"Downside Risks Here Are Material" - 'Mega' Positioning & 'Gamma Flip' Points Loom
AMZN's earnings after the bell today appear to be the last, best hope for rebound-betting-bulls as the index-level impact of the FB debacle is very significant for the broad Equities recovery which was being led higher by said Nasdaq “Mega-Cap Tech” again above-all in recent days...
Nomura's Charlie McElligott notes that the FB mess also hurts the immediate extension of the recent power bounce in Equities in a second-order fashion too, because at the US Equities cash close - and before numbers were released - a number of key Global Equities futures had traded just within striking-distance of CTA “buy triggers” (specifically for NKY, Eurostoxx, SPX and Russell 2k per the Nomura QIS model) as a potential next “upside flow” catalyst for the Equities in the day(s) ahead.
CTAs were "MEGA SHORT" Bonds and modestly short still in Equities (though reducing/covering). Trend 'flip' levels are as follows for that group:
- Nikkei 225, currently -100.0% short, [27540.0], buying over 27373.25 (-0.61%) to get to -61% , more buying over 29241.19 (+6.18%) to get to 39% , flip to long over 29241.19 (+6.18%), max long over 29241.19 (+6.18%)
- Euro Stoxx 50, currently -22.7% short, [4217.5], more selling under 3405.06 (-19.26%) to get to -61% , max short under 3404.63 (-19.27%), buying over 4260.21 (+1.01%) to get to 39% , more buying over 4260.63 (+1.02%) to get to 100% , flip to long over 4260.21 (+1.01%), max long over 4260.63 (+1.02%)
- S&P 500, currently -22.7% short, [4577.25], more selling under 3721.28 (-18.70%) to get to -61% , max short under 3720.82 (-18.71%), buying over 4627.88 (+1.11%) to get to 39% , more buying over 4628.33 (+1.12%) to get to 100% , flip to long over 4627.88 (+1.11%), max long over 4628.33 (+1.12%)
- Russell 2000, currently -100.0% short, [2025.0], buying over 2128.17 (+5.09%) to get to -61% , more buying over 2351.99 (+16.15%) to get to 39% , flip to long over 2351.99 (+16.15%), max long over 2351.99 (+16.15%)
- HangSeng CH, currently -100.0% short, [8365.0], buying over 8805.44 (+5.27%) to get to -39% , more buying over 10647.85 (+27.29%) to get to 61% , flip to long over 8806.28 (+5.28%), max long over 10647.85 (+27.29%)
- NASDAQ 100, currently -22.7% short, [15114.5], more selling under 13155.63 (-12.96%) to get to -61% , max short under 13154.12 (-12.97%), buying over 15993.0 (+5.81%) to get to 39% , more buying over 15994.52 (+5.82%) to get to 100% , flip to long over 15993.0 (+5.81%), max long over 15994.52 (+5.82%)
But now instead, spot Equities have gapped lower and further away from that new / incremental “buy flow” from CTA Trend - which matters here, because we have gradually “burned off” those obvious “first stage of mechanical rally” flows.
The Nomura strategist sets the scene for a potential worst case from here:
Funds sell Delta and grab back into Vol / Gamma as a reaction to FB on concerns it will knock-on into rest of Equities, just as funds had begun re-risking......because the fear is that so many funds are going to “take an L” here on the sheer magnitude of the $drawdown that it will cause liquidation that spills-over into other “liquid” Growth names......and then, AMZN releases absolutely blow-out +++ numbers later, forcing yet-another “lunge to the other side of the boat” as the aforementioned flows then reverse.
Finally, as SpotGamma highlights, "the downside risks here are material."
A fair amount of gamma is positioned at 4600, which adds resistance to a push higher in the S&P before Friday.
4500 should be viewed as a large support line, but if it is broken it may set off a fresh bout of extended volatility. Our models seem to suggest 4355 would be the next material support below 4500.
This rally was driven in large part by the reduction in put positions and/or put values (implied vol drop i.e. “vanna trade”) which drives dealer-delta buybacks. We’ve seen that put cover flow stall the last few days, which is not terribly surprising given the magnitude of the rally.
However, there has not been a demand for index (ie S&P or QQQ) calls. There was a voracious bid for single stock calls to start the week, but that faded sharply yesterday. Call buying is what can extend the rally when the put cover stalls out. This is because as stocks rise, dealers should be buying more stock (gamma hedging). This, along with the decline in implied volatility keeps a bid in markets.
Should demand for downside protection renew, it will add negative deltas to a weakened market.
This suggests dealers would be shorting futures with gamma at/on the negative gamma flip point, and implied volatility elevated.
This means that while we documented our view that ~4300 was a “lower bound” early last week, we’d estimate that something <=4200 may show as a lower bound for second leg down.