” of a renewed stock melt-up. Demand for right-tail protection, proxied by the relative expensiveness of out-of-the-money calls versus at-the-money upside, was negligible, whereas interest in downside protection, both near-the-money and in “crash” hedges, was elevated.
The good vibes accompanying the first tolerable read on core CPI mid-week turned things around a bit, as shown below.
The figures illustrate a sudden bid for wingy upside. “[H]igher stocks [post-CPI] brought about a bit of FOMO chasing, with call skew bid on QQQ, IWM, SPX, SMH and almost across the board,” McElligott said Thursday, recapping the mid-week CPI trade.
The flip side of that was flatter skew and put skew, both of which were bid aggressively in and around the August growth scare and haven’t really relaxed since. That’s part and parcel of the “stressed” zeitgeist discussed here earlier this week.
What happens going forward hinges quite a bit on whether vol sellers continue to reengage on the notion that the worst-case hawkish monetary policy outcome’s off the table now.
“The still high iVol and steep skew will increasingly look like attractive sales to the VRP universe, where in the midst of a rather booming rally [Wednesday], options sellers came out of the woodwork with renewed confidence, supplying back to dealers [and] help[ing] them with their gamma,” McElligott went on.
The green boxes in the figure are “insulation” while the red boxes are potential “accelerant” zones, where negative gamma would see dealer hedging flows amplify directional moves.
Again, there’s a lot riding on whether vol supply from options sellers stays in the market as that “gamma supply acts to choke realized vol and suppress daily ranges, which then further bleeds vol into a virtuous feedback loop where vol control funds eventually need to re-allocate more equities exposure the lower that vol resets,” Charlie added.
