Macro Theme:

 

 

Founder’s Note:

Key SG levels for the SPX are:

• Support: 5,450, 4,565, 5,500
• Resistance: 5,400, 5,350

For QQQ:

• Support: 450, 440
• Resistance: 460

IWM:

• Support: 200, 190
• Resistance: 210, 216

CPI 8:30 AM ET

TLDR: 5,500 is resistance for today, with 5,400 support – these are wide ranges given this AM’s CPI. Overall, the SPX is in a positive gamma position, which infers that there is some market support down into 5,300. Lastly, we note that traders are viewing yesterday’s lower VIX as an implied vol decline, which we debunk, below. This matters because there is still an embedded risk in this market.

And, on this point, we often feel that we have an edge in analyzing markets…like there is a fat pitch to swing at. We generally here do not see that edge in current markets on anything outside of a few “day trades”, and its important for us to relay this. When the next few days of data & OPEX clears, things are likely to clear up, giving us a better forward view.

Yesterday saw a very strong move higher, pushing the SPX above the 5,400 resistance line to close at 5,434. We had been marking the 5,400-5,450 range as stiff resistance into Friday’s OPEX, and that range is clearly in question today. From our seat, it seems that yesterday’s benign PPI seems to have traders at ease in regards to today’s CPI.

There were one major options-based elements that helped push equities higher: 0DTE flows. Shown here is flow from the S&P500 options complex, and what you can see is that 0DTE calls were 100% of the flow, as depicted by the green line overlapping perfectly with call flow from all expiration calls (orange). Second, 0DTE puts (light blue) were positive (people sold 0DTE puts), and also 100% of yesterdays flow (vs all expiration puts, in dark blue).

A second element some are trying to flag, was a decline in Implied Volatility which infers a “vanna boost”.

To be clear, we have been of the opinion that vol levels would “sticky” into Jackson Hole, but this “indexified” vol data (i.e. VIX Index into 18’s) infers IV’s dropped yesterday.

We can analyze this IV decline through SPX term structure, which reflects at-the-money (ATM) IV, deflating 1-2% (i.e. “a lot”) from Monday 8/12’s close (gray) to this morning (teal).

In our recent note we said that we were looking for “sticky vols” through to Jackson Hole (8/24), and VIX holding 20. Below we break down why we’re still right on the “sticky vols”, even though we erred on VIX >20.

Lets compare the above metrics vs our Fixed Strike IV heatmap, which shows the IV at various strikes for different expiration dates. In this case we are comparing IV changes from Monday 8/12 vs this morning.

Here, we observe that the change in fixed strike IV is minimal (<=0.3%) from Monday, which is denoted by most of the grid being black in color (i.e. “unchanged”). If vols were truly declining, you would likely see a deep red color across this grid. That’s obviously not the case, and so those flagging “vanna” (i.e. stock being bought due to IV decline) as a major driver of this equity rally yesterday are not really on the mark.

Alright then, why did the VIX and SPX term structure decline?

We call it the “Fixed Strike Slide”, which we historically discussed during market declines. It was a dynamic we failed to flag here, in the case of a potential market rally.

SPX Implied volatility is typically higher for out-of-the-money (OTM) puts, and lower for OTM calls, creating a skewed volatility surface. This is why the grey & teal liens slope from upper left to bottom right in the chart below of 9/13 expiration skew.

When the SPX price increases, the current ATM strike shifts higher, moving to a region of the skew with lower IVs. You can see this as marked on our chart, where on Monday the IV for the 5,335 strike (i.e. the ATM) was 17% (red arrow). Because the SPX rallied sharply since then, the new ATM strike this morning is 5,435, which has an IV of 15% (blue arrow).

Monday’s 17% vs today’s 15% is the aforementioned 1-2% IV decline shown in term structure.

This skew slide causes the term structure to suggest a decrease in IV, even though the IV for a fixed strike may remain relatively unchanged. This “unchanged” is seen by compare Monday’s IV (gray) vs this morning (teal) and you can see the two skews are perfectly overlaid.

The fixed strike IV heatmap helps confirm that the decline in implied volatility observed in the term structure is more a function of the SPX riding the slope of the volatility skew as it moves higher, rather than an actual reduction in implied volatility across the board. This decline could lead to complacency, with the belief that the market is stabilizing as the SPX rises. Yes, positive gamma should help to stabilize market prices near current 5,400 levels, but IV’s have really not collapsed.

This is not to say that the VIX & its linked products did not decline – which they did because the VIX benefits from the Fixed Strike Slide in the S&P500. This is because the VIX is based off of a near-the-money range of SPX options prices 30 days out in time. So when the SPX rallies, the options that are inputted into the VIX calculation naturally have a lower IV due to the skew slide.

The takeaway here is that traders definitely made money being “short vol” via VIX puts, short VIX futures or playing VIX ETN’s – largely from last week. However, yesterday’s PPI did not “release” vols, and until these vols are released (i.e. fixed strike vol declines) then we believe risk remains high.