Macro Theme:

Founder’s Note:

Futures were off as much as 2% overnight to 6,600, but have reverted to -1% (6,660) after tensions in Iran have escalated over the weekend.

TLDR: We think that the market may find stability in the 6,600s, with our eyes looking at a 6,500 low into March OPEX 3/20 – Q End OPEX 3/31. Following March, we think the 6,500 floor drops out. To the upside, Vol premiums are very wide, but they are all tied to the Iran premium, which offers conflict vol, plus energy vol, which is apparently bleeding into rate vol. That said, equity vol premiums are ~20 points (massive), and from that we can see some violent market bounces as that premium contracts, but true to our recent word, vol cannot fully revert until conflicts have largely resolved. To put it more plainly: We think rips should be sold until the Iran situation resolves. Largely that seems like “Strait of Hormuz has reopened”.

We’ve been looking for a move into the 6,600s and VIX 30s as a sign of a “wash out” in stocks. Futures are currently indicating an open on 6,650, with the VIX at 32. This 6,600s area is the “gamma trough” that has been a topic of conversation at SpotGamma, and we can see that trough remains via the GEX curve below (purple line). What is destined to get attention now is the 3/31 expiration 6,475 JPM put strike.

Interestingly, the JPM put was last in play last March, when chaos erupted with tariffs. The JPM put was at 5,565 (purple line), and the SPX seemed to hold that level on several attempts (black arrows) into March Quarterly OPEX. Note the first bounce at that level was before March Monthly OPEX, with a re-visit into 3/31 expiration.

Following that 3/31 OPEX, the SPX took a big 10% plunge lower, as financial markets begin to seize up. In this case, it may be 6,475 that comes into play as major support, particularly as we get closer to March OPEX. The level may matter more as we get closer to expiration as gamma increases into OPEX. Said another way: We are watching for 6,500 and the 6,475 JPM strike to be a stabilizer into the second half of March.

Turning to implied vols – things have popped!

Here is 1-month skew, which is up >=5 vol points across the curve. You can see how high this skew is relative to the teal band which marks the 90-day skew range for 1-month options. Realized vol for nearly all rolling windows (2 mo, 1 mo, 5 day) is ~13%, and we have ATM SPX IV at ~28% and the VIX at 32. That is a fat premium, to be sure, and it currently is all event-related.

To put the vol premium into context, here is the spread between the VIX & 1-month SPX realized vol. April 25, Aug ’24 (When VIX “Broke”), Jan 21 (Meme Mania)…then GFC are the similar marks.

This brings up the question: “When can we short that vol”? In line with our recent pieces, we don’t think volatility is a “stable short” until there are signs that the Iran conflict is ebbing. The SPX is simply not moving enough to justify this premium. The fear here is that at some point, it does.

Our admittedly ignorant geopolitical thinking on this is that if the Strait of Hormuz re-opens, then the conflict must be stable-ish. Open straits signal oil is flowing, which reins in economic risks related to the conflict. Until then, the major fear here is that the SPX finally syncs to 30 VIX, which would mean cascading 2-3% declines.

So, whats the trade? We think you can roll into put flies when markets pop, as ways to play downside. Outright puts are absurdly expensive, but you can position into very short dated (1-3DTE) put flies, particularly in DIA, IWM for cheap, with the idea that you want to be long the ~2-3% downside put, then short 2 options to offset that cost, and a 3rd equidistant put to offset risk. Why 2-3% downside? Because 2-3% is where we think the JPM strike supports SPX. We also focus on DIA/IWM because they seem to be where we find the cheaper put fly protection on these short dated trades.

That said, longer dated put flies can work in S&P too because the SPX skew is has blown out. You can see this via Compass, wherein all major indices are clustered on top of each other at the 100th %’ile put-skew readings. This is what high correlation is! The idea here with wide longer dated put flies is that if/when the put skew reverts, the 2 options you are short may generated excess positive PNL relative to the option(s) you are long.

The other trade being discussed now is the “Hugh Hendry”, which is selling ~10-15 delta puts in order to buy many ~10-15 delta calls. The tenor you chose here determines the ratio of puts to some number of calls. This trade comes up often in trading circles when vol & skews blow out, as it may be the ultimate way to play a massive market recovery. While the trade looks great right now, and is a fair substitution for simply buying stock, you are indeed short a naked put. So, for now, we are watching this idea, but would more strongly consider it only at SPX 6,500 and/or if it seems like conflicts are resolving.

Nomura smartly highlighted this idea in a recent piece:

“We have highlighted to clients the “Degen Desire” to do the “impossible” Equities Index -level trade and take advantage of said ridiculously steep 100%ile Skew (OTM Puts vs OTM Calls) by doing Risk Reversals with wide strikes to “Short (extreme) Skew,” where you’ve been able to buy nearly 2.5 SPY 15 Delta Calls (or THREE 5D Calls) just by selling ONE 15 Delta Put…but the problem of course is that very few are able to get that “Short Crash” signed-off by Risk right now, where there are still so many risks which are unresolved with no “edge” out there…but it’s a tease if you have a titanium stomach”

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