Nomura: ‘Quad Witch’ Friday Could Trigger “Un-Sticking” Of Insanely High Volatility

It’s ‘quad witch’ week, which historically has meant a collapse in vol and surge in stocks – no matter what the news. But, this week (and last) has been different, to say the least.

However, as Nomura’s Charlie McElligott explains below, this Friday’s option expiration may stall that chaotic volatility… at least to some extent.

While volatility has been extreme across all asset-classes, in equity markets, McElligott notes we are approaching the “nitty gritty” of tomorrow’s VIX expiry and Friday’s “Serial” Options Expiration, which is set to be the largest notional on record – and all with no CBOE floor operation.

The potential for an “un-sticking” catalyst from this insanely high absolute level of Vol and “Vol of Vol” (VVIX at 208, all-time highs dating-back to ’06) is very real then, because our current assessment of combined SPX / SPY options Gamma shows approx. 36% of $Gamma is set to drop-off after Friday’s expiry (approx. 2- to 3- x’s “normal” drop).

Again recall that much of this “Negative Gamma” position Street-wide is due to the two huge buyers of protection in the March expiry (the large S&P Put Wing from last Fall, and the multi-month VIX “Call Wing” buyer)

This *could* then mean that price-movements simply begin to get a little less crazy after expiry (ranges tighten) and that investors may again begin to initiate “short vol” positions, on account of the multi-month tectonic shift “from extreme LONG to extreme SHORT” Gamma (as discussed here ad nauseum) would seemingly then see Dealers much less “Short Gamma” thereafter, and thus, not as sensitive to changes in the Delta, which recently have been seeing their hedging amplify moves in both directions (in mkt ‘down’ moves having to sell more to remain neutral, or in ‘up’ moves having to buy more)

Other “constructives” for the market include that:

• nearly 2600 of 3100 NYSE names are currently in “short sale restricted”;

• Street-wide PB’s saw MAJOR covering days in short-books yday;

• and market “internals” with lighter selloff volume, better adv / decline ratio and overall breadth improvement which might show that “sell supply” may be waning

Additionally, McElligott notes that systematic funds have “little left to sell” (Risk Parity ‘Equities gross-exposure’ at 0.1%ile since ’10; Target Vol / Vol Control Equities exposure at 0.0th%ile; CTA’s already “-100% Short” signal, although the position gross-exposure can be leveraged-up in-time).

The current selling risks continue to come from the “still long” Asset Manager position in S&P futures (still 76th %ile despite recent reduction) and HF L/S, which are increasingly de-grossing it seems judging by the negative reversal seen in “1Y Price Momentum” factor and broad / massive “short” outperformance over “longs” in the past two sessions.