Macro Theme:

• -Rallies should be categorized as “short covering” and subject to failure
• -4000 is significant overhead resistance
• -We look for volatility to increase on a break of 3900, with 3800 major support
• -July 15th & 20th expirations (equities, VIX) which may increase volatility into FOMC. This reduces equity support.
• -July 27th is a key FOMC rate decision which is a key turning points for markets

Daily Note:

Futures are off slightly to 3885. Volatility estimates are in line with last week, with models looking for a max move of just over 1%. 3900-3910( 3910=SPY 390 + Vol Trigger) is first resistance, followed by 3950. We do not see a key downside support line until 3800, however we do not anticipate a test of that 3800 level today.

From a large time perspective our models suggest that options flows which have recently support markets ebb into Friday due to expiration. Further, the theme of selling volatility (which supports equities) likely subsides as we approach VIX exp (7/20) and FOMC (7/27). In other words, we are overall viewing this week as a transition from options flow being a tailwind for markets, to a headwind.

As for the more immediate term, while the gamma complex for SPX has shifted toward zero, we have a fairly large negative gamma position in SPY (this indicates more volatility potential). The Vol Trigger was also at 3800 last week, but that has shifted up to 3900 today. This suggests that bulls have an edge if markets hold 3900, but <3900 “one way” volatility may increase (i.e. a test down to 3800/lack of a bounce). Note that if the Vol Trigger held down at 3800 we’d be looking for more mean reversion type flow if markets broke 3900.

Further to this point we think volatility here is particularly asymmetric. If the market rallies, volatility should continue to decline into the 4000 strike. However if the market declines we’d look for a rather sharp increase in volatility.

Adding to the declining support underneath is our changing view of market support (recall that last week our forecasts were for declining volatility into the start of this week).

The view that volatility may increase toward the end of this week due to several upcoming catalysts we’ve mentioned many times. First of which is expiration Friday, wherein we measure ~10% of SPX options positions rolling off, ~30% of SPY, & 10% of QQQ.

This overall size is now rather small thanks in large part to last weeks market rally (July exp put positions decayed). While this expiration is no where near the size of June’s we think it was large enough to provide market-supporting flows – and that support is waning into Friday.

This equity OPEX is then followed by VIX expiration (7/20), FOMC(7/27) and the onset of earnings.

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