With the benefit of understanding daily SPX put flows (NPD) with some granularity, we have a model to overlay atop our understanding of customers' excess vanna exposure (VGR).
I.e., NPD + VGR = something pretty useful.
Here's a contour map of NPD (x), VGR (y), and normalized SPX return (z) since 2004.
The gold "X" is where we are right now.
With history as our guide, we are a hair's breadth away from some of the most consistently bearish and volatile behavior in the S&P 500.
The current combination of weak put flows and large customer vanna exposure are fragile.
SPX is 4540. Nearby SPX ATM IVs are all under 10%.
Seems like an iffy time to be long SPX / short VIX.
But we're just data vendors.
Enjoy the long weekend!
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A "bad time" is when everyone is overexposed to the same thing. This makes the market fragile.
As you know, an option's delta is not only sensitive to spot price (gamma), but also to volatility (vanna). We've called vanna "gamma's evil twin." She's sneaky.
So you shouldn't be surprised that when vanna [quietly] becomes a relatively larger portion of SPX option customers' delta sensitivity, things can get weird.
After all, when more people are more exposed to vanna, they are more exposed to changes in vol!
S&P 500 (SPX) option dealers hold more and more inventory.
"But what about the other 50%?" you wonder.
Normally, this would be an opportunity for us to plug gamma exposure (GEX).
"Dealer gamma is only getting more important!"
But that's just not true anymore. As dealer inventory gets bigger, and as people model it with increasing accuracy, it actually becomes *less* important.
People figured out that it matters, so it matters less.
Ever since June (at $200/share), Tesla stock has been driven by a perpetual motion machine of hype and call option flows -- nothing more. And everyone knows it.
Here's what not everyone knows:
When a stock joins the S&P 500, it becomes part of a massive volatility complex, which is a terrifying web of arbitrage and pseudo-arbitrage relationships. Tesla will join the index as a top-ten component of a cap-weighted index. It's big.
Its bigness will allow all manner of dispersion, relative value, and market-making traders to begin relying on Tesla's newfound correlation to the index. This will invariably cause arbitrageurs to buy SPX options/vol and sell TSLA options/vol to "close the spread."