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Look Out Below: Why a Rug-Pull Flash Crash Makes Perfect Sense

November 13, 2021

Look Out Below: Why a Rug-Pull Flash Crash Makes Perfect Sense

It makes perfect financial sense to crash the market and no sense to reward the retail options marks by pushing it higher.

An extraordinary opportunity to scoop up mega-millions in profits has arisen, and grabbing all this free money makes perfect financial sense. Now the question is: will those who have the means to grab the dough have the guts to do so?

Here’s the opportunity: retail punters have gone wild for call options, churning $2.6 trillion in mostly short-term calls–bets on gains now, not later. This expansion of retail options exposure is unprecedented not just in its volume but in its concentration in short-term bets (options that expire in a few days) and in mega-cap tech companies that are commanding rich premiums for options.

Goldman Stunned By The Record $2.6 Trillion In Option Notional Traded Last Friday

The options market is like every other market only more so. The price of an option–a bet that a stock, ETF or index will go up or down before the option expires–is sensitive to the volatility of the underlying equity, the demand of other punters for options and the premium being demanded for time: the farther out the expiration date, the higher the cost of the option.

Recall that anyone with 100 shares of the underlying equity can write/originate an option. Each option controls 100 shares, so a call option that is listed at $1 costs the buyer of the call $100.

This is very sweet leverage if the market goes your way. You get all the gains of the 100 shares for a cost considerably less than buying the 100 shares outright. No wonder retail punters are going crazy for this cheap leverage to maximize gains in “can’t lose” trades.

…click on the above link to read the rest of the article…

The Risk of a Flash Crash is Rising

September 12, 2019

The Risk of a Flash Crash is Rising

The Risk of a Flash Crash is Rising

Disclaimer: first of all, calm down. I’m not predicting anything. In fact mostly I’m just tying threads together between a bunch of market risks that have been highlighted by many for some time. Early perhaps they were, but not necessarily wrong. As investors become such increasingly one-sided in their macro outlook, these risks become more pronounced. 

As stocks rallied last week and the U.S.-China trade itinerary got a nice-sounding update, U.S. economic data continued to beat expectations and is now surprising estimates at a positive rate. One graphic I saw on Twitter caught my eye: SocGen’s take on the biggest event risks, in which they describe the probability and potential scope of a “sharp market repricing” as being low and small.

No alt text provided for this image

It’s consistent with what I see elsewhere. There is a view more consensus right now than any I’ve ever seen: the world economy is slowing and the Fed and other central banks will continue cutting rates. Everyone agrees on the basics, they just have different views on how to play it. Among bulls, there is also a strong consensus view that relentless bond-buying momentum is innocuous and central banks will provide an adequate safety net for whatever risks may be associated with the forces behind this market action. Moreover, the general line of thinking I hear is that, even if there is a big bond selloff, stocks will be immune from blowback.

I disagree. A sharp market repricing should be the fattest swan on that diagram.

The greatest risk to investors, the economy, and the tenuous state of geopolitics, is the price of the S&P 500. That does not mean it is the most likely risk — what it means is that the ripple effect of a sizable selloff in stocks right now is monstrous.

 …click on the above link to read the rest of the article…

Corporate Debt Is At Risk Of A Flash Crash

August 24, 2019

Corporate Debt Is At Risk Of A Flash Crash

The world is awash in debt.

While some countries are more indebted than others, very few are in good shape.

The entire world is roughly 225% leveraged to its economic output. Emerging markets are a bit less and advanced economies a little more.

But regardless, everyone’s “real” debt is likely much bigger, since the official totals miss a lot of unfunded liabilities and other obligations.

Debt is an asset owned by the lender. It has a price, which—like anything else—can go up or down. The main variable is the lender’s confidence in repayment, which is always uncertain.

But there are degrees of uncertainty. That’s why (perceived) riskier debt has higher interest rates than (perceived) safer debt. The way to win is to have better insight into the borrower’s ability to repay those loans.

If a lender owns debt in which his confidence is low, but you believe has value, you can probably buy it cheaply. If you’re right, you’ll make a profit—possibly a big one.

That is exactly what happens in a recession.

Investment-Grade Zombies

While it’s easy to point fingers at profligate consumers, households largely spent the last decade reducing their debt.

The bigger expansion has been in government and business. Let’s zoom in on corporate debt.

The US investment-grade bond universe is considerably more leveraged than it was ahead of the last recession:

Source: Gluskin Sheff

Compared to earnings, US bond issuers are about 50% more leveraged now than in 2007. In other words, they’ve grown debt faster than profits.

Many borrowed cash not to grow the business, but to buy back shares. It’s been, as my friend David Rosenberg calls it, a giant debt-for-equity swap.

…click on the above link to read the rest of the article…

Quick Take: The Risk Of Algos

April 13, 2018

Quick Take: The Risk Of Algos 

“Mike ‘Wags’ Wagner: ‘You studied the Flash Crash of 2010 and you know that Quant is another word for wild f***ing guess with math.’

Taylor Mason: ‘Quant is another word for systemized ordered thinking represented in an algorithmic approach to trading.’

Mike ‘Wags’ Wagner: ‘Just remember Billy Beane never won a World Series .’ – Billions, A Generation Too Late

My friend Doug Kass made a great point on Wednesday this week:

“General trading activity is now dominated by passive strategies (ETFs) and quant strategies and products (risk parity, volatility trending, etc.).

Active managers (especially of a hedge fund kind) are going the way of dodo birds – they are an endangered species. Failing hedge funds like Bill Ackman’s Pershing Square is becoming more the rule than the exception – and in a lower return market backdrop (accompanied by lower interest rates), the trend from active to passive managers will likely continue and may even accelerate this year.”

He’s right, and there is a huge risk to individual investors embedded in that statement. As JPMorgan noted previously:

“Quantitative investing based on computer formulas and trading by machines directly are leaving the traditional stock picker in the dust and now dominating the equity markets.

While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals. Fundamental discretionary traders’ account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago.”

As long as the algorithms are all trading in a positive direction, there is little to worry about. But the risk happens when something breaks. With derivatives, quantitative fund flows, central bank policy and political developments all contributing to low market volatility, the reversal of any of those dynamics will be problematic.

…click on the above link to read the rest of the article…

Whistleblower Exposes “Rampant Manipulation Of VIX”

February 13, 2018

Whistleblower Exposes “Rampant Manipulation Of VIX”

We first exposed the “conspiracy fact” that VIX manipulation runs the entire market back in 2015 as the ubiquitous VIX-crushing algo-runs coincided with a non-stop shorting of VIX futures by a seemingly bottomless-pocketed player in the market… which happened to coincide with the arrival of Simon Potter as the head of The New York Fed’s trading desk…

Probably just a coincidence, right?

Then, in May of last year we academic confirmation of the rigged nature the US equity market’s volatility complex, when a scientific study found “systemic VIX auction settlement manipulation.”

Two University of Texas at Austin finance professors found “large transient deviations in VIX prices” around the morning auction,“consistent with market manipulation.”

​Griffin and Shams calculate that “the size of VIX futures with open interest at settlement is on average 5.7 times the size SPX options traded at settlement, and it is 7.3 times for VIX options that are in-the-money at settlement.”

So if you are a trader who owns a lot of the market in VIX futures, you could push around a large dollar value of futures by trading a small dollar value in options. This is particularly true because the S&P option volume is divided among many strikes, and the illiquid deep out-of-the-money S&P 500 options have a big influence on the VIX: You can move the price of those options a lot with relatively small trades, and those price changes have a disproportionate effect on the VIX.

While this was immediately played down by CBOE, and the subject quickly disappeared from the headlines – because VIX was dropping incessantly and stocks were going up, up, up – until VIX flash-crashed rather awkwardly into the morning auction settlement in mid-December, bring the chatter of manipulation back to life…

…click on the above link to read the rest of the article…

BofA’s Apocalyptic Forecast: Stocks Flash Crash, Bond Bubble Bursts In H1 2018, War May Follow

November 21, 2017

BofA’s Apocalyptic Forecast: Stocks Flash Crash, Bond Bubble Bursts In H1 2018, War May Follow

Having predicted back in July that the “most dangerous moment for markets will come in 3 or 4 months“, i.e., now, BofA’s Michael Hartnett was – in retrospect – wrong (unless of course the S&P plunges in the next few days). However, having stuck to his underlying logic – which was as sound then as it is now – Hartnett has not given up on his “bad cop” forecast (not to be mistaken with the S&P target to be unveiled shortly by BofA’s equity team and which will probably be around 2,800), and in a note released overnight, the Chief Investment Strategist not only once again dares to time his market peak forecast, which he now thinks will take place in the first half of 2018, but goes so far as to predict that there will be a flash crash “a la 1987/1994/1998” in just a few months.

Contrasting his preview of 2018 with the almost concluded 2017, Hartnett sets the sour mood with his very first words, stating that he believes “2018 risk asset catalysts are much less bullish than in 2017” for the simple reason that the bearish positioning going into 2017 has been completely flipped: “positioning now long, not short; profit expectations high, not low; policy close to max stimulus; peak positioning, peak profits, peak policy stimulus means peak asset returns in 2018.”  He also goes on to point out that the historical omens are poor:

  • Bull market in S&P500 would become the longest ever on August 22, 2018 (and the second biggest ever at 2863 on S&P500).
  • Equities have only outperformed bonds for seven consecutive years on three occasions in the past 220 years (the last time was 1928 – Chart 1).

…click on the above link to read the rest of the article…

Pound Flash Crashes After Moody’s Downgrades UK To Aa2

September 22, 2017

Pound Flash Crashes After Moody’s Downgrades UK To Aa2 

In an otherwise boring day, when Theresa May failed to cause any major ripples with her much anticipated Brexit speech, moments ago it was Moody’s turn to stop out countless cable longs, when shortly after the US close, it downgraded the UK from Aa1 to Aa2, outlook stable, causing yet another flash crash in the pound.

As reason for the unexpected downgrade, Moodys cited “the outlook for the UK’s public finances has weakened significantly since the negative outlook on the Aa1 rating was assigned, with the government’s fiscal consolidation plans increasingly in question and the debt burden expected to continue to rise.”

It also said that fiscal pressures will be exacerbated by the erosion of the UK’s medium-term economic strength that is likely to result from the manner of its departure from the European Union (EU), and by the increasingly apparent challenges to policy-making given the complexity of Brexit negotiations and associated domestic political dynamics.

Moody’s now expects growth of just 1% in 2018 following 1.5% this year; doesn’t expect growth to recover to its historic trend rate over coming years. Expects public debt ratio to increase to close to 90% of GDP this year and to reach its peak at close to 93% of GDP only in 2019.

And so, once again, it was poor sterling longs who having gotten through today largely unscathed, were unceremoniously stopped out following yet another flash crash in all GBP pairs.

Full release below:

Moody’s Investors Service, (“Moody’s”) has today downgraded the United Kingdom’s long-term issuer rating to Aa2 from Aa1 and changed the outlook to stable from negative. The UK’s senior unsecured bond rating was also downgraded to Aa2 from Aa1.

The key drivers for the decision to downgrade the UK’s ratings to Aa2 are as follows:

…click on the above link to read the rest of the article…

Hobson’s Choice

October 24, 2015

Hobson’s Choice

More than two months have passed since the August “flash crash.” Fragilities illuminated during that bout of market turmoil still reverberate. Sure, global markets have rallied back strongly. Bullish news, analysis and sentiment have followed suit, as they do. The poor bears have again been bullied into submission, as the punchy bulls have somehow become further emboldened. The optimists are even more deeply convinced of U.S., Chinese and global resilience (the 2008 crisis “100-year flood” view). Fears of China, EM and global tumult were way overblown, they now contend. As anticipated, global officials remain in full control. All is rosy again, except for the fact that global central bankers behave as if they’re utterly terrified of something.

The way I see it, underlying system fragility has become so acute that central bankers are convinced that they must now forcefully (“shock and awe,” “beat expectations,” etc.) react to any fledgling market “risk off” dynamic. Risk aversion and de-leveraging must not gather momentum. If fragilities are not thwarted early, they could easily unfold into something difficult to control. Such an outcome would risk a break in market confidence that central banks have everything well under control – faith that is now fully embedded in the pricing and structure for tens of Trillions of securities and hundreds of Trillions of associated derivatives – everywhere. With options at this point limited, the so-called “risk management” approach dictates that central banks err on the side of using their limited armaments forcibly and preemptively.

With today’s extraordinary global backdrop in mind, I’m this week noting a few definitions of “Hobson’s Choice”:

“An apparently free choice that actually offers no alternative.” (The American Heritage Dictionary of Idioms)

“A situation in which it seems that you can choose between different things or actions, but there is really only one thing that you can take or do.” (Cambridge Idioms Dictionary)

…click on the above link to read the rest of the article…

“Another Crisis Is Coming”: Jamie Dimon Warns Of The Next Market Crash

April 10, 2015

“Another Crisis Is Coming”: Jamie Dimon Warns Of The Next Market Crash

Last October’s Treasury flash crash — which Gregg Berman will tell you wasn’t the fault of HFT and which will likely repeat at some point or another thanks to the fact that Fed purchases have reduced market depth — may no longer be a once every three billion year occurrence as statistics would dictate, Jamie Dimon observes, in his latest letter to JPM shareholders, before suggesting that the event “should make you question statistics.” Amusingly, Dimon seems to confuse cause and effect a bit, as it’s really not the fault of “statistics” per se, but rather the fault of shifting market dynamics (and by “dynamics” we mean increased manipulation and never-before-seen distortions and dislocations) that have rendered the old statistical models obsolete. But at least Dimon sees the event, and recent similar shakeups in FX markets for what they are: “warning shots across the bow.” Here’s Dimon:

Recent activity in the Treasury markets and the currency markets is a warning shot across the bow 

Treasury markets were quite turbulent in the spring and summer of 2013, when the Fed hinted that it soon would slow its asset purchases. Then on one day, October 15, 2014, Treasury securities moved 40 basis points, statistically 7 to 8 standard deviations – an unprecedented move – an event that is supposed to happen only once in every 3 billion years or so (the Treasury market has only been around for 200 years or so – of course, this should make you question statistics to begin with).Some currencies recently have had similar large moves. Importantly, Treasuries and major country currencies are considered the most standardized and liquid financial instruments in the world.

…click on the above link to read the rest of the article…

 

 

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