Week of Feb 20
Recap of last weeks action:
My directional bias proved correct again last week, as we rallied from around 4080 on ES (when this substack was sent) into the CPI, hitting 4180 again before any significant down move.
I sent multiple warnings on Twitter as well as my substack to not be short into CPI. There were no if/then scenarios, just crystal clear warning to my followers to not short into such a well hedged event. Despite a hotter than expected 6.4% vs 6.2% expected, the market still managed to rally into 4180 before the down move towards the end of the week. Now last week being OPEX, we had the VIX expiration (usually Wednesday before MOPEX, but not every month) as well as the monthly options expiration (MOPEX). Gamma is very complicated, and its scope is too detailed for me to explain in this blog, but think of it as magnets that the market is naturally attracted to, and when reaching these magnets the gamma strike (such as 4050 or 4100) it then becomes support or resistance. With all the expiration VIX and equity/index options this week rolling off, the market may move more “freely”. Market makers such as Citadel or Susquehanna are the main suspects on the other side of your options trade. For example if you were too long the March 17 $420 SPY call, you would be long the call the Citadel/Susquehanna would be short the call. They would then hedge the call by longing 100 shares of SPY for instance. Now that the options have expired, they can flatten all/most of the related hedges. So long story short, we may have a more significant market move this week that reflects the current environment more accurately. Will be going into a lot of detail below as this is a very important week for bears/bulls alike and will be outlining actionable specific trades.
Next move for markets?
Down. Now the biggest question on everyones mind right now is, is this a bear market rally or a start of a new bull? To be frank I don’t know myself, but I like to break it down like this.
A) If this is a Bear market rally (BMR), then we are going down.
B) If this is the beginning of a new Bull market, then we are going down.
Now why does B make sense? There are a lot of hedge funds, pension funds, money managers who missed this move. They are looking to hop on the train, to increase their net exposure as there is nothing worse for professional money managers to be underperforming the broader market SPY 0.00%↑. But they dont just FOMO in one morning while sitting on the toilet like your average retail trader. They are looking to buy at key technical points, and the mother of them all is the 200DMA.
Image A: SPY key technical points.
Now if you have been trading the markets actively the past year you know we failed 3 times at the 200DMA before finally closing over it in multiple sessions this past month. I think for many who missed this huge rally, and are believers in a new bull market they are looking to buy around this point, which sits at about $391. For me personally, I think there is a good chance at least the 50DMA gets tested, and with enough momentum the 200DMA as well. And part of that is the OPEX gamma rolloff as mentioned previously. We also have been balancing within 4100-4200 range for weeks, finally closing below on Thursday on the back of Bullards 50BPS hawkish comments. Bears then followed up with a gap down on Friday, closing again below 4100, as well as the 20DMA, as well as defending the gap down. In strong trending markets, gaps don’t get filled. So this short term market generated information gives me a bearish price from a technical point of view. The next point in my thesis is seasonality.
Image B: S&P seasonality.
Not to be ignored. The back half of February into March is historically weak. We tested the huge 4200 resistance multiple times and could not break it. What does the market then do? It needs to go lower to find more buyers before attempting that resistance again. It failed again at 4100. So again it needs to go lower before finding more buyers. Now the next piece of the puzzle here is the bond market. I am using HYG 0.00%↑ as a proxy here. We can use this as another barometer for risk, as investors pour money into high yielding bonds with excess liquidity.
Image C: HYG overlaid with SPX.
Now ideally I would like to see HYG “share” the SPX’s enthusiasm for the rally but it has been lagging the past month and may be a leading indicator here. That is another reason to be cautious here. Lastly, FFR (fed fund futures, basically the cost of money) have now made a new high on the latest Fed comments regarding the CPI and PPI, which moves inverse with the $SPX but usually with a lag.
Image D: FFR headed towards 5.3%.
Last but not least we have a look at systematic funds such as CTA’s. CTAs in short are trend followers. They follow price and price only. They are very close to max long. Meaning they will not be buying much IF we march higher, but if we were to sell say 100 pts from here, they have a lot to sell in a very illiquid tape. Simply put, the left tail, downside convexity here is massive. When it comes to R/R this information doesn’t affect the first R, as we will risk what we risk, but the potential reward here if the market gets some traction to the downside is huge. And other traders see this too, there are sharks out there and they smell blood. Flashback to the GameStop frenzy in January 2021, funds smelled blood in the water when it became apparent how vulnerable and exposed Melvin was, and they pounced. It’s a similar situation here where more “intelligent” or discriminate market participants can leverage knowledge about trend following funds like CTAs and leave them holding the bag so to speak. There is a lot of tinder to spark here if the market gets going to the downside. See below from GS.
Image E: CTAs have little capacity to buy left, but lots to sell in a down market.
Trade ideas:
I am bearish biased here, so will be looking for shorts. My bearish bias is nullified with two consecutive closes above 4100.
SPX March 17 3950 Puts. Last price on the mid $37.85
- My target for take profit is 4000, 3950, and then 3900. I would reduce size if we reclaim 4100 early on Tuesday, and close the trade completely on the aforementioned two closes above 4100
Short NVDA 0.00%↑ (Now $214) and Short TSLA 0.00%↑ (Now $208) . You can outright short shares here as they are high beta and will move much more % wise than $SPY. Or you can long some Put options for more leverage. Manage your risk appropriately.
That’s all for this week. If you are a paid subscriber feel free to DM me on Twitter anytime if you have any questions at all.