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“It’s Hurricane Season” In The Markets: Reflexivity & The Weatherman

"It’s Hurricane Season" In The Markets: Reflexivity & The Weatherman


There is a phenomenon called “Warning/Alarm…

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This article was originally published by Zero Hedge
"It's Hurricane Season" In The Markets: Reflexivity & The Weatherman


There is a phenomenon called “Warning/Alarm Fatigue” where people can become desensitized to warnings and risk. This is commonly associated with weather forecasts in which people may ignore alerts if they are too frequent, or have been recently incorrect. We’ve all experienced times when meteorologists predict major storms, only to find a bit of rain. However, there are often tragic consequences to not heeding these warnings.

A meteorologist’s role is to analyze complex models, and then to share a forecast. If there is the right mix of storms and warm ocean water over the Atlantic, a hurricane may form.  Sometimes, predictions of catastrophe fall flat and we experience gratitude for the good fortune coupled with some frustration over spent time preparing for a storm that never came.  Other times, events like Hurricane Katrine or Ida can strike, and ignoring the warnings can be devastating.

In this way, market forecasting is similar to predicting the weather. Both professions have models which portray the likely outcome given current conditions. Warm water and a thunderstorm doesn’t mean a hurricane forms, but cold water and no wind puts the odds at zero. As more variables line up, the greater the odds of a hurricane.

Our approach at SpotGamma is akin to making weather predictions.  We look critically at the Situational Evidence and Historical Statistics, and our approach involves analyzing millions of data points every day and then putting these insights into clear charts and commentary for our subscribers to highlight both opportunities and risks.  While we won’t always be right about what we think might happen, we will always give you a clear view of what could happen based on our analysis and this has proved extremely valuable for our community (see our warnings ahead of the Covid-Crash).

Very importantly, right now, we see the potential for a major pullback and feel compelled to share our insights with you.

The Current Volatility Landscape

Below we’ve plotted the implied volatility (IV) level of 25 delta SPY options. The days left until these options expire are color coded, with near term options colored purple scaling to longer dated options (30 days out) shown in yellow.

Historically implied volatility for the S&P500 is in contango with near term options holding a lower implied volatility than longer dated options. You can see this in the chart below – the yellow dots are typically higher than the purple dots.

However, during stock market crashes the implied volatility of near term options rises over that of longer dated options (backwardation). This is most clear in March of ’20, in which there is a huge divergence between ultra-high short term IV and very high longer dated IV.

S&P500 25 delta option implied volatility

A few other interesting things are apparent from the chart above. First, while longer dated implied volatility has been trending steadily lower, is still higher than it was before the March ’20 Covid-Crash. Interestingly though, very short dated IV is now trading back to pre-crash levels. You can see this by comparing the red boxes above. Furthermore, you could read this as: “traders have some trepidation 1 month out, but they have no worries about tomorrow.”

When we step back, this decline in implied volatility makes sense. 1 month realized volatility (that is how much the market has moved) at ~7% is roughly at its lower bound going back to 2012. In other words – over the past month the market’s been quiet.

After a large volatility spike, subsequent volatility spikes seem to have less amplitude. To place this into context, consider when you bounce a rubber ball: the first bounce is large and each following bounce has less energy. Similarly, options traders seek to take advantage of spikes in volatility by selling equity/index put options and/or VIX futures, which holds in additional volatility.

Over time as volatility pushes towards a lower bound, traders more aggressively sell volatility, causing a reflexive effect by dampening the size of volatility spikes (as seen below). Eventually, this forces volatility into a wedge in which traders are selling volatility at rates which imply negligible market returns.

S&P500 Realized Volatility from

The big takeaway is that selling these options works until it doesn’t…and just like picking up nickels in front of a steamroller, at some point, you run the risk of getting crushed if a single trade goes against you. This dynamic can setup a catastrophic response if the trade reverses.

Lets take an example. On 9/7 the Friday SPX at-the-money put was trading at an IV of 10.3%, with a value of ~$19. This indicates that traders are forecasting a daily move of just 0.65%. This indicates that traders are anticipating very quiet trading days.

What is exceptional is if instead of having this muted response, the markets instead pullback sharply, resulting in more than a 1% drawdown.  In this situation, you see a small shift higher in implied volatility can double losses, as the put value explodes to ~$50.

How does this happen? As we have explained in our videos when traders by and large sell put options, that leaves dealers with large long put positions. As a result, these dealers must hedge their options exposure by buying stock. . This becomes a reflexive feedback loop – where dealers push up the market via hedging, as traders take bets shorting options against below-average market returns. The result is a very perilous setup where a reversal can be sudden and the unwinding violent.

When an event then takes place that causes markets to selloff, these traders must scramble to cover.  This is because when you are short puts you must buy them back, and this reflexively then forces dealers to sell their hedges and at times short stock forcing the market lower, and volatility higher. This squeezes the incremental volatility seller and can rapidly expand volatility leading to a very sharp and sudden decline.

The Takeaway

SpotGamma believes that the conditions are in place for a very violent sell-off  – something akin to September of ’20 when the market declined ~10% over 3 weeks. This could place the S&P somewhere near 4000, which we see as support because of substantial options positions at that strike. This is not a call based on fundamentals, but instead on the positioning in the options market. We think that traders have become acclimated to selling very short term options for increasingly smaller returns and there are some catalysts ahead which may blow these traders out.

Specifically we note:

  • VIX Options Expiration on 9/15/21

  • Index/Equity Options Expiration on 9/17/21

  • FOMC Meeting on 9/22/21

  • Quarterly Index Options Expiration on 9/30/21

The timing of these events are the key piece. The expiration events (as to why they matter go here) may lead to a tick higher in volatility, at which point some reflexive volatility selling may enter. However, because the FOMC meeting occurs right after expiration, not only may be there be less short volatility supply – there may be a sustained volatility bid. It is the combination and timing of these events which provides the conditions for a large spike in volatility & market drawdown.

As a member of our community, we respect your decision to protect your portfolio or let your gains ride.  We just feel it’s our duty to let you know…Its hurricane season.


We wanted to address one aspect of volatility landscape as a more advanced topic. Specifically we want to make note of the fact that longer dated volatility is quite elevated. This is depicted in the chart below which shows the VIX volatility term structure. You can see that spot VIX (green line) is well below that of longer dated futures.

You can see a similar phenomenon in our top chart of the S&P IV by comparing how compressed the data points are in the left red box, vs right box.

This spread between short & long dated IV indicates that traders are holding longer dated hedges which we think protects the market from a catastrophic decline. Our view of a sharp drawdown is based on short dated volatility expanding which would place the IV term structure into backwardation. The bid to longer dated volatility may mute the decline which is why we look for a “September ’20” style move versus a more catastrophic move.

When the entire IV term structure is compressed that sets the stage for a volmegeddonor “march ’20” style blowout.

Tyler Durden Thu, 09/09/2021 - 14:25


Commodities and Cryptos: Oil slumps, Gold rebounds, Bitcoin plunges

Oil Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes…

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Crude prices are sharply lower after Evergrande debt default fears triggered a flight-to-safety that sent the dollar higher.  Evergrande’s woes are threatening the outlook for the world’s second largest economy and making some investors question China’s growth outlook and whether it is safe to invest there.  In addition to risk aversion flows pumping up the dollar, some investors are anticipating further hawkish signals that the Fed will set up a formal November taper announcement on Wednesday. 

Complicating the move in crude prices is the surge to record highs for UK gas futures.  Europe does not have enough gas and the energy problem could intensify if the early weeks of winter are cold. 

The US Gulf of Mexico production continues to recover from hurricane season, with now only 18.3% of offshore production being shut-in.  The oil market will still be heavily in deficit early in winter and if more demand comes that way, energy traders will buy any dip they get with crude prices. 


Gold’s rout is taking a break as investors run to safety over concerns Evergrande’s debt default concerns could spillover.  Gold got a boost as Treasury yields plunged, with the 10-year yield falling 5.4 basis points to 1.307%. 

Gold’s rally could have been much higher if not for the reports that Senator Manchin may be thinking of suggesting Congress take a “strategic pause” until 2022 before voting on the $3.5 trillion social-spending package.  Considering stocks are about to have their worst day since October, it is very disappointing that gold prices are only up around $10.  Gold may continue to stabilize leading up to the FOMC decision, with the next move likely being further downside.  Gold could struggle until the Fed finally starts tapering asset purchase.  It is then that it may start acting more like an inflation hedge.    


A retest of the September low came far too easily for Bitcoin.  The fallout from the Evergrande is putting a tremendous dent in risk appetite that is sending everything lower. Cryptocurrencies, despite all the volatility, have been the best performing asset of the year, so it should not surprise Wall Street they are the first asset sold in the beginning of China-driven market selloff.    

Retail traders remain bullish, albeit many have capitulated in locking in some profit.  Some traders are anticipating a short pullback, while some lunatics are readying to buy more after tomorrow’s full moon.    

In El Salvador, President Bukele tweeted “We just bought the dip. 150 new coins!”  El Salvador’s total is now 700 coins and that enthusiasm has yet to be matched by other countries.   

If Bitcoin breaks below the $40,000 level, it could see momentum selling have it eventually return to the $30,000 to $40,000 range that it was in earlier this summer.  

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Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Asia’s Largest Insurer Hammered As Investors Sell First, Don’t Bother To Ask Questions

Few were surprised to see that the crash in Evergrande…

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Asia's Largest Insurer Hammered As Investors Sell First, Don't Bother To Ask Questions

Few were surprised to see that the crash in Evergrande dragged down property names (one among then, Sinic Holdings, crashed 87% in minutes and was halted), banks exposed to the property developer (according to report there are over 120), with the contagion spreading to commodities directly linked to China's property sector (such as Iron Ore which plunged 10%), as well as FX of commodity-heavy countries, one ominous decline was that of Asia Pacific's largest insurer, Ping An (whose name literally and unironically means "safe and well"), which dropped 3%, following a 5% drop on Friday, and hitting a four year low on concerns about its property exposure.

The selling took place even though the company issued a statement Friday saying that its insurance funds have “zero exposure” to Evergrande and other real estate companies “that the market has been paying attention to.” Real estate accounts for about 4.9% of Ping An Insurance’s investments, versus an average 3.2% for peers, according to Bloomberg Intelligence.

“For real estate enterprises that the market has been paying attention to, PA insurance funds have zero exposure, neither equity or debt, including China Evergrande,” Ping An said in a statement as it rushed to reassure investors.

While it may have no exposure, Ping An does have RMB63.1bn or $9.8bn in exposure to Chinese real estate stocks across its RMB3.8TN ($590BN) of insurance funds, and took a $3.2BN hit in the first half of the year after the default of another developer, China Fortune Land Development. The insurer is also head of the creditor committee for China Fortune Land, which specialises in industrial parks in Hebei province and suffered from delayed local government payments. One of its restructuring advisers, Admiralty Harbour Capital, was hired by Evergrande this week.

At a time when any Evergrande counterparties or even rumored counterparties are immediately deemed radioactive, Ping An's plight demonstrates how acute and widespread the selloff could become in China if Beijing fails to intervene.

“I expect a lot of financial institutions could be hit by the worries” about Evergrande, said Zhou Chuanyi, a Singapore-based analyst at Lucror Analytics. "As long as a financial institution has exposure to developers, Evergrande should take quite a significant share of that."

Yet as the market waits for some response official response, hopeful that Beijing will step in, we discussed earlier that China's policymakers have instead sought to crack down on excessive leverage across its vast real estate sector over the past years, which makes up more than a quarter of the economy, imposing a firm threshold known as the "3 Red lines" which developers must adhere to, and which has meant most developers are limit to % or 5% debt growth at best. 

For now it remains unclear how far the contagion will spread, although if Beijing stubbornly refuses to intervene, expect much more pain as capital markets seek to force Beijing's hand by make it unpalatable for the CCP to suffer even more selling which could spark social unrest.

“The price action across several asset classes in Asia today is horrendous due to rising fears over Evergrande and a few other issues, but it could be an overreaction due to all of the market closures,” said Brian Quartarolo, portfolio manager at Pilgrim Partners Asia.

As discussed earlier, Xi faces a tricky balancing act as he tries to reduce property-sector leverage and make housing more affordable without doing too much short-term damage to the financial system and economy. Mounting concerns that he’ll miscalculate are spreading ever-further beyond China-focused property developers and their suppliers.

“It’s what the Chinese would describe as trying to get off a tiger,” said United First Partners research Justin Tang, best summarizing Beijing's lose-lose dilemma.

Tyler Durden Mon, 09/20/2021 - 15:28
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Summarizing China’s Short Term Economic Outlook

Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map: Source: McKenna/Guo,…

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Wells Fargo Economics analyses the extent of the current slowdown, and contemplates the impact on regional economies. Here’s the heat map:

Source: McKenna/Guo, “China Economic Gauge and Sensitivity”, Wells Fargo Economics, 20 Sep 2021, Figure 1.

From the report:

Our dashboard (Figure 1) suggests the short-term outlook for China’s economy is indeed deteriorating, consistent with the multiple downward revisions we have made to our GDP forecast over the past few months. Given the signals our gauge is showing, we believe easier monetary policy could be the next major policy move from the PBoC, and another RRR reduction could be imminent as authorities look to offset some of the deceleration.

This report is in line with the Goldman Sachs report (discussed here).

Wells Fargo highlights Singapore, South Korea and Chile as most sensitive to growth developments in China (on the basis of exports). Looking more broadly at “beta’s” of equity returns and currency values as well as export dependence, the list of at risk countries expands to include South Africa, Brazil and Russia as well.


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