Macro Theme:

Short Term SPX Resistance: 4,325

Short Term SPX Support: 4,225

SPX Risk Pivot Level: 4,315

Major SPX Range High/Resistance: 4,400

Major SPX Range Low/Support: 4,200

‣ If the SPX closes <4,300 on Friday 10/20, we look for a short relief rally to start next week.*

‣ Nov 1st FOMC is a major turning point for equities*

*updated 10/20

Founder’s Note:

ES Futures are 75bps lower to 4,218. Key SG levels for the SPX are:

• Support: 4,211, 4,200, 4,173, 4,150
• Resistance: 4,250, 4,300
• 1 Day Implied Range: 0.79%

TLDR:

• We do not think 4,200 goes down without a fight, and anticipate mean reversion back into this level.
• Because of high VIX/vol premium traders have to watch out for the “vanna bounce” which can quickly rally equities +1%
• Equities can continue to decline (as likely dictated by rates), but should do so in a controlled manner (i.e. grind down vs “puke”)
• In any scenario, and over time, we highlight 4,000 as a major downside level.

US10Y has broken above 5% which is pressing futures lower. Linked to this is the VIX, which is at +6 month highs of 23.

420SPY/4,200SPX is a our

Put Wall

level and major support. Higher rates are going to mechanically place a bid into equity vol, which places downward pressure on equities.

If rate pressure persists over the next several sessions, the major, long term support line that comes into play is SPX 4,000. This is a massive options level, and an area that we consider significant structural support. This strike is currently -4.5% from current S&P levels. We view a test of this level as the result of many -75bps sessions instead of a 1-2 day SPX drop.

To the upside, some rate relief/IV decline could lead to a sharp recovery to the 4,300 level, but that is likely it before the Nov 1 FOMC.

In equity-land the question on everyone’s mind is: “Are stocks setting up for a crash?” Or, in options parlance: “Will realized volatility finally pop?”

Thus far, we can view higher rates as pressure to reprice equities lower. This leads to traders simply selling equities rather than hedging positions (and driving up VIX/IV) because higher rates are decreasing the future value of single stocks. This selling process has been gradual, and the lack of put demand has kept convexity out of the picture.

Convexity is roughly the idea that if many traders are long put options, dealers are short puts. As markets decline and IV increases, put options gain exponentially in value (thats bad if you’re short them). This requires hedging flows that exponentially increase. This is a major component to market crashes.

So far (and this goes back to 2022), the selling has been “linear”. Generally put demand has been low, and equity selling has been orderly. Linear movement shifts to convex as credit risks increase and demand for tail risk (VIX/vol/equity puts) increases.

Shown below is SPX realized volatility[RV], with 1-month SPX RV at 13%(green), and 1-week RV at 14%(red). These are similar levels to what we saw in the August ’23 SPX decline, wherein the SPX lost 3% over ~3 sessions. These levels are still under the last major vol event, which was the March bank crisis wherein the VIX took out 30, with 1-month RV hitting 18%/1-week RV 21%.

An RV or VIX of 20 equates to average daily SPX moves of ~1.25%. Recall that RV measures how much the SPX is actually moving, where as the VIX is the SPX movement that traders think will happen in the future.

The plot below shows the spread between the VIX and 1-month SPX RV. One could view this as the premium that traders are paying for equity protection, with a high cost of protection being at the blue dashed line. As you can see, we are near the March ’23 premium highs (black circle) as higher rates collide with the geopolitical risks. Today we have the risk of things breaking, whereas in March things broke.

Also, today the VIX is 20 with SPX 1-month RV of 13%, vs back in March a VIX of 30 with SPX 1-month RV 18%.

Why does this matter? This premium is a carry cost for traders, and it can also be framed as “vanna fuel”. At current premium levels (i.e. where we are on the chart below in red), one could argue that traders are paying too high of a premium for downside protection, and they need something to break for the cost of this protection to pay off. Framing this another way: the SPX is not generating enough movement to justify a +20 VIX. This does not mean traders aren’t justified for wanting to own this protection – its just that it is coming at a high relative cost.

Is something going to break? We have no idea – and we suggest it is unknown.

Is the options market poised to increase volatility, and help the SPX “earn” +20 VIX? If something breaks (banks/credit/major war escalation) then that would change the equation, but we currently do not see “20 RV” in the cards.

This opinion comes from our SG 1-Day implied move which currently sits at 80bps (open-close range), which interestingly equates to ~13% RV. We also see SPX gamma curves positioned in a way that imply dealer hedging flows may absorb downside moves, rather than exacerbate them (see recent gamma curve discussion).

The implication of this for traders is that if you are looking to purchase put protection, you risk paying quite a bit for that protection, and it only pays off if something breaks. The risk here is that you are not only betting on a tail event, but there are substantial odds of the equity market intraday/daily ripping higher as the IV premium drops.

The summary of all this is again that:

• equities can continue to decline (as likely dictated by rates), but should do so in a controlled manner (i.e. grind down vs “puke”)
• In any scenario, we highlight 4,000 as a major downside level.
• because of that VIX premium traders have to watch out for the “vanna bounce” which can quickly rally equities +1%