Stock index options and futures business have grown immensely over the last couple of decades and now exert a considerable influence on all markets. An influence every trader should at the very least be aware of.
The hedge ratio is the calculation of this influence with white being neutral, then yellow for minimal following on through red into grey for ever increasing levels. At each level you will see futures buying or selling generated by dynamic delta hedging brought about by the market re-balancing its risk profile.
As we highlighted last week, the monthly rollover and expiry time one of great change and heightened activity in relation to the markets dynamics and trader positioning. It is for this reason that we produce specific charts to try and capture this changing landscape.
However, today we have in fact included our conventional chart of the S&P 500 followed by our “rollover” chart to not only give you an understanding of continuity, but primarily to showcase that turbulence does not necessarily mean big market moves.
In fact, we realised on Monday of this week in our US note that after the markets extreme reaction last year to the Fed meeting where we stated: “Trouble is this year it seems everyone is waiting for the Fed meeting to give it an excuse to move, whereas last year it was caught off balance, which is how you get extreme moves not by waiting for them”. Hopefully that’s clear?!
Also, there was a totally different hedge ratio scenario in play then.
As you will see from our charts below, this is still a non “game-changing” triple witching expiry to us but one that may well alter the perceived percentages regarding the neutral banks. Indeed, out of the last 12 triple witches, 9 have reversed the market’s direction, 2 caused a dead stop and 1 had no discernible influence (apart from to us of course).
So here is OUR conventional S&P 500 June expiry chart which goes out in a little over 2 hours and which you will recognise from our previous postings, hopefully easily identifying where we had forewarned you over the index hitting firstly 1925 and then 1955.
It also neatly encapsulates the point that we previously stated, that being that “turbulence does not necessarily mean big market moves” by highlighting that just over a week ago 1955 was a point of serious hedge ratio resistance and yet today it is just minimal yellow hedge ratio. Scarily at the start it was black hedge ratio.
More importantly the where do we go from here? Which is after all the reason we produce our rollover charts, as they give us the first indication of what’s in store for the next expiry.
Derivative business dwarfs conventional equity business and we believe therefore exerts a direct influence on markets, and this is a window into that world.
Do not forget that July does not become the alpha (as in alpha = dominant) expiry until Monday 23rd June 2014.
The most obvious aspect from the charts is that the neutral zone has jumped up twice, and is already standing at 1945-1955, pre-empting a probable move in July’s to the same level.
The second striking feature is the predominance of the minimal yellow hedge ratio.
For those unfamiliar with the hedge ratio, it results in dynamic delta hedging, which is futures activity, either buying or selling. This can be and is frequently influential both as naturally occurring support and resistance levels.
The minimal yellow hedge ratio denotes the lack of this and in this absence, or void, markets can have extremely big daily movements.
Rather strangely the levels of red hedge ratio have not really evolved at all in July, but you can easily see where they are, so the only unanswered question is how sensitive will this market be to them? Especially in America we like to see all three indices acting together, or in symphony, and one on its own is a bit like a one leg stool, although the SPX is by far the biggest of them, so does carry extra weight.
However, both the DJIA and Nasdaq 100 are in a similar situation with an awful lot of yellow hedge ratio in the frame. Implying neither material resistance nor support at current levels. We could therefore get quite a large move either way next week.
Turning towards the FTSE 100 and the June expiry could not of been more boring, as sports commentators are wont to say “one for the purists”. Basically it got stuck in a hedge ratio “rut” – 6800 to 6850. And when it did break down, it got stuck between 6750 and 6800 while all the while other markets were making new record highs.
Sadly, looking at the rollover chart below we can see only a little improvement, but not a great deal.
The main aspect to note is the neutral zone, which is 6750 to 6850, as well as the strip of yellow hedge ratio just above it, giving this index a good shot at getting up to 6900.
However, then the red hedge ratio starts, so if it get punchy it could eke out another 50 points either side (6700 & 6950) but the red hedge ratio level that proved so impassable in June lies in wait at 6650 and 7000 in July…
Onto the DAX 30 which has already been “punchy” in June and even tested its dark red hedge ratio. Whether that exuberance carries over into July we can only wait and see…
However, you can see from their rollover chart the red hedge ratio is building up considerably both above and below so if either the bulls or bears really “want it” they are going to have to work for it, either way.
Good luck whichever way you are positioned!