Physik Invest’s Daily Brief is read free by thousands of subscribers. Join this community to learn about the fundamental and technical drivers of markets.
Administrative
A long(er) letter, today. Through the end-of-this week, newsletters may be shorter due to the letter writer’s commitments. Take care!
Fundamental
Yesterday’s letter focused on the SVB Financial Group (NASDAQ: SIVB) failure, albeit with an optimistic tone. In short, the bank could not make good on fast accelerating withdrawals. Read more here.
According to one TechCrunch article, the likes of Founders Fund “reportedly advised their portfolio companies … to withdraw their money, … [and], if everybody is telling each other that SVB is in trouble, that will be a challenge,” as it was.
Authorities later put forth emergency measures guaranteeing all deposits. The effort shored up confidence in the banking system and markets strengthened, though some regional names such as First Republic Bank (NYSE: FRC) continued trading weak. In FRC’s case, the Federal Reserve’s (Fed) new bailout facility does not help. As former Fed trader Joseph Wang explains, “you need Treasuries and Agency MBS to tap the facility, and [FRC] barely owns any.”
Anyways, as yesterday’s letter briefly mentioned, expectations on the path of Fed Funds shifted. Traders put the terminal/peak rate at 5.00-5.25%, down from 5.50-5.75%, while pricing cuts after spring. Previously, no cuts were expected in 2023.
Some Treasury yields fell spectacularly, too, …
… on par with those declines experienced amidst major crises, at least in the case of the 2-year.
Measures of US Treasury yield volatility implied by options (i.e., bets or hedges on or against market movement) adjusted higher, accordingly. This is often a harbinger of equity market volatility.
Call options on the three-month Secured Overnight Financing Rate (FUTURE: SOFR) future (i.e., bets on interest rates falling in the future) paid handsomely.
For instance, bull call spreads that expire in December 2023 (e.g., BUY +1 VERTICAL /SR3Z23:XCME 1/2500 DEC 23 /SR3Z23:XCME 96/97 CALL @.0375) increased in value by about 650.00% to $0.33 (i.e., $750.00 per contract).
In the equity space, some readers may have caught some commentary on spot-vol beta in the VIX complex strengthening like we have not seen in a while, a nod to the harbinger of equity market volatility remark a few paragraphs higher.
Recommended Readings:
- Read: The Ambrus Group’s Kris Sidial on two major risks investors should watch out for in 2023. In short, volatility’s sensitivity to underlying prices (spot-vol beta) was low, and Sidial cast blame, in part, on commodity trading advisors and strong volatility supply.
- Read: Simplify Asset Management’s Michael Green on using option and bond overlays to hedge big uncertainties facing markets. Following 2022, investors swapped poor-performing long-dated volatility exposures for ones with bounded risk and less time to expiry, hence the increase in 0 DTE trading.
This spot-vol beta remark suggests that (at least some of) the volatility in rates, as well as certain small pockets of the equity and crypto market, manifested demand for crash protection in the S&P 500, “which feeds back into VIX,” one explanation put well.
Notwithstanding, for these options to keep their value and continue to perform well, realized volatility (RVOL) must pick up substantially, which is not likely.
Unlimited’s Bob Elliott comments: “the bond market is pricing a broad-based credit crunch, … [and though] it’s not crazy for the Fed to slow down here given the current uncertainty,” odds are financial problems are contained and the Fed moves forward with its mission to get (and keep) inflation down.
Consequently, “the pricing of Dec23s and 5yr BEIs makes no sense,” Elliott adds. This means the example SOFR trade above is/was ripe for some monetization, and equity volatility must be dealt with carefully (i.e., price movements must be higher than they are now which would be difficult given that authorities/Fed do not want liquidations).
In support of siding with the less extreme take, we paraphrase Kai Volatility’s Cem Karsan who says that for years prior to the 2007-2008 turmoil, macro tourists were calling for a crash.
For markets to crumble, there would have to be an exogenous event far greater in implications than what just transpired with SIVB over the weekend. With odds that such turmoil doesn’t happen soon, coupled with participants easing up on their long-equity exposure (i.e., selling stock and not needing to hedge, hence the statement that owning equity volatility must be dealt with carefully), RVOL is likely to stay contained. That’s not to say that this volatility observed in the rates market can’t persist. It’s also not to say that markets can’t continue to trade lower (in fact, with interest rates rising and processes like quantitative tightening challenging bank liquidity, there is less incentive for investors to reside in lower-yielding equities). It just means that, barring some exogenous event, the market remains intact.
Positioning
Following important events like the release of the Consumer Price Index (CPI) today, the compression of implied volatility or IVOL, coupled with the nearing of big options expirations (OpEx), sets the market up for potential short bursts of strength heading into the end of the month and next month.
A quick comparison of the Russell 2000 (INDEX: RUT) and Nasdaq 100 (INDEX: NDX) suggests this options-induced strength may help keep the recent re-grossing theme intact. The compression of wound IVOL and passage of OpEx, coupled with the still-live re-grossing theme, may put a floor under equities.
To play, one could place a portion of their cash in money market funds or T-bill ETFs or box spreads, for instance, while allocating another portion to leverage potential by way of some call options structures that use one or more short options to help bring down the cost of a long option that is closer to current market prices (e.g., a bull call spread or short ratio call spread). To note, based on options prices as of this writing, it may be too early to enter call structures (i.e., too expensive given the context).
Technical
As of 6:30 AM ET, Tuesday’s regular session (9:30 AM – 4:00 PM ET), in the S&P 500, is likely to open in the middle part of a balanced overnight inventory, inside of the prior day’s range, suggesting a limited potential for immediate directional opportunity.
The S&P 500 pivot for today is $3,904.25.
Key levels to the upside include $3,921.75, $3,945.00, and $3,970.75.
Key levels to the downside include $3,884.75, $3,868.25, and $3,847.25.
Disclaimer: Click here to load the updated key levels via the web-based TradingView platform. New links are produced daily. Quoted levels likely hold barring an exogenous development.
Definitions
Volume Areas: Markets will build on areas of high-volume (HVNodes). Should the market trend for a period of time, this will be identified by a low-volume area (LVNodes). The LVNodes denote directional conviction and ought to offer support on any test.
If participants auction and find acceptance in an area of a prior LVNode, then future discovery ought to be volatile and quick as participants look to the nearest HVNodes for more favorable entry or exit.
POCs: Areas where two-sided trade was most prevalent in a prior day session. Participants will respond to future tests of value as they offer favorable entry and exit.
Volume-Weighted Average Prices (VWAPs): A metric highly regarded by chief investment officers, among other participants, for quality of trade. Additionally, liquidity algorithms are benchmarked and programmed to buy and sell around VWAPs.
About
The author, Renato Leonard Capelj, spends the bulk of his time at Physik Invest, an entity through which he invests and publishes free daily analyses to thousands of subscribers. The analyses offer him and his subscribers a way to stay on the right side of the market.
Separately, Capelj is an accredited journalist with past works including interviews with investor Kevin O’Leary, ARK Invest’s Catherine Wood, FTX’s Sam Bankman-Fried, North Dakota Governor Doug Burgum, Lithuania’s Minister of Economy and Innovation Aušrinė Armonaitė, former Cisco chairman and CEO John Chambers, and persons at the Clinton Global Initiative.
Connect
Direct queries to renato@physikinvest.com. Find Physik Invest on Twitter, LinkedIn, Facebook, and Instagram. Find Capelj on Twitter, LinkedIn, and Instagram. Only follow the verified profiles.
Calendar
You may view this letter’s content calendar at this link.
Disclaimer
Do not construe this newsletter as advice. All content is for informational purposes. Capelj and Physik Invest manage their own capital and will not solicit others for it.
