We’ve written about some of the major risk signals showing over the last several days/weeks, and those risks manifested in a 4-5% drawdown over the last few trading sessions. Todays bounce appears to be mainly off of the closing of short term put options trades (delta hedge unwind) along with a crush in implied volatility. As implied volatility declines, put options lose value. As put options lose value, options market makers can cover short hedges.
You can use the VIX as a gauge of the implied volatility of the S&P500. As you can see todays session opened (9:30-AM EST) with the VIX declining from 28-28.
We wrote about this before the market opened:
Implied vol being up in a put heavy regime may give dealer flow extra impact.
— spotgamma (@spotgamma) May 13, 2021
Here is est SPX options delta exposure. On 5/11 dealers were sellers at higher prices, now they’re buyers at higher prices.
This is because delta exposure drops if mkt rallies/iv drops & puts die pic.twitter.com/9PclKU2Zlu
Now that puts have been covered, the market has less hedges underneath to support it. As a result there could be less fuel (less hedges to cover) to support the market if it retests recent lows. Said another way, we suspect this could simply be a “dead cat bounce”, and lead to a test of the 4000 level.