Head of Equity Strategy
Summary: Nasdaq 100 was down 5% yesterday driven by dynamics in the options market where market makers likely created a negative feedback loop through their delta hedging activities. Based on estimates of these dynamics we believe the technical drivers for the sell-off have exhausted themselves and that the market will stabilise here potentially bouncing back into the weekend. Longer term we still remain positive on equities as the rebound narrative is intact supported yesterday by better than expected initial jobless and continuing claims.
Before the US equity market opened we put out an equity research note Skewed options market causes huge moves in US tech stocks warning of a potential violent trading session in US technology stocks and unfortunately it happened. The three trading sessions leading up to yesterday’s bloodbath showed unusual behaviour in Apple and Tesla shares and especially the day before on Wednesday the shares tumbled sharply while the broader market was up. This is very unusual for mega-caps. These dynamics made us surer that something was lurking under the surface of the Nasdaq 100 rally. While the sell-off was painful we remain positive on equities both short-term and longer term.
As explained in yesterday’s note the most likely cause was feedback loops arising from options. Commission-free trading in US equity options and strong bullish sentiment have caused options positioning to become very skewed on the call side (far more outstanding calls than puts). All these long call options sit on the books of market makers which are then short these calls. They would lose money if the underlying stock continued to go up. Therefore, these market markets hedge their short call positions (delta hedging) by buying the underlying stock (in these cases Apple and Tesla). If the notional outstanding amount becomes big enough the delta hedging activity by market makers become a too share of the normal trading flow in the underlying stocks and thus suddenly they activity causes price impact hence the increased intraday volatility in the chart above.
In our Saxo Market Call podcast this morning we have slides explaining some of these dynamics and more. The technical concept in options called gamma explains the rate of change in the delta of the options. What likely happened yesterday was that the gamma exposure so large that when prices fell the delta of all the call options held by retail investors fell fast and market makers reduced their positions of underlying creating a negative feedback loop. Based on estimates of this gamma exposure and the curvature of this net position means that we believe the technical reasons for the sell-off are no longer present.
We are still positive on equities
Short-term and going into the weekend it will be interesting to see whether US retail investors can muster the strength to set in motion a rebound. Regardless of the potential rebound today and the technical sell-off yesterday, we remain positive and constructive on equities. Yesterday’s initial jobless and continuing claims showed significant improvements which caused the New York Federal Reserve to update its Weekly Economic Index tracking US GDP growth in real-time. For the week ending 29 August the index now estimates US GDP growth at -4.4% y/y a significant improvement from the -11.5% y/y in late April. If the rate of change in this index is positive (i.e. the negative GDP growth gets less negative week by week) the rebound narrative is well alive, and equities will continue to outperform bonds. While the macroeconomic uncertainty is still high the support from the fiscal side is still enormous with France announcing additional €100bn in stimulus and South Korea over the weekend announcing the country’s largest stimulus programme in many decades. All this fiscal stimulus will flow through to the broader economy.
The chart below is a 5-year chart on the stocks mentioned in the research note. This is for regulatory purposes.
The end of the road
Emboldened by surging crude oil prices, Saudi Arabia makes waves on the international stage, as Crown Prince Mohammed bin Salman manages to create a World Champions League, after buying the UEFA Champion League franchise.
As the world embraces GLP-1 obesity wonder drugs, the people next in line to get a prescription stop caring about dieting and exercising, figuring that the drug will later solve all of their weight-related health problems.
With the US budget deficit spiraling above 10% of the GDP, the government is desperate to foster demand for US Treasuries. Under intense pressure from the White House, Congress makes income from government bonds tax-free.
After a criminal group deploys the most deceptive AI deepfake ever seen, generative AI becomes a national security threat. With public distrust soaring, governments crack down with harsh new laws, puncturing the AI hype.
To fix the divergence in the global trade and financial system, the largest deficit countries unite to negotiate new world trade terms. For surplus countries, the reset of the global economic model is a painful adjustment.
As discontent with Biden and Trump rises to fever pitch, Robert F. Kennedy Jr sees his support rising inexorably in the polls. On November 5, Kennedy wins the US presidential election, ushering in a new era in US politics.
Stepping up Japan's economic transformation in 2024, PM Kishida brings in a host of populist policies to boost domestic demand. As the GDP growth rate hits 7%, the BoJ is forced to abandons its yield curve control policy.
As people wake up to how little tax Europe’s billionaires are actually paying, the EU Commission implements a wealth tax of 2%. The tax sends shockwaves through Europe's luxury industry, with luxury giant LVMH plunging 40%.
