Tag Archives: delta

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.

Gamma Radiation, Gamma Reversals, and Gold

I grew up watching Bill Bixby playing The Incredible Hulk on TV.  Readers will be familiar with the general story – mild-mannered scientist Bruce Banner is exposed to gamma radiation, which transforms his molecular structure. The exposure causes Bruce Banner to turn into the radiation-green colored Hulk when he experiences extreme anger.

Bruce Banner has a “tell” for when his anger reached the point of no return and the Hulk would appear.  

His irises turn white. 

When Banner’s irises turn white, the Hulk is on his way to restore justice and create order. In this article, I discuss a market “tell” to alerts us as to when a market is likely to shift from chaos to order.

Gamma in the Financial Markets

Gamma not only defines the type of radiation that transformed Banner into the Hulk, but it is widely used in science and mathematics. In the financial world, gamma is one of the “option greeks,” which help to measure the price, risk, and time dimension of options. 

Gamma in the financial markets has had increasing attention lately. The Wall Street Journal and Bloomberg have recently published articles which discuss how this “obscure concept” has moved markets over the past year.  Bloomberg, for instance, claims that the rapid fall in oil prices in the 3rd quarter of 2018 was due to “gamma.” In other words, Bloomberg says that gamma was the “tell” that predicted a more than $35/bbl decline in oil prices. 

My analysis has demonstrated that gamma data has been a “tell” for many major price pivots over the past year, including the stock markets, energy markets, and grain markets.

First, let’s better define my “tell.”

Gamma Reversal

A Gamma Reversal denotes the occasion when a spike in Neutral Gamma coincides with a nearby monthly pivot level.  Over the past year, there have been six significant Gamma Reversals, which I highlight below.  

The most notable and memorable Gamma Reversal occurred in the S&P index last December 2018.  The chart below shows the price decline of the SPX from September through late December.  At the market troughs, in the days leading up to Christmas, Neutral Gamma (blue) spiked off the chart, corresponding with a major pivot level.

This Gamma Reversal was a strong signal that sellers exhausted their ammunition. The price quickly reversed higher after this event.

The natural gas market in late 2018 had a similar scenario.  In November and again in December, natural gas saw Neutral Gamma spike out of range. In both cases, the spikes corresponded with nearby reversal pivots.  Once again, we could say that the buyers became exhausted, and the price declined.

In June 2018, there were four cases of what I would call a Gamma Reversal – in corn, soybeans, wheat, and natural gas.  In each case, Neutral Gamma spiked out of range and a nearby price pivot occurred. 

Why Does This Happen?

Here is an explanation of why I believe that gamma signals can coincide with nearby price pivot(s).

Neutral Gamma is defined as the price level where market risk is neutral for the entire options market.  This is to say that market participants are well hedged, and the options market is in balance with the underlying market. In aggregate, traders are not exposed to meaningful risk.

When Neutral Gamma spikes “off the charts,” it means that the options market is out of synch with the underlying market.  Such spikes tell us that option buyers and sellers are experiencing extreme risk and emotions – an acute kind of fear and greed.  In such times, most active managers are feverishly working to mitigate risk.  Such events usually end up with greatly rewarding winners and punishing losers.  

When gamma spikes, the Bruce Banner in traders becomes agitated and their irises turn white.   

Gold Gamma Spike

On July 23rd, our data recorded an out-of-range spike in Neutral Gamma in the gold market.  With this spike in gamma, I am looking for two primary possibilities: 1) the potential for a short squeeze above $1,450, the peak of which could become an upside price pivot, or 2) the recent closing high for gold could be an upside pivot which marks the beginning of a pull-back or a reversal. 

The chart below shows the relationship between price, Neutral Gamma, and Neutral Delta since the beginning of 2019.  Option expiration in COMEX gold options was Thursday, July 25th.

Final Thoughts

I have outlined and defined a few terms here, all of which are worthy of further research and review.  I have shown several instances where Neutral Gamma spikes out of range and ultimately marks the top or bottom of trends. Since gamma is a measure of financial risk, it can also be viewed as an indicator of human emotion.  Spikes in gamma also result in spikes in human emotion, and the spikes in human emotion can lead to exhaustion, capitulation, and the creation of nearby tops and bottoms.

This market “tell” which is followed by so few investors can provide great entry and exit points. If nothing else they heighten our senses to the whites of traders’ irises and the growing possibility for a burst of volatility.

If you would like to learn more about these topics or my other research, please visit my website.

Disclaimer

This article is for information purposes only, and is not investment advice. 

Counting Cards In The Casino

In some ways, Wall Street is like a casino.  Both have shiny lights, bells and whistles, with distractions galore and a myriad of different bets for the making.  Wall Street and Vegas both profit from volatility, liquidity, distractions, and volume. Unfortunately for you, Wall Street and Vegas have the odds in their favor, and they don’t really care if you win or lose.  The bottom line is that both Wall Street and Vegas will turn big profits as long as enough people play their games.

The casino analogy doesn’t “walk on all fours.”  For one, not all investors and traders are gamblers.  Great investors are more like “entrepreneurs” than “gamblers,” in that they take measured risk within a disciplined system.  In the long run, most gamblers lose money.  In the long-run, most disciplined investors make money.  

In my daily newsletter, I report over-bought and over-sold signals based upon key signals of financial risk.  My goal for the newsletter is simple: to help subscribers achieve their financial goals.  Zig Ziglar says, “you can have everything in life you want if you just help enough other people get what they want.” 

Side Bets and Synthetic Securities

Often in most casino games, side bets are more important and/or lucrative than the actual game itself.  A perfect example of this is typified in the movie The Big Short.  Selena Gomez is playing blackjack and explaining how the side bets she placed on her hand are like synthetic securities that are now pervasive throughout the financial markets.  Both in the movie and in the real-world financial markets, the synthetic side bets are many orders of magnitude larger than the “real” bets.

In most financial markets, synthetic transactions dwarf the actual physical supply and demand of a security or commodity.  This is true for stock certificates, barrels of oil, ounces of gold, and bushels of grain, to name a few. 

As an example, each day the NYMEX WTI crude oil futures contracts trade as much as ONE HUNDRED TIMES the actual daily physical supply of crude oil.  Think about this, the paper trading of crude oil IN ONE LOCATION (Cushing, OK), traded ON A SINGLE exchange (NYMEX) – not including any over-the-counter or other exchange trading – is often ONE HUNDRED TIMES the actual physical supply of crude oil over the ENTIRE United States.  Such enormous differences hold true for almost every commodity.

Since trading activity in synthetic paper markets often overwhelm the physical markets, it is important for investors to stay informed of factors that highlight derivative risks and potential order flows. The options market often provides these clues and this is the crux of my analysis.

Option expiration (op-ex) is a key moment in time when profit is realized and risk is purged.  All options bets and hedges on the books settle, roll over, close, or expire worthless on the op-ex timestamp.  My work shows the repeatability of a few different dynamics as the date of op-ex gets closer. These include:

  • Mean reversion of market price prior towards delta neutral on or before op-ex.
  • Forced selling and/or buying following a spike in market gamma. 

Counting Cards in the Casino

“Synthetic paper”, including options and derivatives, are very complicated topics even for financial professionals. As such I believe it is essential to make my daily report as user-friendly as possible. I compile and process reams of data and boil it down to simple actionable advice.  When a market price is in the top 10% of aggregate risk to call sellers, I report an over-bought signal.  When a market price is in the top 10% of aggregate risk to put sellers, I report an over-sold signal.  This doesn’t provide a definitive “answer,” but it does give a unique and potentially actionable perspective with defined risk measures.

If we are sticking with the Blackjack analogy, the program that I run each morning is a card-counting machine.  I “count the cards” so you don’t have to.

Bloomberg and the Wall Street Journal Agree

I am not the only one who sees the relationship between option risk and market price.  Over the past year, there has been an increasing awareness in the financial mainstream media about “gamma” as a measure of market risk.  In November 2018, Bloomberg suggested that intelligence on market gamma can give advance notice of an oil market plunge.   In July 2019, the Wall Street Journal reported that intelligence on market gamma can explain why markets “suddenly go crazy.” 

Bloomberg and the Wall Street Journal agree that gamma is an important concept for investors, however you cannot find actionable gamma data on a $25,000 per year Bloomberg terminal.

I know of no other service where you can get information as comprehensive and inexpensive as I offer it.  Give my service a try with a free two week trial and see if helps you become a better investor and trader.

Will History Repeat Itself in the Gold Market?

Mark Twain once said, “history doesn’t repeat itself, but it often rhymes.”  Since President Nixon removed the gold standard in the early 1970s, gold has seen several significant rallies, all of which have similar wave characteristics.  Gold rallies seem to rhyme.

The first two price rallies began in 1971 and 1977, during and after the de-linking of the U.S. dollar from gold. The most recent price rally has its seeds in the dot-com bubble in the early 2000s.  The chart below shows two long-term monthly gold rallies, with the second rally appearing to be an amplified but similar version of the first.  I have overlaid Fibonacci sequence numbers to demonstrate how the price of gold has spiked upward in expanding, fractal waves during these prior surges. 

In the 1970s, gold traveled through four Fibonacci levels (by this measure) in less than a decade after the removal of the gold standard. From 2000 through 2012, amid the dot-com and housing bubbles, gold also traveled through four Fibonacci levels on the way to $1,900.  

If history rhymes again, and I believe it will, then the price of gold will again spike upward through three or four Fibonacci extensions to the upside, but then re-trace 50% to 70% of that upward move.   If so, then the next upward spike could peak in the range between $7,000 and $11,000 per ounce.

Investors tend to make rash decisions based on fear and greed. These emotions are typically amplified during times of financial stress. It is during such times that gold solicits fear and greed motivated buyers.  During a crisis, fear investors will rotate into gold to hold value, and greed investors see the upward momentum and jump on the train. The upward momentum of the next gold rally might feel like the Bitcoin surge in 2017.

“Striking Out” in the 1980s

In baseball, its “three strikes and you’re out.”  After the 1970’s surge and blow-off top in 1980, gold failed three key technical tests.  After these failures, the gold market floundered for another decade.  Let’s take a closer look at those three technical failures.

First, in early 1983, gold failed to retake and hold the psychologically important $500/oz price level.  This rejection resulted in sideways to lower movement for another year before gold failed again, breaking below its upward trend line near $360/oz.  After falling to a low in early 1985, gold moved higher over the next three years, only to fail a third key resistance test near $500/oz in late 1987.  After “striking out” in the 1980s, gold fell throughout the next decade back to $250/oz.

Current Technical Structure Is Bullish

Unlike the gold bear market of the 1980s, gold has been passing periodic tests of support and resistance since its sharp decline in 2013.  Gold’s price retracement from a high above $1,900 to a low near $1,040 kept the price above a 61.8% Fibonacci retracement level as well as the psychologically important $1,000 per ounce level. 

The monthly wave structure of gold is bullish, and the price is now trading above key resistance levels, with solid support at $1,379 and $1,250. Even if the price of gold falls back to support at $1,250 per ounce, the long term technical picture remains bullish.  I view the recent breakout over $1,380 to be significant and has likely opened the door towards the $1,580 resistance area.

To the downside, technical breakdowns below $1,250 could lead the way to $1,211 and $1,043.  If history does indeed rhyme, a breakdown below $1,043 could lead to another decade of futility.  This downside scenario does not appear likely, especially not with the uber-accommodative interest rate policies worldwide.  High U.S. dollar interest rates broke the back of the gold rally in the 1980s, and there does not appear to be any such risk of this happening again anytime soon. 

Short-term Indicator

In addition to my longer-term view on gold, I also track shorter-term price signals to locate areas of accumulation and/or hedging.  An indicator I developed shows a mean-reversion relationship between price and the point of Neutral Delta in the options market.  Essentially, the point of Neutral Delta shows where the options market participants have placed their bets and hedges.  At the moment, Neutral Delta is near $1,345 per ounce for the options which expire on July 25th

When the price is over-bought in relation to Neutral Delta (as it is now), we tend to see headwinds for further price increases.  Interpreting the current data, I am led to believe that the price of gold will re-test the $1,380 price level before July 25th, and this will give the options hedgers an opportunity to optimize their hedge book ahead of the next few option expirations.  A lower probability event would be a price spike again towards $1,450 which would like force a short-covering rally by the call option sellers who may already be out-of-the-money.

If we are in the opening innings of a new rally in gold, a retest of $1,380 or even $1,250 will represent great opportunities to buy or add to your gold positions.

You can learn more about my research by clicking this link: Introduction to Options Sentiment.

Final Thoughts

Gold can be best viewed as financial insurance.  If you believe that you should own insurance, then you should also own gold.  In terms of investment performance, gold will do best during times of international financial stress.  In the past, the price of gold has moved exponentially higher during these periods as demand for the ultimate safe haven goes viral. 

The world is slowly but steadily transitioning from a U.S. dollar-backed financial system to a multi-currency, multi-polar system.  One day, the leaders of our world will let the rest of us know the plan for a modified financial system, and we will have to admit that we were warned many times in advance.  I expect that the gold price spike will happen before, during, and after a new Bretton Woods-type conference.  While there are many signs that a new financial order is imminent, the transition to this new financial order could take more time than many have been led to believe.

From a short-term perspective, I use gold puts to protect my current precious metal allocations.  This is like purchasing insurance on the value of my current insurance policy. It also helps preserve my wealth allowing me to buy more gold if prices do in fact, drop to $1,380 or $1,250.

Disclaimer and Notes

This article was written for informational purposes and is not a recommendation to buy or sell any securities. All my articles are subject to the disclaimer found here.

Can Tesla Hold The Line?

Tesla bulls and Elon Musk fans everywhere are hoping that the decline in Tesla stock price will end soon.  After the stock breached the technically important $250 price level, the next key support level is in the $180 range, close to where the stock is trading now. 

Tesla has emotionally attached both bullish and bearish investors. Spend ten minutes on financial Twitter and the emotions from those thinking Tesla is going to zero to those thinking the right price in the 1,000’s is easily evident. Bulls certainly want Tesla to hold the $180 line, but as Toto sang in the 1970s, “Love isn’t always on time.” 

On a weekly chart, we can see that the $180 price level has served as important support and resistance since 2013.  More evidence supporting the Tesla is oversold, is that weekly RSI is as over-sold as the most recent dip below $180 in early 2016.

A linear regression of the recent TSLA downtrend on a daily chart shows price currently extended at the bottom of the range.  This linear regression has a high confidence factor over 92%.

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, liquidity is abundant in TSLA options.  I imagine that there are many retail and institutional investors who short TSLA by buying puts.

The market makers who facilitate this 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 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 individual portfolio is delta neutral.  As a result, it can be enlightening to track neutral delta levels for Tesla as we do for many different stocks, ETFs and commodities.

TSLA Op-ex Sweet Spot

I consider the price range between Neutral Delta and Neutral Gamma to be the “sweet spot” for stock prices on or before option expiration.  On May 29th, TSLA had a sweet spot in the $207 to $225 range for the June 21st op-ex.  As such, our indicator currently considers TSLA to be over-sold near $180/share. 

Source: Viking Analytics

Additional Comments

  1. Put-call ratios in the 1.2 to 2.4 range suggest that there is potential support for TSLA in the event of a sharp decline in price.  TSLA’s put-call ratios have fallen somewhat over the past week, however. 
  2. At the closing price of $188 on May 30th, the total value of at-the-money puts in TSLA stock was $1.25 Billion greater than the total value of at-the-money calls for the next three option expirations.
  3. The basic theory behind the Neutral Delta and Neutral Gamma levels can be found by reading a quick introduction on this link: Introduction to Options Sentiment.

Price and Neutral Delta Converge

Due to order flow, contract rollover and hedge dynamics, there tends to be a convergence between stock prices and the point of delta neutral as option expiration comes nearer.  Here is TSLA stock price versus Neutral Delta and Neutral Gamma for the month of May 2019 into the June option expiration.

Gamma is a Wild Card

Extreme divergences between Neutral Gamma and price can also point towards forced-buying or forced-selling events.  I have outlined this dynamic in several articles, including: Negative Gamma and the Demise of Optionsellers.com.   Neutral Gamma is currently trending with price, which is common.  However, our data shows that Neutral Gamma may begin to spike as option expiration comes nearer.  This highlights the potential for forced selling by the put sellers as option expiration comes nearer.   

Final Thoughts

Tesla is over-sold on several metrics.  The weekly RSI is at a multi-year low, and price is currently at the bottom of an orderly downtrend channel.  The options market has priced in a modest recovery into June option expiration; however, there is potential for a forced selling event if too many puts remain in the money.  I will consider a long trade in TSLA in early to mid-June if it successfully tests the $180 price level and the forced selling potential dissipates.

Disclaimer

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.