As cash indices were grinding to session lows yesterday, Nomura's Charlie McElligott points out that there was substantial closing-out of downside (selling Puts / Put Spreads to close - notables incl ARKK and KWEB, as well as a bunch in single-name) along with some buying of upside (KRE Calls and Call Spreads, XBI CS, single-name 'stock replacement' trades). In other words, constructive behavior, taking some protection off, others tilting to offense, and perhaps that explains the rebound overnight in futures...
To this 'constructive' point, the Nomura strategist notes that the highs in spot VIX yesterday were made overnight and well-ahead of the ugly morning cash Equity session, where despite the ongoing selloff in stocks with ES -2.0% by late US noon-time, implied Vols just kept getting crunched and sharply lagged weak stocks (SPX 1m paper only +9bps, while QQQ and IWM vol finished down 30 and 18bps, respectively, while Skew was lower on all three major indices), as traders monetized hedges, or played the market constructively...
And from here, McElligott warns there is "potential to get squeezy in the major US indices as we turn into the new year."
As a reminder, the US Equity realized Vol "crash up" relative to implied (1m SPX rVol from 6 to 20 — 100th %ile over the past decade), which began late last month, has now triggered a remarkable amount of Equities deleveraging in a short-period of time.
This deleveraging has left the index options environment in much better shape than where we were starting out the day yesterday. The Nomura MD points out that:
SPX / SPY consolidated now nearing the “neutral Gamma vs spot” level at 4612 (overall $Gamma -$4.2B, 14.8%ile), while also now positioned “long Delta vs spot” above the neutral line at 4589 (net $Delta close to home at -$49.9B, 19.5%ile)—note: 4600 is a big strike level with $2.1B $Gamma, with $1.2B up at 4650 and $1.7B down at 4550
QQQ still “negative Gamma vs spot” below the flip level up at $390.53 (overall $Gamma -$269.9mm, extreme 9.3%ile), while also still very “short Delta vs spot” territory w flip up at $391.45 (net $Delta -$13.5B, 5.0%ile—which means we could get very chase-y to the upside with “fuel for a squeeze” as so much positioning has been deleveraged—big strikes 390 ($336.1mm $Gamma), 380 ($324.5mm), 385 ($202.5mm)
IWM also remains extreme, deeply “negative Gamma vs spot” (flip at $220.73, overall $Gamma -$278.9mm, 10.3%ile), while also remaining in deeply “negative Delta vs spot” territory (flips up at , net $Delta -$12.6B, 3.2%ile)—same dynamic, “short Gamma” and “short Delta” could see vicious rip higher during these periods of headline calm and large deleveraging “cleared” as we make the new year PNL / risk “turn”
Which means, moving forward, both of these strategies are likely to be substantial sources of mechanical demand for Equities, as particularly from the Vol side, it will be difficult to sustain realized ~1.4% daily changes as implied by spot VIX @ 22. McElligott points out that this means implied Vols will likely continue to bleed (dragging realized lower with it), incentivizing further monetization of hedges and selling of “rich” vols and create Delta to buy, in a virtuous feedback loop for higher Equities.
And, as SpotGamma explains, QQQ has a much steeper, more “skewed” structure vs SPX.
This suggests that dealers have relatively more QQQ to buy as prices go higher, and more to sell as QQQ declines.
This is what creates higher volatility, and is a function of both the negative gamma position and elevated implied volatility.