When it comes to forecasts about upcoming major quant trades, few have been as prominent or as accurate as JPM's Marko Kolanovic, although to be fair, after having predicting up to $1 trillion in expiring S&P options two weeks ago, when he said that the "gamma imbalance turned towards puts yesterday ($9bn per 1% currently), and this will likely push realized volatility higher near term" and... nothing happened. While that does not mean that JPM's "quant guru" has lost his magic touch (yet), it has opened up the financial playing field for forecasting challengers to emerge. Challengers such as UBS derivatives strategist Rebecca Cheong, who picked up Kolanovic' baton, and according to whom selling of US stocks in the aftermath of Brexit is just getting started for quantitative traders who make buy or sell decisions based on price trends.
According to Cheong, such sales could total as much as $150 billion should equity volatility persist in the S&P 500 Index for the next week. “They’ll be buying volatility and selling the S&P,” said Cheong. “On days like today, when the VIX goes up, they have to buy.” And judging by the early attempt to slam VIX down only to see it ramp higher again during the day, a rising VIX is almost assured especially as now the "exit" bug in Europe has awoken another other nations such as France, the Netherlands and Italy are also demanding independence referendums.
As Bloomberg adds, "strategies designed to mitigate risk will actually add to downward pressure in the S&P 500 over the next week as computerized selling ramps up to keep pace with falling prices. It reminds Cheong of the rapid stock selling that roiled markets in August, when the S&P 500 fell 11 percent to a 10-month low while facing similar behavior from algorithmic traders."
“The bigger the down move today, the more they have to sell, which would basically create a vicious cycle,” Cheong, head of Americas equity derivatives strategy at UBS, said in a phone interview. “We’ll see front-loaded selling in the range of $100 billion to $150 billion over the next two to three days. It could be very similar to August in terms of model-based selling.”
Cheong went so far as to quantify how much the seeling could be: rebalancing of risk control funds could result in up to $98 billion in S&P 500 selling should the index see price swings of about 3.5 percent or more over the next several days. Risk parity instruments may stir up as much as $30 billion in selling given similar volatility, she said. The number may end up being far more if Bridgewater, which as we exclusively reported yesterday was down 6% through last Friday, is forced to rebalance in order to once again get neutral. This would involve the selling of far more equities.
Additional downward price momentum will be created as owners of leveraged exchange-traded funds linked to the CBOE Volatility Index buy more shares as part of their own rebalancing process, according to UBS.
In short, the actionable information here is that i) a new "Kolanovic" may have emerged, one we should pay attention to and ii) if Cheong is right, the sharp market selloff from last August is just a few days away. Which reminds us: the August 24 plunge was on a Monday (also known as Black Monday 2.0) and took place after Chinese devaluation concerns the previous Friday sent the S&P sharply lower... just like today.
So is today's Black Friday about to be followed by another Black, or pick any other color, Monday once more? If the UBS analyst is correct, buying a few puts here may not be such a bad idea.