Before we look into what the options markets are telling us and giving us as opportunities, a quick strategy comment. I am still on sell-rallies mode. I monetized all of my equity downside trades, and am now looking for a bounce to reload on downside as I do not think this correction is done.
Firstly, let’s look at the setup. Bears are in control here, and bulls are on their backfoot, scrambling between whether to take profits, to hold, or to go on CNBC and declare this a generational buying opportunity. The 5000 level is next support, followed by 4800. The latter is key as I will explain in a minute.
The 4800 level is a major line in the sand. We are already seeing some small systematic selling from vol control funds, but the next shoe to drop is large CTA selling flows that have triggers around the 4800 level. Thus, a break below there should see steady selling. It just so happens to be a key area where dealer gamma flips negative, so they will be selling as the market declines below these levels, contributing rather than dampening large moves. The vanna profile (vega to buy per change in vol) is the really scary potential here, as dealers have a lot of vega to buy on further moves up in vol. This means, if we get a sharp 5% move down to 4800, we could easily see this cascade into a 10-15% move over a short period of time. Thus, there is a non trivial potential this entire rally or much of it from November gets unwound.