Traders Holding Support – Earnings – Dollar Drifts Down – Options Expry Week- 17Oct, 2022

S&P 600 Small Caps are outperforming the S&P – not saying that’s positive but folks are saying it is attributed to dollar strength so if you have been hiding there and the dollar loses its foothold up there where it is – it might be time to head back to cash.

I am positioned quite negatively in the market right now – and the lift this morning I suspect is due to the UK reversing tack on its spend and others suggesting that we are moments from an intervention. For this reason, I will anticipate that the bounce is short lived but I will be posting some bullish trades in the Teams environment after the first 15min of trading.

Market Outlook – Bearish bounces in play- traders are anticipating a move by Central Banks that will be more accommodative. I’ll take the ‘under’ on that one. Just not going to happen (in my mind, anyway)

Here are the charts and levels noted for the week

So, my thoughts are that we have a big move coming – and I am not sure of its size or sustainability – I’ll be watching the VIX for that

Chris Capre of 2ndSkies Forex thinks that the VIx needs to settle down a bit and then move forward once more -all long as it holds above 30 – our longer dated options are going to hold nicely

T1 Alpha Sit-Rep: Monday, October 17th

While Friday certainly provided more drama than we would have liked, with a near-complete retracement of Thursday’s gains, they managed to hold the line. Only the most cynical would fail to appreciate the potential for a double-bottom against June lows. We understand the fundamentals appear terrible and our bias remains for lower lows at some point in the future, but we have seen both systematic positioning (eg vol control strategies) and discretionary positioning collapse over the past year:

To change positioning in this manner, taking down net positioning from 90% to 63% in hedge funds or from 60%ile to 13%ile in vol targeting requires concerted selling which in turn helps explain the markets dismal 2022. We have not (yet?) seen the signs of retail selling or capitulation in broader equity market funds (e.g. passive). This does not mean it will not arrive, but the question is whether the bearish asset allocators may be forced to blink before then. The “crash” feeling from a few weeks ago is increasingly replaced by the scent of bear sweat.

Gamma Exposure:

Gamma remains firmly negative as we approach option expiry this month and the obvious magnet is the 3600 strike. There is some risk of a pull higher towards 3700 as short-dated calls around 3625 could propel us higher should the market makers be so inclined.  With more and more of the outstanding option notional extremely short-dated, the risk of very sharp moves cannot be underestimated.

While nothing like the wild swings pre-Covid, 2022 has been impressive for the persistence of negative gamma. This is obviously reflected in the elevated VIX quotes for the year.

Gamma & PV Bands:

After a wild week of trading, SPX found itself in the middle of our probable vol bands, making the next move anyone’s guess. During this aggressive consolidation, the S&P 500 is flat for October, as the wild swings have put us back to the September 30th low, which roughly matches the June lows. We’re on a road to nowhere. With the recent volatility, our bands have responded with a wider-than-average spread. This spread has so far been able to catch the high and the low of last week within just a few percentage points. For today, it’s 4.3% to the upside and around -3.5% to the downside.

Overall risk/reward setups are favorable as spot prices are broadly trading closer to their lower bands. Amazon sticks out as the most depressed asset with over 9.8% upside. Again, the current spreads on these assets are wider than their averages as our models adjust for gamma-sensitive volatility.

Last Friday, tech stocks continued to sell off, bringing them to the lowest close since July 2020. That brings the index drawdown to -35.75%, roughly equivalent to the crash of ’87. That was also the last time the Nasdaq composite was this sold off while not being in a recession. Currently, the index sits just 3.1% above the lower PV band and over 5.5% from the upper range. This is a mildly favorable setup for the bulls, although the overall trend of the bands continues to head lower. If the bulls can hold the line in this area, a potential “double bottom” at the June lows would be a reasonable interpretation.  Remember many commentators were prepared to call a new bull market at the August highs. While we are not calling for the end of the bear just yet, we continue to reiterate that the bears cannot become complacent.

Small caps are continuing to hold their own as the Russel 2000 remains above the June lows, where it has persistently found some support. As we’ve noted several times, the YTD selloff in equities has been mostly about the Fed rather than recession. When it shifts, we would expect the R2000 to lead us lower. Currently, spot sits just -2.85% above the lower band with about 6% to the upper range.

S&P 500 Market Breadth:

SPX traveled an impressive 6.3% last week as correlation remains high. On Friday, our MBAD indicator showed a 92% downside day with an average decline of -2.5%. Apple and Amazon were the leading factors in the decline, making up around 10% of the S&P 500 and down -3.2% and -5.0%, respectively.  On top of that, Tesla was also a contributing factor in the sell-off as the 1.92% weighted stock hit a 16-month low at $204.99. That also marks a -50% loss for the stock after peaking last November. Sorry, Elon… We hope your sales of Burnt Hair perfume are enough to cover some of your losses.  https://www.boringcompany.com/burnthair

75% of the S&P 500 is currently in a technical bear market, down -20% or more from their 52-week highs. This reading is the second-highest level we’ve seen for this metric this year, which leaves few places to hide for the bulls. SPX stocks that are down at least -40% from their recent high have also grown to over 27% of the index. As mentioned above, both Tesla and Amazon are now firmly in this group.

After Thursday’s crash up and Friday’s crash down, single-stock volatility is yet again on the rise. Ranking in the 93%ile, over 72% of the index has a 1-month realized vol level above 30, matching the levels seen in both 2015 and 2018. While 2020 reminds us it can always still get more volatile from here, bearishness is running awfully high with little to show for it over the last four months.

Vol Control Implied Rebalancing:

Realized vol is also continuing to rise at the index level, with our 1-month vol window increasing over 3.8% last Friday. This triggered an implied $3 billion in equity selling, as vol control funds continue to move into cash positions as volatility rises. For the funds that rebalance at a slower pace, this likely also eased some of the rebalancing requirements from earlier in the week, which have now been reduced to only $4 billion.

This week, all else being equal, we expect realized vol to decline a bit as three of the five dates to be dropped exceeded +/- 1%. For each of those days, if they are not replaced with a similar return or greater, realized vol will drop, and risk-targeting funds will start buying back equity exposure. As the gap between the 1-month and 3-month vol is fairly wide, we expect the 1-month metric to remain in control of the model.

Today, we expect selling to pick up around +3% on the upside and not until -4% on the downside.

Bonus Chart:

The 2-Year Treasury broke out to its highest level since 2007 last week as the latest CPI numbers came in hotter than expected. That gave the Fed the green light to continue raising rates, even as the economy is slowly deteriorating towards a recession. In prior cycles, the 2-year tends to lead the Fed funds rate by around four months and has done a reasonable job of anticipating the peak Fed Funds.  However, the speed of this hiking cycle draws a comparison to 1994 when the 2-year moved far ahead with the Tequila crisis necessitating a Fed pause and reversal. Currently, Fed futures have priced in an 88% chance the Feds raise rates by another 75bps in November, so if the lead/ level of the 2-year is correct, that leaves another 125bps on the table to be hiked into next year. Of course, that’s assuming something doesn’t break in the meantime.