After Rebounding Sharply From Tuesday’s Rout, Stocks Face A Big Gamma Test

As expected, yesterday’s bearish month-end rebalancing which saw over $8 billion in MOC for sale orders has given way to the traditional strong December equity inflows, sending futures sharply higher.

Forced selling dump into the close today.

Forced Dec 1 buying frontrunning after the close

— zerohedge (@zerohedge) November 30, 2021

So now that reflexive fund flows have reversed and the narrative is quickly changing to one where both the bearish Omicron and Powell developments have been mitigated, at least according to today’s price action, the question is what comes next.

One answer comes from our friends at SpotGamma who look at the latest option exposure and continue to see major support down near 4550 noting that one of their largest combo strikes filled in at 4565 overnight. “This implies the “base” in options positions is building” and should the market revisit that area “price action would stall – and that would lead to a drop in implied volatility. In turn this incentives traders to close put options, which leads to dealers buying back futures.“

More importantly, and in keeping with what we said last week (“Is This A Real Crash? Keep An Eye On The VIX For The Answer“), SG points out that “implied volatility is down sharply this morning (black line today, blue y’day), as indicated in the graph below.” This shows that the VIX complex (aka implied volatility) is decompressing, which is a tailwind for equities.

So looking forward, the first hurdle for the S&P to clear is that of the Volatility Trigger/gamma flip line of 4640 – which is where futures are trading right now – and which markets could gain a bit of positive gamma support according to SpotGamma.

Alternatively, if we dip back below that line elevated market volatility is likely to remain.

But more critically for bulls is for the market to enter the “orbit” of the large 4700 gamma strike, which would initiate more positive gamma pull. That said, it will likely take some type of macro catalyst such as a reduction in fear around Covid, clarity on policy from Powell or a clear resolution on the debt ceiling that leads to a real release in this elevated implied volatility. Naturally, any continued drop in implied volatility should be seen as fuel for higher prices – this, as SG reminds us, is the vanna component that is critical to rallies.

Finally, the most efficient way to view the composite picture is through the gamma profile below. Here SpotGamma notes that one can see the positive strike distribution that starts at ~4670 and builds up into 4717. From 4650 below there gamma remains quite neutral which is why markets are “fluid” – read volatile – in that price area.