Dip-Buyers Beware Ahead Of The Fed

This week has seen carnage at the surface and below the index level in US equity markets, capped off by the chaos around the open today and the start of a $3.1 trillion options expiration, that we have detailed previously.

An ugly week...

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And a chaotic open...

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However, what really matters is what happens next? Is it time to buy-the-f**king-dip? Or is Fed fear too much to overcome in the short-term?

First things first, in order to judge what happens next, we need some color on WTF happened yesterday as markets puked with barely a bid. Nomura's Charlie McElligott lays out exactly how things happened...

  • The PTON shock headline was important to “get the ball rolling”—it had been a “Growth Darling” on the public equities side (+498% from 2019 IPO into early 2021 highs), and for many funds, was once a private-side holding--which optically and sentiment-wise VERY MUCH MATTERS right now, as those “unicorn” books are finally getting an MTM “come to jesus” which is crushing performance now for many funds, instead of previously carrying it—so there was fear of cascade into other “legacy” growth names with stupid valuations
  • So shortly thereafter (about 15-20 minutes), when the critical 100dma in ES of 4570 I mentioned in the morning note couldn't hold, that was first “ruh roh”…bc up to that point, the Dealer Delta covering HAD been a rocket ship
  • At this point, our internal Equities Futures "pressure" / imbalance monitors began showing that same heavy ongoing “vwap-style” de-risking seen in prior days, hitting bids, particularly in 'large lots'—meaning big institutional / asset-manager –type size
  • We then saw some really really big cash “sell” baskets which started going off at 2:30pm and escalated into the close, with TICK (proxy for large notional “program” flows from customers across single-name equities) hitting -1850 a few times in waves, and actually printed -1875 at the peak, which is largest “downtick over uptick” impulse across NYSE Equities since 9/20/21
  • From there, the kill-shot from the FLOW-perspective was when we began approaching the CTA "sell trigger" in S&P at 4507 I wrote about in the morning, when stating that it “had to hold”…..i had about 50 bberg chats pop-up once we moved down below 4520, as Traders were clearly “keying” on it / front-running it
  • And we absolutely BLEW through the flip level (4507 to the cash close of 4474 in about 20 minutes), which by our estimates meant $25B of Spooz to go from CTA Trend
  • This flow then took-out the 4500 strike with ease (notably the largest $Gamma strike)—where at that spot level also saw us near yesterday’s point of Dealer "max short Gamma," in the area of ~ -$22B per 1%
  • And of course, the coup de grace was the NFLX outlook whiff after the cash Equities close, where this (former?) “General” of the FANGMAN / mega-cap Growth -era was slaughtered like a Microcap Lamb, -20% after-hours—which then further spiraled fears ‘liquidation cascade” fears across the Fund universe, where so many “thrivers / survivors” of the past decade simply overweighted 5-10 of these names and watched their “returns vs benchmark” drive asset growth

So now we know how we got down here, we should remember that into today's Op-Ex, the set-up is as follows: massively short $Gamma and vs spot...

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...but with a huge percentage of $Gamma set to roll-off thereafter, which means potential for Delta relief next week.

The majority of the (negative) Gamma set to roll-off today is in client downside / Puts, meaning that Dealers will have MUCH less Delta exposure to hedge / sell futures against come next week…i.e. if we are now closer to the end of client de-risking and there is “less hedging required on smaller underlying books = downside not rolled-out,” Dealers will be buying-back their “short futures” hedges.

As SpotGamma highlights, yesterday certainly felt like some forced liquidations, which fed into large negative gamma and an accelerated drop. 4500 is the major gamma strike currently on the board, but all strikes are very put-dominated. As such we think today's flows will be hyper-sensitive to shifts in implied volatility (vanna) and decay (charm).

We show >=33% of total S&P + QQQ gamma expiring today, which will lead to put covering. We therefore anticipate some relief rally today (or an attempt at one).

Its likely that a lot of put flow is rolled out due to the FOMC (+ volatility & other general risks), and still feel that a meaningful, multi-session rally cannot take place until after Wednesdays Fed.

In other words respect the magnitude of possible rallies today, but we advise not to consider them stable.

SpotGamma concludes then that the clearing of puts is supportive of markets, and may spark a short cover rally. However, because of the FOMC we do not think implied volatility will be offered in large supply as traders hedge the event risk. While we do give an edge to “pre-Fed” S&P lows being in, but anticipate large directional swings into Wednesday.

This is very risky, fragile market with lots of large flows that can shift price rapidly.

But, McElligott notes that CTA shorts are now in-place for US and could act as further “fuel for a squeeze” on spot stabilization / client monetization…as for now, “buy to cover” triggers in S&P, Nasdaq and Russell 2k futures are far more proximate than next “sell triggers”

...the case for at least a short-term “mechanical” rally (meaning not one really built on bullish sentiment improving, per se) following Op-Ex and out-of the Fed next week still largely stands.

But the Nomura strategist concludes with a warning not to get too excited:

"Bigger picture however, the above is just providing a temporary “mechanical relief” and little more…because there is undoubtedly a sense we are in a new-regime from the Vol-sense"

We are forcibly transitioning to a world that requires “tightening” of still-too-easy financial conditions which requires simultaneously policy hiking and balance-sheet unwind

And that’s why all I keep hearing about from clients is a resumption of the “4Q18 Playback,” as the scar-tissue from that QT + hikes experiment is the backtest people are drawing on…

...but this time, with just so much more extensive speculative & valuation excess as a starting point...

...but this time, due to the inflation issue, a “Fed Put” which is now struck much lower below spot...

...meaning no “dovish pivot” relief unless things get much, much worse from the markets-side.

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