Forward Note - 2024/02/17
Last week, we left you with a playful Jay-Z-inspired quote: "If you are long VIX 13, I feel bad for you, son. I've got 99 problems, but a spike ain't one.”
For anyone long on VIX 13, the spike did indeed happen, and we hope you capitalize on it quickly: it faded into the background as swiftly as it appeared, barely giving it enough time to become a problem.
Let’s rewind.
On Tuesday morning, the CPI report was released, surprising the market by coming in hotter than expected. It wasn't a dramatic increase, but enough to lend credence to the stagflation narrative, or at the very least, to the notion of inflation's stickiness.
The CPI hit 3.1%, surpassing the anticipated 2.9%, sparking a robust selling day. The S&P 500 was down 2% in session, a drawdown unseen for almost a year. And the VIX? It leaped from a gentle 14 to brush against 18—a 25% surge in a single day, enough to catch everyone’s attention. While such percentages are more striking in a low-volatility environment, a four-point jump is far from trivial.
And half an hour before the close, the market did what they do best - they shrugged it: “It doesn’t matter; let’s bring the VIX below 16 and move on.”
We must admit, the swift rebound from a VIX of 18 on Tuesday afternoon to 14.25 by Friday left us scratching our heads.
Macroeconomists might argue that inflation is a byproduct of growth, suggesting the market's current focus is squarely on the growth narrative. This perspective could also shed light on why Friday's PPI report, which also exceeded expectations, didn't trigger a significant market reaction. Despite a slight sell-off towards the session's end, the S&P 500 closed the week down just 0.33%, with the Nasdaq following suit -1.5%.
Therefore, the fluctuations observed this week could simply be the market recalibrating its expectations for rate cuts in 2024. Recall the post-Powell euphoria last year, with bets on eight cuts of 0.25%? Now, expectations have moderated to just three or four cuts over the year, prompting fund managers to adjust their long exposure in anticipation of clearer signals or buy some hedge and start the move in the VIX.
While macro explanations offer a broad perspective, they often fail to capture the full complexity of market dynamics. Those who spend hours observing price actions, especially as expiration nears, have a very different explanation: with the VIX futures and options contracts expiring on Thursday morning, it's conceivable that a large short position rollover could have initiated a spike in the VIX. But even there, we can’t be 100% sure.
Generally, a significant move in the VIX indicates widespread option buying by the market, usually by fund managers and large stakeholders hedging against potential risks. It's uncommon for such intense buying to cause a swift VIX increase, only for the demand to vanish just as quickly.
Some analysts see that as another clear indicator of an overcrowded volatility trade; every uptick in demand encounters an overwhelming supply, pushing down option prices and, consequently, the VIX itself.
While conceivable, we're not entirely convinced by this argument either. If the demand were peaking up only to be met by ferocious supply, we'd expect to see significant activity in the VVIX (the volatility index of the VIX itself), even after the VIX came down to a lower level, and clearly, this was not the case.
So, what's the real cause behind this move?
The honest answer is that we simply don't know—and perhaps more importantly, it may not even matter. Unless you're deeply committed to a particular market narrative and need to understand why things didn't pan out as expected, it truly doesn’t matter: we hope you managed to cash in on the move or at least didn’t get burnt.
At Sharpe Two, our primary focus is on identifying opportunities, and the upcoming week promises to be just as eventful, with the FOMC minutes set to be released on Wednesday. This will give market participants a chance to dig deeper into what Chairman Powell meant by "data dependent" and potentially adjust their strategies accordingly.
The real market event to watch, though? NVDA's earnings announcement on Tuesday. Given the recent excitement after SMCI's earnings, it's not far-fetched to anticipate a similar frenzy around NVDA. However, NVDA's massive market cap means that even small percentage changes in its stock price can significantly impact the broader market. We still vividly recall the +25% surge in May 2023—a painful reminder for those of us who were short on volatility at the time.
So stay patient and resist the urge of a quick and dirty bet right before the earnings. And if you really have to, make sure the size is so insignificant that you can laugh at the worst possible outcome.
Explaining why the market moved may not really matter, but how you manage your PnL does.
In other news
SMCI for a brief second break above the 1000 price point barrier. And then tank, leaving many retail traders nursing heavy losses.
This should be a stark reminder of our point above: always control your risk so that even in market mania like the one we are observing, you stay safe.
That being said, we also want to take the opportunity to warn you against the defacto market position recently, calling for a bubble. It’s a great way to get attention at a cheap cost (unless you are actually short.)
We're witnessing a technological shift towards AI that mirrors the internet boom of the '95. And many stocks receiving a lot of attention will be at the forefront of this revolution as pivotal suppliers of AI technology. We don’t ask you to be convinced, although, with the release of Sora and the Apple vision, we encourage you to broaden your perspective. And if this was not enough, think about why Sam Altman is reportedly seeking to raise $7 trillion for a competing venture; the scale of what's unfolding becomes clear.
Is it a bubble? Maybe. However, history teaches us that we often overestimate the short-term impacts of technology while underestimating the long-term possibilities.
Thank you for staying with us until the end, and here are a couple of interesting reads from last week:
Because it is yet another Fed week, we couldn’t finish this note without mentioning
the stellar piece about the dilemma the Fed is facing.Remember when, not so long ago, European economic strength was synonymous with Germany? What happens to Europe if Germany enters into recession? Find out with
in this article.This week in Sharpe Two, we talked about using institutional flow in short-dated options to find profitable trades in EWZ and TUR. Thank you again for all the positive feedback
We wish you a very pleasant week ahead and happy trading!
Ksander
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