Here Comes The Short Gamma "Crash Up"

There is a palpable tension between the two "quant" teams over at Nomura.

On one hand, you have the Japanese team led by Masanari Takada, who as we reported last week, is the cause of many a trader nightmares with its predictions of a September "Lehman shock" event in the market.

On the other, there is NY-based Charlie McElligott's one-man quant team, who has been decidedly more sanguine about the market's directionality, and most recently said that as a result of the extreme gamma positioning in the market, the next move in the market would be violent, but it could push stocks higher just as easily as lower.

And judging by Monday's action, McElligott may have been closer to the mark - at least when it comes to month end flows (September is a different matter entirely) - and in a note published this morning, the Nomura strategist writes that the "negative convexity/short gamma" flows which he had anticipated "we were likely to expose into August’s already established “+++ VIX” seasonality (largely as a function of illiquidity and tight VaR/risk limit- constraints) have clearly continued to be the impetus for outrageous price-swings and “rolling volatility shocks” experienced last week."

However, with the risk vortex having seemingly peaked if only for the time being alongside with the price of the Austrian 100Y bond which on Monday entered a correction, dropping more than 10% from its all time price of 210...

... we are now seeing what McElligott calls the "soothing" phase as macro catalysts are now introducing an at least local “Vol Killers” into both US Rates and Equities, including i) the previously mentioned German ‘fiscal stim’ trial balloons, and ii) Trump shifting-back to “good cop” mode on trade/tariffs)."

With tumbling yields setting the mood last week, and dragging stocks lower and sending vol surging, it is then to be expected, that amid speculation of fiscal stimulus from German (which Mizuho was quick to throw up on), and amid a trial balloon of more US supply with 50 and 100Y TSYs again supposedly being contemplated by the US Treasury, it is safe to say that today's yield jump will lead to a widespread risk grab, or as McElligott puts it, "an easing of the “duration grab” would too then see vols “ease-up” too—and this is the environment many are walking-into this morning (if working at all during this holiday “peak season”) as a broad cross-asset  “vol dampener.”

Additionally, and particularly within the US Equities vol space, the Nomura quant expects to see an ongoing reversal lower in "spot VIX" levels, and a re-steepening of the VIX curve, "because much of “crash protection” daisy-chain is now likely to be worked-through and re-priced LOWER as said hedges ”bleed” (the month-long accumulation of tail hedges both due to macro trade risks over the course of August, as well as the offsetting hedges for Options Dealer Desks to the “50 Cent” VIX “call wing” flows and knock-on impact in SPX downside skew).

The resulting “short Gamma" in VIX futures will then likely drive further selling-pressure the lower front-VIX travels and support Equities higher, "especially with broad monetization of “long vol” positions (VIX ETNs) accelerating, SPX dealer Gamma now back to “Neutral” or an even more calming “Long Gamma” position, likely trigger of CTA re-leveraging and / or short covering in Equities and potential return of VIX roll-down players."

VIX ETN net "long vega" with significant potential for further monetization.

Away from VIX, traders will keep a close eye on the reversal of the recent dealer "short gamma" trade as algos scramble to go long gamma, and unwind the past 3 weeks-worth of manic seemingly “irrational” and chase-y price-action.

Estimated dealer positioning in SPX/SPY options now back in "long gamma" zone and likely insulating the price action from here.

In summary, "here we are now, with all of this “crash” bot now increasingly likely to “bleed out”/decay further, thus risking further “short gamma” selling in VIX futures--the lower we grind, the more needs to be sold", creating a virtuous feedback loop which lasts at least as long as there is no adverse tweet from Trump, Chinese invasion of Hong Kong, or Powell not doubling down on "mid-cycle adjustment" this Friday.

And indeed, as McElligott concludes, this this morning we are seeing spot VIX sliding lower, with two additional risk-on catalysts being the following:

  1. VIX ETN longs” starting to take profits, and...
  2. increasing likelihood of roll-down players returning to VIX as the curve normalizes/re-steepens plus heightening likelihood too of CTA Trend RE-leveraging / short-covering in remaining Global Equities “shorts”...

Yup, the CTAs are about to start buying again as we near the short squeeze "buy-trigger" price levels across equities:

All of which are likely to act as a “tailwind” for higher stocks in the near-term.

Confused? Perhaps one can simply summarize all of the above as follows: