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Searching for Liquidity
What it looks like as the market finds a fair price
Good Morning!
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Quote of the day:
"An auction is not just a way of selling goods; it is also a way of discovering the true market value of those goods."
On Friday Feb 24th, the Fed’s favorite inflation metric, PCE, was released. It showed that inflation is trending in the wrong direction (up not down)… uh whaaaat?! But JPow said he has very powerful tools to fix inflation?!
Basically, the market had to digest “higher for longer” (higher interest rates for longer, and according to the Fed, no cuts anytime soon) and what that means for asset prices.
Let’s review day because it’s a good example of authentic price discovery.
The market gapped lower on the open. And as you can see in the bottom pane, VIX opened slightly higher. This tells me that the market isn’t overly shocked that PCE missed (makes sense since PPI/CPI had similar issues).
The rest of the day is what’s interesting. Volatility remained stable, and the market had multiple 0.5%-1% moves. I.e., a persistent level of uncertainty
This is what a market looks like when it’s searching for a “fair price.” As we’ve written before, volume precedes price, so in essence, the market is searching for liquidity.
Price wasn’t controlled by some VWAP algo (volume weighted average price pronounced VEE WOP…no offense to my guinea brethren!) where price grinds in one direction and volatility decreases regardless of direction.
Please forgive me Tony!
Buyers were aggressive in limited pockets of price, and same goes for aggressive sellers. Remember, there is always a buyer for every seller, but quantity available at that equilibrium determines the next price. And the next price determines if you got a deal!
BANG for Your Buck:
2/27/2023 SPX = 3970.04 | Handles of Movement | Implied % Move |
---|---|---|
BANG (intraday) | 54 | 1.4% |
BANG (weekly) | 119 | 3.0% |
As we said last week, things are orderly, but persistent uncertainty smells like “risk off.” In general, VIX over 25 will definitely lead to more “risk off” as systematic institutional garbage (you know, the never ending list of ETFs/Mutual funds) use it as a key metric. Also, if the market on net wants to sell, it needs to attract buyers, and vice versa. So always be on the lookout for sneaky traps.
Options Market Positioning
4100 = major resistance
With large option open interest, staying below it perpetuates the bearish lean.
4000 = critical support and entering large negative gamma land.
Since we’ve broken through 4000, dealers tend to hedge with the direction of the market, which naturally increases real volatility. Ex: as the market breaks, dealers need to sell the underlying.
If selling begins to build, systematic momentum chasers (e.g. CTAs) will show up to the scene of the fire and dump gasoline on it,
Although, if get over 4000, it’ll serve as a support level. Look out for long traps.
3950 = large speedbump
Lot’s of put open interest. As the market approached this level on Friday, put selling increased. So some customers believe this downdraft is potentially short lived and worth getting short volatility and long the market.
If they blast through this, there’s quite a bit of pain and lack of “hedge insurance” to the downside.
Volatility bets are on!
As we alluded to last week, large VIX trades occurred that essentially bet volatility will go up precipitously (50% to 100% higher from here) into March through June.
We’re nowhere near 30 VIX…but I guess it’s trending in the right direction for those bets.
News/Reports
Typical bullsh*t. Couple a two tree Fed speakers. Expect them to thoroughly telegraph what they will do to rates on their next meeting (March 21-22).
Housing related stuff will be interesting since the buying season for the Northern Hemisphere starts relatively soon.