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Good Morning!
This is the Jumping Cholla (CHOY-uh). The newsletter that turns options market insights into a fun, easy-to-read email that helps you reduce your chances of getting pricked while trading!
Quote of the day:
"Now you've piqued my interest"
-Vince McMahon
Well, well, well, what do we have here? The man's interests are definitely open!
I can't tell...is he in the process of hiring a hot assistant on live TV in the middle of a wrestling ring OR did he just figure out that options open interest tells you where people are placing their bets?!
For Vince, looks like it was the former (20yrs ago sure was different!) But for us, let's figure out what open interest is and see if we can glean any insight from it!
BANG for Your Buck:
| 1/18/2023 SPX = 3990.97 | Handles of Movement | 1-Day Implied % Move |
|---|---|---|
| BANG (intraday) | 49 | 1.2% |
| BANG (weekly) | 107 | 2.7% |
As we noted yesterday, the options market positioning (read: open interest) kinda has the underlying by the bawlz around the 4000 level.
With no catalysts today, SPX oscillated around 4000 (purple line) due to dealer hedging. FYI, open interest is what allows us to deduce dealer directional exposure rebalancing needs.
Things to look for this week
Large shorter term option positioning at 4000 level in SPX
This creates larger impacts on dealers' (bookies) need to reposition in order to remain market neutral (also known as hedging)
Dealers seem to be net long the calls around here, meaning as the market rallies above 4000, they need to sell SPX underlying. As the market sells off below 4000, they need to buy SPX underlying
4000 level should act as temporary oscillation point (this can change with a "re-pricing shock" such as news)
VIX < 20 & implied volatility via options is less than realized volatility via underlying movement.
This has generally marked a short-term topping process, and the expectation of a move lower
Moves greater than BANG, in either direction, need a catalyst
Reports / News
Couple of Federal Reserve talking heads spewing rhetoric
Manufacturing numbers
Report: Empire State manufacturing worse than expected
Effect: Nothing material ~ 15 handles of movement
Bank of Japan
Homebuilders, building permits, building starts, and jobless claims
Bunch of Q4 earnings reports
Remember, we don't care about what these numbers say, rather how the market reacts to them.
World Economic Forum
A lot of "do what I say, and not what I do" types will be planning your future for ya!
What is Open Interest?
Open interest reflects the number of outstanding contracts that are held by market participants. It is considered a measure of market activity and liquidity.
Key Point: A contract must have a buyer and a seller.
If the contract is not yet settled or closed, it will be represented as "open interest" to the marketplace. Effectively, this tells us that two parties have a bet on, and the bet is still live!
In the options market, open interest is located at the contract's definition: call or put at a specific strike. In the graph above, strikes are listed on the x-axis, the total number of open contracts are on the y-axis, and calls are blue bars while puts are red bars.
SPX closed at 3990 yesterday...notice that big spike right in the middle at the 4000 strike. That's a crapload of bets, both of the market going up and the market going down from the 4000 level!
The other day I wrote about how both sides think they're winning. Considering the open interest, it should make more sense why volatility decreased as the market rallied towards 4000.
How does this relate to dealer hedging?
Every contract has a buyer and seller. And, options are basically bets with bookies, right?
We'll never know how each "gambler" will manage their bet, but we do know how the bookie needs to!
In order to take massive amounts of bets from market participants, they need to stay nuetral to the market.
As time passes, volatility changes, and the underlying moves, the only way for a dealer to stay market neutral is to offset its byproduct exposure with equal and opposite exposure!
-Newton's Third Law of Motion
Our insights about the market comes from our open interest analysis and dealer hedging model, which attempts to predict which open positions are dealer managed. That way, we can anticipate how they will hedge as stuff happens!
Tomorrow, we are going to dive into the precise mechanics of hedging a call or put, and then eventually tie it into insight about the market... so stay tuned!