Macro Theme:

 

 

Founder’s Note:

Correlation risk is flaring this AM. AVGO, the 5th largest NDX &10th largest S&P500 component, is -9% after reporting earnings last night. This is pressuring the chip sector lower, with NVDA -2% pre-market. These large components push indexes down.

ES Futures are 65bps lower this morning, pushing the SPX down below our risk-off level of 5,500. NQ is -1.1%. Accordingly, the VIX is pressing higher, to 22.3.

NFP is at 8:30AM ET, and the anticipation of this number, combined with pre-market action has today’s 0DTE straddle at a large $64 or 1.1% (ref 5,470, IV 43%). This reflects the market pricing in big moves today, which should be unsurprising given the move <5,500.

Before we dig in, we note 2 fairly large 0DTE put strikes today, with +20k OI each: 5,450 & 5400. Its not clear how dealers are positioned in the 0DTE space with respect to these strikes, but these strikes have the potential to add volatility. We think dealers are a bit long at this 5,450 strike, which could offer initial support. Meaning if we test it once then, markets could bounce, but subsequent tests may not hold.

What is more interesting is that we read 5,400 as a pretty large negative gamma strike for dealers. What does that infer?

Before we get into that, lets cover the upside. >5,500 we have been, and remain, neutral. This is because while you may get a tradable intra-day rally, there is nothing to “make it stick”. As a result, strong ~1% AM rallies the last two days quickly reverted.

Its not until >5,600 that we’d look for a rally to hold.

Now, back to the downside discussion.

In recent notes, and in yesterday’s Q&A, we discussed the “gamma trap” which comes into play at SPX <5,500. The gamma trap is the reflexive, negative gamma hedging flows that could now push markets lower. 5,400 is the currently the main supply for negative gamma.

The model here is that as equities drop, dealers need to sell stock. As they sell stock, it pushes prices lower, implying they need to sell more. The way to break such a cycle is with some type of material news (ex: central bank policy, etc), or an expiration. In this case, the FOMC & a huge OPEX line up, but not until 9/18-9/20. This suggests that high volatility may remain for the next few weeks, unless we can get back >5,500.

What could offer a bit of downside respite, is some dealer positive gamma strikes down near 5,350. This implies that while pressure may ultimately pick up into 5,400 there currently is less flow to continue momentum <5,350. We’d therefore look for a nice bounce should the SPX test that area.

Somewhat syncing with this is the vol complex. Our new models suggest that there is not currently a ton of dealer pressure to really shove VIX to the upside (a la 8/5). We also checked the SVXY (a “short vol” ETF) assets as a proxy, and what you can see is that AUM has sharply dropped after a massive August 5th short-vol surge. This too suggests there isn’t a big short vol cover trade pending.

All this taken together, it feels more like markets may continue to slide lower, more than crash. Almost more like a “re-pricing” vs “armageddon”.