Good Morning,
- Last Friday's market reversal was another classic example of how negative gamma flows can amplify volatility in both directions, as dealers were forced to chase the market higher.
- Despite the reversal, there was still a notable demand for downside protection last Friday, as evidenced by the increase in implied vol skew and elevated Put option premiums.
- This further suggests the move in SPX was mostly in response to dealers hedging their short gamma exposure to the upside rather than a fundamental shift in market sentiment.
- Dealers will start the week off in negative gamma, which implies the conditions for higher volatility are still in place. However, given how close the spot SPX is to our gamma flipping point at the 5228 strike, these Vol-supplying flows will likely have a more pronounced impact on the downside, while an upside move would place dealers back into a neutral position.
- In our opinion, this is a dangerous setup to have ahead of a macro catalyst like CPI, especially if dealers remain in negative gamma, which could supply enough volatility to force systematic funds to aggressively deleverage their equity positions.
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-Craig Peterson
