With traders puzzled by the sharp rebound in stocks from last week's modest selloff, earlier today we reported that Nomura's Charlie McElligott had a theory that explained said market move higher, one which revolved around three catalysts:
- Buybacks (Healthcare, Tech, Industrials and Fins are the top 4 S&P sectors today and are 4 of the top 5 Buyback desk ‘executed’ sectors, with Mutual Fund Overweights / Megacaps +1.4% vs S&P +1.0% and RTY +0.8%, respectively)
- Overwriters continue to systematically roll-out into Friday’s Quad Witch OpEx, driving a dealer “delta-grab” and further spurring mkt gains
- Finally, VIX term-structure continues to compress and steepen further into contango, with systematic roll-down strats in “high cotton” again shorting volatility (VIX back to Oct 3rd / pre-Powell “a long way” from neutral on interest rates comment the following day)
Of these three, the key driver was simple - the notorious March Quad Witch, i.e. "Freaky Friday" (as a reminder the last two quads took place at key inflection points: the 21st Sep print of 2940 preceded a three month equity selloff of almost 20%, followed by a 21st Dec print of 2458, or 16% below current spot).
The "March Surprise" window-for-stock-pullback scenario has anticipated this type of “melt-up” into Friday’s options expiration, as that’s the seasonality of “up into OpEx, down out of OpEx" shown on the chart below.
And speaking of the "extreme" gamma and delta positioning, McElligott noted that the sum of Nasdaq Gamma within 1% of spot is currently in the 98th %ile, while the sum of QQQ Delta across strikes is 96th %ile, which explains the forced dealer delta grab via overwriter roll-outs CEASE and aligns with the buyback blackout commencement.
The electronic ink was barely dry on McElligott's note when Goldman's vol trader, Moran Forman, magically came out with "his own" take on the upcoming market reversal, which surprisingly also revolved around two things: an anticipated slide in dealer long gamma positions (just as Charlie noted above), and the drop in buyback activity (an idea which again was "inspired" by, well, see above).
Whatever the source of Mr. Forman's analysis, the Goldman trader is correct that after Friday, 2 major "vol-dampening" forces will be gone, meanwhile with Trump also kicking the China Trade can down the road into April (at the earliest), Goldman writes that "it feels like VIX creeps higher again."
To summarize Goldman's three catalysts for market turbulence:
- BUYBACK BLACKOUT WINDOW: 3/25/19 – 5/3/19 desk models +75% of S&P co’s are in their dormant period for discretionary buybacks, which typically corresponds to a -35% decline in activity for the biggest buyer of US Equities link
- TECHNICALS: Moran references Goldman chief technician Sheba Jafari’s call, which is bullish on a break above 2817 and bearish below 2798
- VOLUMES: Yesterday’s break higher came on the lowest cash volumes YTD (5.7bn shares) yet elevated options volumes +10% vs YTD, focused mainly on buyers of short-dated upside spurring the spot up/vol up dynamic.
Forman's full note is below:
The last two quarterly SQ prints occurred right around market turning points. 21st Sep print of 2940 preceded a three month equity selloff of almost 20%, followed by a 21st Dec print of 2458, or 16% below current spot.
Technically, there are a number of important points between 2798-2817 – which leads our technical analyst Sheba to conclude buying on a break above 2817, or selling tactically if we fail to break (target 2706).
Today was the first day in a few weeks we saw spot higher with vol higher (1m vol +0.4v), and we started to see upside chasing from the macro community. Positioning is still very light, as seen below in the long/short ratio of the GS PB Book. Bad data is being excused by the shutdown and seasonality, and investors seem more buy-the-dip than sell-the-rally.
We have seen systematic vol selling pick up as realized has trickled lower with term structure steepening. As we view vol selling as part of the global search for yield, it is perhaps not surprising that this flow has picked up, with 10y yields 60bps off the Q4 highs. The correlation between yields and equities has been consistently positive in the post crisis era. The current equity rally, with bonds stable, is testing whether we have shifted into a different, dovish Fed regime that allows for growth, higher inflation and less hikes.
As most of our flow has been rolling out March optionality farther out the curve, we believe some of the market long gamma will roll off dealer books this Friday.
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Bottom line: If the last two quad-witches were any indication, the market's recent melt up is about to come to an abrupt end.