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The Prophecy Continues

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September 2, 2020


Macro – SPY, QQQ

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The past few days have been gut-wrenching, having to deal with the loss of my 13.5-year Golden Retriever. She was the first dog I ever had; the story behind how we got Lexi is too funny not to tell.

Before I had made my move to my buy-side trading position, my wife, then-fiancee, and I visited a local puppy store on Long Island; at this point, we lived in Manhattan. My wife had been begging me for months to get a dog, and I refused. The idea of having a Golden Retriever and living in a 700 Square Foot 1 bedroom apartment on the Upper Eastside seemed like a disaster in the making.

To get my wife to stop going on about the dog, I made her a bet. I told her if I got this new job, we could come back the next week and get the puppy. Of course, I had two outs in this case to avoid the dog; one was not getting the job. The second was that the dog would be gone by the following weekend. Of course, I got the job, and the next weekend, we returned, and the puppy was eagerly awaiting us. So Lexi became the first piece of our family. She brought a lot of great memories to our lives and will be missed.

Clearly, not easy to let go, but it was, unfortunately, her time.

The time off from watching the market and dealing with life events did give me some time to think about what has been happening in the market. I have not been satisfied with many of the narratives that are floating around the market, from low rates to M2 money supply and equity risk premium. They do not work. But finally, it seems to all come together in a rather fantastic way, and perhaps I wasn't too far off when I started focusing on gamma exposure in the options market more.

The truth is, at this very moment, I believe the equity is something of a self-fulfilling prophecy. The higher it goes, the more it goes up. My old boss always used to say buyers are higher, and sellers are lower. The chart below shows how call volumes have exploded in recent months, well above historical levels.


Now, the more that calls are bought, the more the dealers are short calls. To hedge their positions, dealers need to buy the stock. That pushes the price of the stock up, which, in turn, helps to bring in more call buyers and more hedging. At some point, dealers will get long to much of one stock and perhaps look to diversify that risk across a basket like the NASDAQ 100 or S&P 500. So again, now buying futures of the index sends the entire index higher.

Now I don't think it started this way, but this what this has become over the past few weeks. So, taking on more risk means higher options pricing, which comes in the form of higher implied volality. We could see that the VIX index has been trending higher in recent days.

The VXN, which is the NASDAQ 100 VIX, is rising even faster.

Implied 30-day volatility levels for the Qs have risen from 23.9% on August 20, to 33.8% on September 2.


The IVOL in AMZN has risen from 32.1% on August 17 to 43.4% today. You'd think Amazon's stock was crashing.


So when will the music stop? When the implied volatility levels reach a point that options pricing no longer makes sense and traders stop buying calls. That will cause dealers to have too many long positions on their books, and result in a significant reversal.

The Qs did hit the upper end of the trading range to around $302. It is impossible to know how much higher they go, but you have an RSI over 81 and is at the top of a channel. It should result in some mean reversion.

Right now, the S&P 500 is still on track to hit 3,590. Haven't thought about what happens next. Again, it is positioned like the Qs.

Anyway, that's all for today. I haven't done much the last few days, so I have lots to get caught up on.


Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.

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