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Volatility trader – risk smacked hard into the US close

Head of Research

Feb 16, 2023

That escalated quickly – one moment I am focused on subdued market volatility and seeing evidence of traders buying dips in risk post a super-strong PPI print – and then St Louis Fed president James Bullard tells us he was open to a 50bp hike and risk gets carted out into the US close – the NAS100 was even threatening to turn positive, but in the last hour of power, we saw the NAS100 cash market dive and close -1.9%, as we saw the short-term VIX index having a run, as traders bought volatility into the close.

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Personally, I'm not sure we learnt anything new from Bullard's comments – he’s a known hawk and a non-voter in FOMC meetings this year – maybe this was a market already nervous after the 6% YoY US PPI print and positioned aggressively in short vol exposures - as the market moved, they were forced to cover these positions, and this was reflected in a pronounced a rapid move. With all the talk of 0DTE options and traders selling calls which had suppressed cross-market volatility, it is understandable that we could get a punchy move in US equity markets – consider in the sharp equity move, the moves were more contained elsewhere and US 2’year Treasury yields gained a mere 4bp and the USD added just 0.3%.

We come back to our friend flow – sometimes while we try and justify price action, it doesn’t always have to make sense – there is a mountain of hedging activity, volatility and options-related positioning that is quick to move when price goes on a run – a lot of this is very opaque.

So, the question of whether this last-minute US equity vol shock has further to run is going to be one that Asia could enlighten on – our NAS100 cash index may get a look in here, and this is a priced off the Nasdaq 100 futures, so activity to keep selling this one lower could be worth putting in front of the screens. The USD is threatening a bullish breakout of the 8-day consolidation phase – the USD index is just creeping higher, and I question if implied vol starts to rise and we see better-trending conditions – USDCNH could be central here and if the USD rallies against the yuan, then we could see that USD flow in a weaker AUDUSD and EURUSD.

One swallow doesn’t make a summer, and while the craze to trade 0DTE and suppress volatility may not fade initially, if the USD starts to bull trend, then I’d argue that the likes of the VIX index are likely going one way and we should see range expansion across markets – something many of the day traders would be hoping for.

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FOMC

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