Tag Archives: bloomberg

Will The Last 2-Weeks Of 2019 Be The Inverse of 2018?

Every professional investor knows that month-ending, quarter-ending and year-ending timestamps are important. Throughout the year, positions are hedged against these timestamps, and as a result, the year-ending option expirations almost always have the highest open interest. Generally, the higher the open interest the greater the volatility and financial risk.

Last December, in and around the final option expiration of the year, the S&P 500 fell by nearly 300 points. This dramatic decline coincided with a spike in market gamma as shown below. It is my view that this decline was furthered by forced selling by the put sellers who needed to sell the S&P 500 index to cut their losses. 

As we approach this year and the S&P 500 continues to grind higher, we may be facing the inverse of last year. Call sellers are beginning to feel more pain, as evidenced by a first-time spike in Forecast Gamma Neutral in my December 17th report.  While I am not saying that stocks will melt up through the remainder of the year, the possibility of that scenario playing out is looking more likely.  The chart below shows the relationship between the cash value in the SPX and the metric that I call Gamma Neutral.

SPX Value versus Prompt-Month Gamma Neutral

The Study of Market Gamma

There has been an increasing amount of attention to an “obscure” concept in the market called “gamma” over the past year.  Last November, Bloomberg published an article titled: Two Words Which Sent the Oil Market Plunging: Negative Gamma.  Since then, there have been an increasing number of market analysts – such as Nomura’s Charlie McElligott – who discuss the implications of gamma exposure in mainstream and other forms of financial media.

The study of “gamma” is akin to the study of market risk. When market gamma is relatively high, then financial risk is also high.  When market gamma is relatively low, then financial risk is low.  The study of gamma is based upon actual bets in the options markets—where hundreds of millions will exchange hands. In this way, the study of market gamma can be viewed as the ultimate “smart money” indicator.  And, the gamma smart money indicator has a definitive time stamp, its option expiration date.

Option expiration this week for the S&P 500 week will occur at 9:30am and 4:00pm December 20th.  At 9:30am, the SPX monthly options will expire, and at 4:00pm, the SPX, SPY and ES futures options will settle.  The SPX monthly options expiring at 9:30am have several orders of magnitude more value-at-risk than the other option expirations.

Whereas other analysts tend to report on cumulative gamma, I tend to focus on discrete, time-stamp specific gamma metrics.  The study of market gamma in all of its forms can provide context for mean-reversion events, Black Swan events, and intra-day volatility. 

Gamma Implications For Year-End 2019

The graph above shows regular mean-reversion of the S&P 500 value back to the levels of Gamma Neutral, and that value is currently around 3,070, a 120 point drop from current levels.  On the other hand, if call sellers in 2019 were to experience the same level of pain as the put sellers in 2018, then the level of the cash SPX would need to be at 3,295 today, a roughly 100 point increase from current levels.

So, from a “gamma” perspective alone, I will not be surprised to see a 100 point swing in SPX over the next week or so.  Of course, there are other market risks such as China trade and impeachment proceedings.  I will either be watching from the sidelines, or perhaps buy a straddle to profit from a big move in either direction.   

Should Tesla Bears Look To Hibernate

In May 2019, I published an article that outlined hope for TSLA bulls in which I suggested that $180 could provide an opportunity for a long position.  Since then, Tesla (TSLA) has established and strengthened along a new uptrend line.  There is now evidence of key resistance near the $260 and $280 levels.  The technical levels below show the key resistance trend lines, based upon weekly highs and lows since 2017. 

The prior five weeks saw TSLA trade in a narrowing technical triangle, and last week’s breakout, followed by this week’s strength, appears to be a breakout through the first level of technical resistance.  The current uptrend line is gaining strength and momentum.  If the price closes convincingly above $280 on a weekly basis, the Tesla bears may want to hibernate for the winter.  

Fundamentals and Markets

When it comes to valuing stocks and commodities, I call myself a “recovering fundamentalist.”  Having spent much of my career building private businesses, I am used to focusing primarily on EBITDA, discounted cash flows, and other fundamental metrics when evaluating stocks.  When it comes to TSLA, I tend to agree with the bears that TSLA’s share price is not justified by fundamentals.  In fact, TSLA’s market cap could be used as exhibit #1 to support the thesis that stocks are not valued upon fundamentals at all.

In the short run, stock and commodity prices are driven by human emotions (fear and greed) and subsequent money flows.  Fundamentals – positive or negative – can provide the narrative and longer-term trends by which investors become bullish or bearish.  I certainly don’t want to dissuade anyone from assessing TSLA weekly auto-deliveries or to research its accounting statements.  Nevertheless, this recommendation is based solely on my technical view of the current price action, regardless of Tesla’s bearish fundamental backdrop.   

The TSLA Options Market

The options market provides institutions and other large position holders an ability to hedge their TSLA exposure, whether the funds are invested long or short.  Since TSLA has a history of being difficult or expensive to short, the options market provides an outlet for those negative on the stock price. Due to the high demand, TSLA options tend to be liquid with high open interest.  There are many retail and institutional investors who short TSLA by buying puts.

The market makers who facilitate the options trading almost always hedge their exposure instantaneously and dynamically with delta-neutral strategies. 

What this means is the market makers perform combination trades to (theoretically) hedge their exposure to price while also profiting from options volatility.  The maximum profit for the market makers will occur if the price of the stock settles near the price level where their portfolio is delta neutral.  As a result, it can be instructive to track delta- and gamma-neutral levels in many different stocks, ETFs and commodities. For more on delta and gamma signals, you can download a quick presentation from this link.

Stock Price and Options Sentiment

Due to order flow, contract rollover, and hedging dynamics, there tends to be a convergence between stock prices and the point of delta- and gamma-neutral as option expiration comes nearer.  We can provide evidence for this convergence for many different stock indices, ETFs and commodities.  The chart below is TSLA stock price versus Delta Neutral and Gamma Neutral for the last several months.   Of particular note is the convergence between price (green) and Delta (red) and Gamma (blue) Neutral for each option expiry period (black square).

Not surprisingly, as TSLA broke through technical resistance last week, its Delta- and Gamma-Neutral levels followed price upward.  Our interpretation of this data is that the option market makers are also buying into the upward momentum.  Beyond the option expiration this coming Friday, additional data for November and December suggest that the options market will not necessarily be a headwind for continued advances in price.

The table below shows bullish put-call ratios and Gamma Neutral levels above $280 for the coming months.

Source: Viking Analytics

The basic theory behind the Delta Neutral and Gamma Neutral levels can be found by visiting our website www.viking-analytics.com.

Final Thoughts

Based upon the technical analysis and the Delta Neutral and Gamma Neutral levels, a long position in TSLA should be considered, preferably on a retest of $240. We would also advise limiting risk with a stop loss rule that would exit the trade on a weekly close below the key trend line.

This is for informational purposes only and is not trading advice.

Is Corn Ready To Pop Or Drop?

Corn volatility has spiked in recent weeks, fueled by weather-related delays in planting crops in the U.S.  The record amounts of rain and resulting flooding in the U.S. Midwest, which is bullish for corn and other crops, follows bearish tariff tensions with China which had pushed the July 2019 corn futures contract to all-time lows just two weeks ago.

Source: TradingView

On a weekly chart, we can see that this is the sixth time that the front-month (continuous) corn futures contract has spiked over $4 per bushel since late 2014.  In every prior instance, the price was short-lived, and corn quickly retreated towards the $3.50 price level.

Source: TradingView

The corn options market is very liquid, thus providing the opportunity for farmers, merchandisers, and other participants to hedge their exposure and lock in profits or costs.  The market makers who facilitate the options trade almost always hedge their exposure instantaneously and dynamically with delta-neutral portfolios.  The market makers perform combination trades to (theoretically) hedge their exposure to price while profiting from options volatility. It is these trades that provide with an insight that few follow.  

Option Expiration Sweet Spot

Due to order flow, contract rollover, and hedge dynamics, there tends to be a convergence between futures prices and the point of delta neutral as option expiration approaches.  We can provide evidence for this convergence for many different stock indices, ETFs and commodities.

Source: Viking Analytics

The chart below shows the regular convergence of the corn price towards market delta-neutral (black square) for the past several months.  Last Friday’s option expiration was the first of two option expirations that are priced off of the July futures contract; as a result, we had been informing our followers to focus on the June 21st option expiration rather than the just passed May 24th expiration.

If we call the point of Neutral Delta, the “sweet spot,” then the options market continues to have a sweet spot of $3.67/bushel for the June 21st option expiration.  Also, both the July and November dated option expirations have currently priced in sweet spots in the $3.60 to $3.75/bushel range.  These delta neutral levels change as the option participants adjust their wagers and hedges. Regardless, they portend a sharp drop in the price of corn.

Source: Viking Analytics

Gamma Signals Caution For Shorts

Neutral Delta and Neutral Gamma often trend with price.  Extreme divergences between Neutral Gamma and price (such as now) can also point towards short-covering events, and we have outlined this dynamic in two different articles: Perfect Storm in the S&P 500 (Seeking Alpha paywall) and Negative Gamma and the Demise of Optionsellers.com.   

Points to Consider

  1. The put-call ratios for the key option expirations are all in the 0.4 to 0.6 range.  This means that there are considerably more call options than put options.  If price continues to rise, then the call sellers may be forced to purchase corn futures to cover their exposure.
  2. At the intra-day price shown above, the total value of calls for the three expirations was $850 million greater than the value of puts.  This is an unusually large difference in value for the corn market.
  3. The basic theory behind the Neutral Delta and Neutral Gamma levels can be found by reading an introduction here: Introduction to Options Sentiment.

Current Trading Plan

The over-bought signal in corn has had my attention for over a week, and I have therefore been stalking a short trade.  On the other hand, the data also shows potential for a short squeeze, so I remain cautious, waiting for a confirmation that the upward momentum has dissipated.  It will be important to see how price reacts to planting progress over the next few weeks. 

This analysis is critical for those trading corn futures and options but should also be of interest to those focused on broader economic activity. The Midwest floods have taken a serious toll on many crops. Couple the potentially bad harvest along with the possible tariffs and the nation’s heartland may be adding to a string of already weakening economic growth

I look forward to any feedback below.

Disclaimer

This is for informational purposes only and is not trading advice.

Quick Take: Volatility Ahead in the Oil Market?

A week ago, I wrote an article discussing how the options markets can provide clues to future price direction and/or volatility in the crude oil market.  In particular, we addressed the question, “how can a trader spot these option clues in advance?”

This morning, we got a signal which may indicate volatility is in the cards again for crude oil.

As crude oil has continued its upward advance from late December, call sellers have become increasingly off-sides with their hedging and position taking. In fact, our measure of sentiment in the options market is now off the charts in the 99th percentile. Simply, all investors appear to be on the bullish side of the boat.   

We recently saw a similar situation play out in the natural gas market. When the level of market neutral gamma spiked out of its recent trading range (or it becomes incalculable), natural gas experienced a short squeeze and rallied substantially.

Current NYMEX crude oil options expire next Tuesday, April 16th.  While today’s level of neutral gamma is in range, we have forecasted that the level of market neutral gamma will spike on Sunday night – unless market conditions change.  This forecasted spike is shown in the graph below (blue line).

Source: Viking-analytics.com

What Does it Mean?

The safest conclusion to arrive at is to expect volatility ahead.  The market may experience a form of a short squeeze as options traders scurry to cover their off-sides net short.  Or, the market will correct lower towards our calculated Price Magnet in the low $60 range.  Based on our research, we would not be surprised to see a $5 move in either direction by the end of next week. 

I look forward to any feedback on these concepts in general, or the oil market in particular.

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech. You can see more of his work at: www.viking-analytics.com.

Bloomberg, Greeks and the Crude Oil Market

In November 2018, Bloomberg published an article entitled Two Words That Sent The Oil Market Plunging: Negative Gamma.  The article opens with this paragraph:

As oil suffered its biggest one-day slump in three years, it wasn’t OPEC or President Donald Trump that was shaking the market. Instead, trading desks were abuzz with chatter of “negative gamma.”

The article then continues by saying that this “obscure concept begins on the options desks of Wall Street” and includes an explanation of why producers buy puts to hedge their production and also some of the risks involved in being on one side or another of this trade.  

Since the Bloomberg article was written largely as a post-mortem, the question retail traders might ask themselves is: “how can I spot this kind of aberration in advance?”  The article does not provide a definitive answer to this puzzle, however we can provide some clues.

Option Market Imbalance

On October 3, 2018, WTI crude oil hit a 2018 settlement high of $76.40 per barrel.  At that time the NYMEX WTI options market was pricing in an October 17th option expiration settlement value in the low $70s and a November 14th option expiration settlement value in the low $60s as shown below in blue and red(and as published in our daily report).

Source: Viking-analytics.com

Prior to the sell-off in crude oil which began on October 4th, the levels of delta- and gamma-neutral provided a reliable point of mean-reversion for the WTI futures price for at least the preceding four months. In the chart above this is shown as the oil price (green) traded at the model magnet (black square) which is predicted by neutral delta and gamma. To add to the ammunition, the November 14th option expiration was for the December futures contract, which, as the anchor and/or primary contract for many producer hedges, increases the volume of the particular contract.

To simplify the concept, we can think about the gamma imbalance as follows:  producers had locked in a significant amount or sold a significant amount of crude oil in the low $60s – either by selling call options or by buying put options.  These trades created pressure for the order flow in both the futures and options markets to mean-revert to this lower level. Our charts clearly showed this massive imbalance in the stark difference between where the price of oil was (green line) and where delta and gamma (red and blue) implied it would be in the future.

In hindsight, the crude oil market breached $60 and then $50 per barrel level to the downside. While we will never know the ultimate catalyst that sparked the sharp selloff, both Bloomberg and I believe that this massive imbalance played a role.

Order Flow in The Age of The Machines

The majority of financial market trading is performed by machines.  Computer algorithms are designed to arbitrage and hedge the markets along many different time frames.

As market makers and large traders create positions, they will often arbitrage and hedge with delta-neutral portfolios.  These portfolios are instantaneously and dynamically adjusted in micro-seconds. 

As option expiration approaches, the computer algorithms must unwind and roll forward their delta hedges.  This creates order flow that tends to compress market delta and market price.

The price of a stock index or commodity will often revert to the point of delta-neutral.  The mean-reversion is seen above as the relationship between the red and green lines on the option expiration date, which we call the Final Price Magnet.

The algorithms which actively and instantaneously hedge delta must also monitor their gamma exposure.   When gamma spikes, covering events may occur, such as occurred in the natural gas market (Oct 2018) and in the S&P index (Dec 2018). 

The example provided in this article is extreme but it is worth highlighting as it shows the value of tracking market delta and gamma. The financial media can be quick to assign blame or credit for every squiggle up and down in the financial markets. Sometimes the media is correct, but frequently there are advance clues that professional traders understand better than the media.

Understanding what drives the market makers can improve your odds of successful trading.  The Price Magnet Report is a tool that considers order flow and open interest in the options markets to calculate expected mean-reversion in and around the option expiration date.  Our daily report includes over a dozen key stock indices and commodities.  This daily report provides intelligence that Bloomberg says is meaningful, but you can’t access this information on CNBC, or even on the Bloomberg terminal itself.   

I look forward to any feedback on these concepts in general, or on the oil market in particular.

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech. You can see more of his work at: www.viking-analytics.com.