Upcoming Market Events

Friday, July 14 (before open): Earnings for UNH, JPM, WFC, BLK, C, and STT.

Tuesday, July 18 (before open): Earnings for BAC, NVS, MS, LMT, PLD, and SCHW; After close: IBKR

Wednesday, July 19 (after close): TSLA and NFLX earnings! Also IBM earnings.

Thursday, July 20 (before open): TSM and JNJ (FCX still at an unspecified time).

Friday, July 21 (before open): AXP and SLB earnings

Friday, July 21: Monthly opex

Tuesday, July 25 (2pm EST): Fed Interest Rate Decision

Tuesday, July 25 (still at an unspecified time): MSFT, GOOGL, V, MCD, and UPS earnings.

Wednesday, July 26 (8:30am EST): GDP.

Wednesday, July 26 (before open): Earnings for BA and KO. After close: Earnings for META.

Thursday, July 26 (still an unspecified time): AAPL, AMZN, INTC, and MA earnings.

Friday, July 28 (before open): PG and CVX earnings.

What’s Happening in the Market

This morning we got the triple bullish signal that the

Call Wall

was promoted for SPY, QQQ, and IWM; SPX is holding onto 4500. The market squeezed up for most of the day, growing into this higher ceiling. SPY and IWM both finished up about +0.80%, while QQQ stole the day with a 1.70% gain.

SPY went after the

Call Wall

in a heat-seeking fashion, retreating once colliding with it.

Overall, tech (XLK / QQQ) and communications (XLC) led by a wide margin, while competing against and losing to basic materials (XLB) on the weekly timeframe (via Finviz).

Most of the volatility complex was up today, with the exception of skew, and the VIX6M and VIX1Y. Curiously, tails were up today (3 standard deviation SPY puts), but they have much room to grow up as can be seen here:

<Nation’s TailDex as charted on thinkorswim desktop>

Dynamics: Guiding Dispersion with Implied Correlation

In our Discord community, we have been seeing lots of questions and discussion on this, so we wanted to make sure that our members understand what is going on here with this particular market dynamic. This meme, for example, shows that the word is getting out even if generally mocked and not quite understood in some social media circles.

First to address implied correlation, which can be tracked fairly well on broker platforms with the COR3M ticker as a real-time metric from the CBOE (whitepaper here). Also, here is the CBOE page with a chart here.

<Charts of COR3M from thinkorswim desktop>

What implied correlation measures is the average correlation of a basket of stocks (the CBOE measures 50 stocks) and focuses on implied volatility as the basis of the calculation. When this [COR3M] metric is low, it means that the stocks in the basket are generally not correlating with each other.

Ultimately, this ends up rewarding long straddles on the stocks and short straddles on the index because that non-correlation means that stock movements are cancelling each other out.

However, if stocks in the basket are highly correlated, then the index can become dangerous with respect to being more prone to continuations and extended momentum.

With the main stocks of an index moving in the same direction, which is usually the case during a market crash, the stocks in the basket can easily lose far more than what is gained from the short on an index. At this point, a diversified basket can be harmful as compared to an index.

To define dispersion in its simplest form, “A long dispersion trade involves selling an ATM straddle on the SPX and buying ATM straddles on the component stocks” (CBOE, p. 1). The connection of implied correlation to dispersion helps investors to decide when it might be relatively safer to go long on basket volatility and short on index volatility.

Advanced Discussion: Implied Correlation Skew

Implied correlation skew is applying the implied correlation equation to a specific delta. This analyzes the floating implied volatility of stocks in a basket at that delta versus an index’s floating implied volatility at that delta.

The classic use of dispersion based on implied correlation skew is to be long a basket of stocks and short OTM index calls (OTM credit call verticals to be safer). Since the short calls in this model are out-of-the-money (OTM), this is sampling the 20 or 30 delta strike, which is still a slice of implied correlation skew. However, technically this is implied correlation call skew.

Strategy Idea: Calendarizing the COR3M

The COR3M attempts to tell us the current correlation risk in the market, but the implications of this are not necessarily straightforward. For example, we know that volatility is easier to predict at longer durations because volatility has a strong tendency to revert to deep historical averages.

Based on this, it seems we can reasonably conclude that—for shorter duration trades—going with the flow of the current dispersion status would have stronger probabilities on shorter durations (less DTE) but then it can be used in a longer-term contrarian way as well.

The suggestion here is that COR3M is a decent leading indicator for shorter-duration forward momentum while it could be a contrarian indicator for longer durations (more DTE). This is just an idea, and as always is not advice, but is something we will keep digging into. As a concluding suggestion, the JEL [Economics] classification section of SSRN should serve as a much more enriching bookmark than wherever this meme was sourced.

One of the big questions for traders is what happens when these implied correlation flows reverse and then long dispersion (long baskets and short an index) will begin to suffer.

For those of you out there who do not trade options, this same approach can be used to trade realized volatility (actual moves) by being long stock delta but short index delta; however, the directional protections from this are indirect and not guaranteed.

Conclusion

Reflecting on our theme today of how dispersion means to be gaining more from being long volatility on individual stocks (in a basket) and short index volatility, we can see how there was a bidding war on GOOGL calls this morning.

The big picture however, is that, regardless of dealer positioning, there is a ton of call OI rotating as high as 4600 convincingly, which is teasing at the next

Call Wall

candidate.