Recent Equity Price Action Significant Influence of CTAs and Option Hedgers
In less than
48 hours, many major markets lost ~5% (nearly an average annual gain). The sell-off unfolded as follows:
the ISM miss on Tuesday triggered selling that pushed the S&P 500 lower by 1.2%. Later in the night,
significant selling came in futures as the S&P 500 broke through 50- and 100-day moving average signals
as well as 1- and 12-month price momentum. A nearly identical sequence occurred with the Eurostoxx 50,
which broke 1M, 3M, 6M price momentum signals as well as 50- and 100-day moving averages. This has
prompted one of the largest CTA reversals (from long to short) and helped push the market lower. Even
more importantly, due to the significant recent increase of put options outstanding, dealers were caught
significantly short gamma in both indices. This resulted in selling related to hedging index put options
that is likely more important than the selling by CTAs. Technical flows likely drove more than ~$100bn of
equities selling in a 48-hour period. Going into this week, the setup for indices (CTA levels and option
gamma) was vulnerable, and it didn’t take much fundamental selling to trigger much larger technical
selling. Yesterday’s services PMI print, while underwhelming, triggered another bout of instantaneous
selling, which did not succeed in triggering more technical selling. In fact, the market retraced ~2%
intraday (nearly the whole previous day’s loss), which was helped by the same short gamma exposure
(exaggerating any directional move). An acceleration of buybacks likely helped stabilize the market, but
it is likely that many fundamental investors did not change their view on the cycle based on a few noisy
Where does this leave us today? Dealers are still short gamma, and both the S&P 500 and Eurostoxx 50 are
right below all of the key technical levels breached earlier this week. If the market can move ~50bps
higher during the day, it could spark a significant rally driven by the trend followers (CTAs) and the
same put options that helped push the market lower earlier in the week.
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