Good Morning,
- Market makers are still modestly short gamma heading into today's CPI event, which implies there is a higher probability of gamma-induced response.
- Under these conditions, we typically see markets overreact to the data being released as dealers will be forced to chase momentum in either direction to minimize their delta exposure. However, with SPX sitting just 30bps below our gamma flipping point, we suspect these vol-supplying flows will mostly be towards the downside, as a move higher would place dealers back into a neutral position.
- From a directional standpoint, we generally see today playing out in one of two scenarios. The first scenario is the favorable one, where the CPI data comes in as expected, and the associated risk around the event starts to dissipate.
- In this case, we'd expect to see the rapid monetization of short-dated hedges, which would allow dealers to repurchase their delta positions and inject some bullish flows into the market. This is our "Hedged pot never boils" scenario.
- On the other hand, if the market reacts negatively to the CPI data, likely due to a hot print, we'd expect to see investors seek protection by buying longer-dated put options.
- To hedge the risk of these sold puts, dealers would need to short the underlying (e.g., SPX Futures) to maintain delta neutrality. This selling pressure from dealers would add some accelerant flow to the downside, exacerbating volatility and increasing the overall negative gamma exposure the dealers hold.
- Unfortunately, we don't get the script ahead of time, so we don't know exactly how the market will respond today. However, we do have a strong understanding of the mechanics that will likely drive the following momentum, and under that context, we can use our PV bands as a guide.
- The implied trading range is fairly straightforward today, with the 5275 strike to the topside and the 5150 strike towards the downside. Notable levels are the 5200 and 5250 strikes, with anything in the middle fair game.
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-Craig Peterson
