Tail Wagging The Dog; CRASH UP on hold until after March; & Gold as a Tell

CLUB/EDGE Client Post

Tail Wagging The Dog

I use this expression often when referring to the options market driving the market moves. This is not about dispersion trading per se. This is not about 0DTE gamma squeezes that make a directional move in a stock more volatile (or force the dealers to sell out of their stocks after a manic call buying results in large theta decay - see my SMCI write up about this.)

This is about Dealers on the other side of your options trade, hedging, by taking the opposite side in futures or underlying stock. It is also about the level of gamma imbalance.

When dealer gamma imbalance is heavily long, it acts to dampen volatility. This is because dealer/hedgers will buy into highs in order to keep their books delta-neutral. Long gamma begets low volatility and low volatility begets long gamma. When dealer gamma profile switches negative, they must sell futures or stocks deeper into lows. This can trigger vol-targeting and CTA (price-insensitive fund) deleveraging.

Clients often hear me say, in a market that has ample liquidity and a bullish backdrop: "We need a MACRO trigger to disrupt the flows."

That’s because, macro event risk triggers market participants to buy puts (either as directional plays or as hedges), which can trigger a reversal in the dealer flows, forcing them to sell the underlying, which triggers volatility.

The CRASH UP Scenario

That's the current backdrop I’ve been spying this year, even entitling my Feb 12th market thoughts for clients: Crashing UP Market? In it I detail my bullish Macro AND Micro reasons for this equity market to advance.

My  #1 Micro Reason To Remain Bullish:

Again, as long as VIX declines or goes sideways, dealers are short stocks, so as they have to buy these back, there is the potential for a bigger squeeze higher in  markets.
Added fuel would be if key levels above (likely $5100-5200) trigger and forced shorts (betting against the market) to cover.
That is the recipe for a continued grind higher or even melt-up.

From a market structure standpoint, it is a backdrop for a perfect storm:

I'm talking about:

• how manic call BUYERS chasing upside moves (forcing delta-hedging dealers who are short those calls in essence to buy shares of the underlying as market moves higher)...

• intersects with call SELLERS ('overwriters' who have sold calls above as hedges that they then must cover/buy back as we melt up into those strikes)...

• that also intersects with put SELLERS (the bullish option tactic that also forces dealers who are on the other side of that trade to buy shares to hedge their position.

I have warned of it often in my trading room, that a CRASH UP can happen once SPX gets above $5100 and stays there, also QQQ gets/stays above $444.

We got there today, as I have been predicting pre FOMC/QRA on Jan 26th:

Best swag:
After a burst of volatility - likely from confused market as Yellen issues slightly more longer- duration bonds over Tbills & Fed intonates more "normative cuts" in the future...

• SPX to $5340

• QQQ to $444 (472 overshoot)

• IWM (higher)

You will notice that I still spy higher levels: SPX $5340 & QQQ $472, but wen volatility?

CRASH UP On Hold Until After March

For those in my trading room or following along with my my portfolios, you will know that I have been very bullish since Mid-November, calling this rally "1999-esque.
Then I doubled down in Mid-January and said this market could be very 1995 OR 1999-esque.

I added a bunch of long swings then and made a call that oversold 'value and growth' would move higher under the surface, even if indices corrected sideways in time not price.

That happened.

I also made a strong pitch for "My 4 Horsemen of sector rotation" - IPO, IWM, XRT, XBI - which I updated daily in the trading room, as well as positioned for in my portfolios for clients, and discussed in both MarketWatch and Bloomberg interviews last month.

So far so good. I mean great actually: VKTX, CRSP, SE, CELH, DIS, CAT, GE, IBKR….

EXCEPT, NOW, I see more likelihood into March 15th OpEx for some shake-n-bake, and then I will revisit for the CRASH UP continuation call.

Quant Positioning & Analysis

Nomura's Charlie McElligot has a theory on why markets have pushed higher so sharply - up +12.5% and SPX +9.5% since Jan 4th low. Options of course.

On Feb 25th he saw, "an extreme client tilt" towards upside exposure where:

Dealers are consistently “Short Upside Gamma” and grabbing Delta to hedge into a never-ending  melt-up in Index.
Traders are selling puts not just for income, but “to fund cheap convexity into calls,” which is forcing dealers to continue to add exposure resulting in the "spot index hitting levels which were inconceivable just a month and a half ago.”

More on his assessment of the huge skew to calls over puts:

“The fact of the matter is that in a US equities market where stocks only go up and simply refuse to pull back due to 1) the AI mania / NVDA ‘halo effect,’ along with 2) the perception of US economic Goldilocks allowing for a soft landing while still too getting ‘insurance cuts’ from the Fed into year-end, has made this a market for vol sellers to collect extra yield,” and the return of the "Fed put" means investors see little need for big downside protection.

Until today...

Put volume picked up A LOT today and Gold spiked.

Gold Spike Today Tells Nasdaq To Slow The F*** Down

Panic FOMO picked up post NVDA earnings Feb 21st. I was reading aloud live in my trading room how much flow I was seeing in large, later-dated option positioning.

Since, I found this data point:

From a flow perspective, the GS trading desk saw a late day surge in overall demand on Thursday, driven by the Long-Only community, resulting in the largest single day overall buy skew on the year (92nd percentile 12-month). LOs bought a net $3bn on Thurs (50% was in Tech). (GS Prime)

Funds were already in the house:

strong inflows into equity funds ($15bn) for a fifth week, totaling $75bn, the strongest in 2 years. (Deutsche Bank)

But both should slow now, as buyback pace slows.

GS blackout window starts on March 14th and lasts to April 26th.

We are exiting Q1 earnings season, which usually supports a lower velocity grind higher and vol compression/normalization.

It has been pretty muted in CTA land - because they are fully gorged. However, over the next 1 month they will have to sell $166bn of equities in a down-tape.

So against the backdrop of CRASHING UP from dealer hedging, we also have a market that if it goes down a little, it could go down a lot.

Syncing with USDJPY for the Gold Trade

Rule of thumb, intraday:
As USDJPY rises, typically, DXY + 10Y rise with it.
As USDJPY falls, typically, Yen, TLT + Gold pop.

But that's just the trade, NOT the trend.

The trend is based on macro factors, like my call last November that the "USD Has Likely Peaked".

I said the equity markets would be well supported because of it.

I also said then the 10Y yield would fall from 5% to 4% then be range-bound - between 3.8% and 4.7% for a few quarters - before moving above 5% and into potentially 6.5% end of year.

A lot of that market-timing call is based on the 10Y rate of change. ROC is not excited right now which means MUCH chopping in a channel versus a directional move out of its channel: 3.8% to 4.4% gives it a lot of room to head-fake yen, bond and gold traders.

UNLESS the USDJPY gets/stays above 152, or some other macro risk enters, to trigger a potential carry trade unwind, which could be very disruptive to the short Treasury/long Nasdaq bets that would also need to unwind.

More likely, US yields + DXY will be range-bound in an election year versus spike higher triggering a duration shock for equities.

I firmly believe, without an exogenous event, these assets - USD and 10Y yield - are in the "not allowed to go up TOO FAST category" with oil.

And gold.

Gold moving too high would be very problematic for central banks.
That's one reason that moves in gold are not binary in my book.

Gold is a chameleon by default and design - sometimes used as currency (eg. China buying gold in exchange for USD), sometimes commodity (supply/demand use in jewelry and industrial applications), sometimes inflation hedge (tied to real yields inversely) and, sometimes crash protection (as rotation from risk-off macro event).

Some might say this spike higher today foretells a well-disguised macro risk.

JUST IN: US Debt Rises $1 Trillion in 100 Days

Maybe, but I have also seen this gold spike before - just as market is about to CRASH UP, Gold catches everyone's attention.

I consider Gold akin to the grandparent who only steps in to over-rule the parent when their grandchild is about to put themselves in harm's way.
Kid and parent may ignore, but the warning is there.

I think today's spike in gold is a warning that gold smells the melt-up coming and is telling Nasdaq to slow the f*** down.