Dip-Buyers Beware: "The Reflexive Short Vol Trade Has Left The Building"

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by Tyler Durden
Monday, Oct 11, 2021 - 01:55 PM

Something's different this time.

For the first time since the collapse in March 2020, the S&P 500 has failed to rebound back to new highs after testing its key uptrend technical levels...

Source: Bloomberg

So what happened?

SpotGamma notes that the OCC data we collect offers some insights into what happened last week. According to this data, Index call options were sold to open in pretty strong size (top chart, blue line). Along with that there was some light put options shorted (orange line), but much less aggressively that in months past.

Source: SpotGamma

For months the default reaction to any selloff in markets was to short volatility (with the recovery time of any dip in the market measured in hours).

Off of the debt ceiling punt last week there was a snap-back rally in which very short dated options (1-3 days to expiration) were sold but nothing “real” (ie larger, longer dated) moved.

It seems like traders used Thursdays rally to reposition long volatility/short markets.

The bigger takeaway is this: that reflexive short volatility trade has apparently left the building. We’ve viewed this reflexive vol shorting as a primary driver of markets in the short term. With this mechanism absent, the market seems unable to recover.

If we map out what this means for today, you can see below that its critical for the S&P to hold 4375.

Source: SpotGamma

The rate of change of gamma (“SG Momentum Index”, Y axis) changes sharply beneath there, down to 4300.

As SpotGamma concludes, this indicates the market will have a lot of speed on a move down aka little support.