Hey There Income Hunter,
Last week was one for the record books.
On Thursday, global markets reached a new all-time high of more than 53 million contracts.
Thursday was only one of five days in the past 30 years that the S&P 500 went from down more than 2% to finishing up more than 2%.
That’s a hugely significant swing.
So, you would think that was a key reversal day, with bullish reversal patterns across many sectors of the markets, right?
Wrong!
The critical 3700 SPX strike held resistance on Friday morning, fueling more put buying and a reversal back down of almost 3%.
Don’t expect a drop in volatility this week as the US 10-year bond yield closed above 4% and bond volatility (MOVE) is signaling that the Fed has lost control of the bond market.
Today we’ll look at market internals for more clues on what to expect this week.
Don’t Expect Any Pull Back in Vol
The US Bond market and problems in the UK and Europe will keep volatility high into Friday’s monthly options expiration.
Notice the SPX chart below illustrating the extreme prices established on CPI releases and the major option expiration days. Also notice how important the key gamma levels are. As option volume grows, especially short-term option positioning, gamma levels become much important to be aware of …
For review, option Greek delta measures the change in option pricing relative to the change in stock price.
So, for an at-the-money option, delta is roughly 50%.
Gamma, then, measures the change in delta relative to the change in the stock price.
The reason why gamma has become so important to measure is because option dealers must constantly rebalance their gamma risk based on volatility levels and market direction.
For example, as put options are purchased by customers hedging their portfolio, dealers build short put positions, which must be delta hedged with short stock positions.
This creates negative gamma risk for dealers, which means they must sell additional shares of stock as the market trades lower Hey There Income Hunter,
Last week was one for the record books.
On Thursday, global markets reached a new all-time high of more than 53 million contracts.
Thursday was only one of five days in the past 30 years that the S&P 500 went from down more than 2% to finishing up more than 2%.
That’s a hugely significant swing.
So, you would think that was a key reversal day, with bullish reversal patterns across many sectors of the markets, right?
Wrong!
The critical 3700 SPX strike held resistance on Friday morning, fueling more put buying and a reversal back down of almost 3%.
Don’t expect a drop in volatility this week as the US 10-year bond yield closed above 4% and bond volatility (MOVE) is signaling that the Fed has lost control of the bond market.
Today we’ll look at market internals for more clues on what to expect this week.
(and vice versa) …
Now, the 3700 strike above is the critical gamma pivot level where, above 3700, gamma shifts from negative to positive and rebalancing hedges creates a VIX crush environment.
However, on Friday when the 3700 strike kept a lid on the rally and put buying came in, negative gamma increased and dealer selling of stock at lower prices accelerated the sell off.
Thursday’s Relief Rally via Option Positioning
Notice the SpotGamma real-time option flow graph from Thursday …
You can see that right at the critical SPY 350 strike, call buying and put selling flow dominated option trading …
So, the option dealers who were counterparts to the customer-driven call buying and put selling had to purchase underlying stock to delta hedge their negative delta risk.
The delta hedged positioning fueled a gamma squeeze rally that drove the SPY price towards the 370 gamma pivot level within two hours.
Notice in the chart how the option flow turned negative above 365.
This signaled a possible failure from the 370 strike and, sure enough, Friday morning SPY failed up against 370 and the market reversed back down.
Monthly Oct. 21 OPEX
As the Oct. 21 option expiry approaches, the impact of gamma will intensify this week.
Heavy negative gamma positioning could fuel a test of 3500 and possibly as low as 3400 …
However, at that point, negative gamma would reach extreme levels, which could fuel another intense gamma squeeze rally through Friday’s expiration.
We will see at least 40% of the negative gamma getting wiped out through expiration, which will force dealers to cover their short stock hedges, potentially fueling another vicious relief rally.
Bring It Home
The bottom line for this week is, barring any positive news in fundamentals, we should see a push lower to start the week, which may present a buying opportunity.
The key drivers will be the dollar and bonds. With bonds closing above 4%, we may see a capitulation sell off in price/rise in rates
That will push the dollar higher and potentially force more foreign bond selling and even higher rates.
It is this doom loop of bond selling, higher rates, higher dollar. Rinse and repeat, that continues to hurt the stock and bond markets …
Stay tuned for more specific macro news and the option flows it creates this week
And as always …
Live and Trade With passion My Friends,
Griff