Where's the Volatility?

This is a continuation of research compilation which started back in August.

The latest article is here:

In doing this series during the week, I hope to make it clear to you all that the bulls are in full control through the year. With that being said, the market is fragile (not weak) and any exogenous shock can bring about a brief period of consolidation/weakness for a few weeks before continuing higher. It’s my belief that any weakness is going to be pounced on for “another doomsday spin.”

At the end of the day, nothing in this article should shock you if you’ve been around for a while…

Let’s Begin

RV & ATM Straddle Pricing

I regularly touch on the rolling RV periods but we’ve seen a slight uptick (noise)

I’ve included the values below so you can see a tabular view along with the graphical view of how low RV is vs this year.

Another metric which I regularly talk about on the day but haven’t quite contextualized is the ATM straddle as a % of premium - Charlie McElligott has an interesting graphic on the relative lows of this metric.

Bottom line looking at both of these metrics is the volatility is nonexistent in the market.

I’ve touched on the fact (starting in May) that when RV < IV, options sellers dominate the market - An interesting note from Nomura shows that fact

RV < IV; Vol Selling Strategies pick up

Vol Harvesting has reigned supreme as we’ve seen weeks (and months) of low RV relative to volatility expectations and options sellers have achieved better returns - Something that should not be blindly followed by retail investors without a clear understanding of the risk.

We’ve discussed the positive gamma environment (support), systematic strategies are at record allocations (support) and talked corporate buybacks (still on pause) as another supportive metric This year has seen record YTD share buybacks and Q4 is normally one of the strongest quarters for share repurchases.

Corporate Buybacks - The passive bid currently on the sidelines

Consider what the above points mean - in times of record low volatility, leverage is amplified by all investors. I’ve discussed the gross v net leverage metric.

Equity Positioning

Per DB, equity positioning is nowhere near stretched levels.

The above statements should make you say, wait - you mentioned leverage is at extreme levels but equity positioning isn’t at stretched levels - how is that possible?

Simple - Participants are using high gross leverage but are generally not overly leveraged long - They’re long + Short…

Circling back to the corporate buybacks, we know tech companies are the ones that buy back so much of their stock… Positioning in them is actually near local highs (going back a few years) but can definitely stretch higher.

Leveraged ETFs - The Unspoken amplifier of the Upside Acceleration

Leveraged ETFs have seen record growth the past year between single name ETF growth (If you follow headlines, there are now more ETFs than single name stocks - many of these ETFs are leveraged single name stock ETFs).

Nomura published this interesting metrics showing how concentrated the Leveraged ETF space is in “leadership”

SPX and the tech component comprise 82% of the AUM of the 155B in Leveraged ETFs…. Bottom Line - The market is extremely focused in AI and the benefits its set to bring to the economy - If you’re doubtful, then wait for that to materialize before you preemptively try to bet against it.

Right-Tail Hedging - “Stop the Bus!!!”

Nomura posted this interesting graphic using SMH 0.00%↑ as a proxy to “AI Euphoria”. The main takeaway is this…. Call skew is at record highs while put skew is in the dirt - there’s an intense focus on buying right-tail “hedges” to not be left behind in the AI sector.

Volatility Positioning: Amplification of any downside risk

I briefly touched on this weeks back, but an interesting point on the spot up/ vol up market we’re seeing (Yes I know VIX was red yesterday) is the focus on VIX as a hedge vs Puts

We’re nearing local highs in the VIX space that any shock to the system will be amplified from the amount of leverage in the system and the high concentration of OTM VIX calls (a very simple explanation is VIX upside is hedged with ES shorts)

Summary

None of this information above is meant to invoke fear or cause one to Panic - it’s just to say, the current market is being driven by AI euphoria and any risk to the matter can see a sharp pull back. The environment is fragile but there are not yet cracks forming - Consider your grandmother’s China… It can shatter if hit with a baseball that wasn’t supposed to be in the house (oops - sorry grandma) but it needs an outside force to break it.