Déjà Vu All Over Again

Good Morning!

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Quote of the day:

"It’s like Déjà vu all over again"

Hey Boo-Boo! What do you do when a trading day looks like a day that just happened?

Do what worked until it doesn’t! One of the greatest fallacies in trading (and life) is “this time it’s different.” That may prove to be the case, but until then, trading psychology and behavior is reinforced and seems to play out the same way…a lot.

Remember the January CPI report two days ago, and how that trading day looked? Quick recap: number released in the morning, sells off pre-open and eventually bid it up all day.

Yesterday, Feb 16th, PPI was release pre-open, they sell off, and then it appears to be bid up all day…until it’s not. The “not” part might be attributed to Fed speaker Bullard spooking the market a bit by talking about 50 bps rate hike in March, but that merely started what was destined to happen…

Here is what the last four trading days looked like:

Those look awfully similar. Just buy the open all week, and you’re good to go! (I wish it were that simple…)

The dynamics this week have been controlled by ultra short dated options, yes, I’m talking about my precious 0DTEs!

Yesterday morning, short dated call buying started right from the jump (as it did every day this week). Recall, customer call buying = dealer call selling => dealer buying underlying to hedge (Calls Opposite Puts Same).

As the calls get further and further into the money, dealers need to buy more and more underlying to offset their short call losses. And bingo bango, a beautiful positive feedback loop is born!

As the market inches towards higher levels, the calls make $$, and eventually the customers liquidate those calls for a hefty profit. (Dealers also profit because they remained market neutral with dynamic hedging and made a “vig” on the bet…ah, to be a bookie!)

What happens when in-the-money 0DTE calls are liquidated?

Well, the dealer does not need his long underlying hedge to protect a bet that no longer exists!So, without a short call position, dealers dump their offsetting long underlying exposure.

And viola, the market sells off. FYI, this will happen even if the customer doesn’t liquidate, and they just expire in-the-money. This is why rallies (or sell offs) built on short dated options do not last.

But if you’re trading intraday, this should excite you! You don’t need to “predict” the market, you just need to go with the flow and anticipate what the dealers (and sometimes customers) will do and when.

BANG for Your Buck:

Today’s options expiration removes ~25% of anticipated dealer hedging flows (i.e. gamma). This frees up the market to move until more option bets are added. Potentially, macro-theme traders can push this market at their whim for once!

In notional terms (i.e. value of stock), $1.75 trillion of bets expire today:

• $750B in SPX at 8:30a CT

• $600B in SPX/SPY/ES at 3p CT

• $400B in single name stocks at 3p CT

This frees up the market for higher volatility. (hmm, maybe those VIX call buyers are onto something!)

Also, Hot Carl still has his 24k 4050 Put trade on that expires tomorrow at 3p CT, and he bought another 23k of the 3950 Puts in March. Let’s see if he’s right!

Volmageddon 2.0

The market isn’t really hedged to the downside. Maybe they don’t need to be because they aren’t too long stocks. But lately, the 0DTEs are kinda doing the trick for protection…

But what happens if there is a ton of demand for short term put buying in a single day? Well, for dealers to sell puts, they will also need to sell underlying. This amplifies realized market volatility, and also implied option volatility, which on net causes even more underlying selling.

You may have seen some people refer to this as Vol ma get it on 2.0, and yeah, it could happen…

As always, pursue the process NOT the profits!