Macro Theme:

Key dates ahead:

 

Founder’s Note:

Futures are -3% after China announced tariff retaliation. VIX is now at 39, as traders price in “worse than worse” case scenarios. We also have the feeling, based on vol movement, that someone(s) is getting margin called.

NFP is at 8:30AM ET.

HIRO

is showing unusually large pre-market/overnight put buying, as shown below. Anecdotally we cannot recall seeing -$650mm of pre-market S&P500 deltas (

HIRO

signal).

Yesterday AM we were flagging 5,400 as major support, and that served to provide a ~1.2% bounce. However, as noted last night, the positive gamma support at 5,400 deteriorated greatly on that mid-day bounce (dealers lost positive gamma), and

HIRO

signaled longer dated put buying from 2PM – 4PM ET. Longer dated put buying suggests increased dealer pressure to the downside.

When we check the TRACE map this AM, we see lots of negative gamma across the whole strike range, with the only significant support level at 5,000 (that’s not a typo).

Instead, for “support” (i.e. finding an equity low), we now have to look squarely at the volatility market.

If you recall, yesterday we saw a solid 1-2 vol pt shift across the SPX vol surface. This, as the SPX was -4% into the open. Today, with the SPX -2.6%, we see the overnight vol change at a HUGE 3-14 points (see %’s in the grid). For comparative purposes, the vol shift from Friday August 2 to August 5th (when VIX marked +60) was 6-12 vol pt shifts.

So – this is indeed nasty, and has the hallmarks of forced liquidation. Why?

Who is going to pay for put protection/long vol at these prices? Likely only someone who is forced to.

Below is the 1-day VIX change vs 1-day SPX % change, using current indicative cash open prices for VIX/SPX. As you can see, today is rarified air in terms of VIX move vs SPX. The key here being the VIX move relative to SPX is larger than the fairly linear correlation we see on typical days. This suggests forced options/vol buying.

Of the 11 days with a bigger VIX move than today, 6 of them in 2020 (covid crash) & 2 of them are August ’24 (8/5 & 6th).

Here is the long term VIX to SPX vol premium (1-month SPX realized vol). As you can see, the premium max since 2020 is 20pts, and we are near 12 right now. What does that mean? We certainly have the possibility of VIX gapping higher, but we are likely in the death throes of the final move. Given today is Friday, the weekend break may force some cleansing of portfolios today, but provide a break in the energy for next week. Said another way, today into Monday may line up with interim lows as the equity market cannot likely sustain this pace of movement. The options just get too expensive (we can’t keep annualizing SPX vol at 40%).

How do you trade this? First, size down, as swings can obviously be much more violent than anticipated.

Second, if you didn’t buy puts already, its likely way too late. Now obviously if you have something you have to hedge, or some mandatory reason, thats different. But if you are just speculating, well you are buying put prices at historical highs.

Third, if you are going to trade options to play a bounce, we recommend spreads as IV(vega) is going to be very high. Therefore if vol does come down, IV will come down too. As IV comes down, options prices decay. With that in mind, options here are as much a pure volatility trade as they are directional bets (this is delta vs vega). Along with that, we recommend going out in time +3 or even +6 months in order to give yourself more time. Call flies may be an interesting way to play upside, and a vol contraction.