I have several questions and they're kinda all over the place haha. I appreciate any time you can give to answer as many as you are able. I understand some are large questions and basically asking for another newsletter.
1.
How do MMs make money if they're usually short, and S&P usually rises?
2.
"If the market does not sell-off, then the large vanna and charm flows of March OpEx take over and it’ll be a monstrous tide that will skyrocket the market."
Would this be indicated by lower than normal trade volume that slowly rises into Mar Opex?
I'm taking the understanding that these Vanna & Charm trades are an undercurrent of trade volume that always exist (so long as these big investors want "insurance"). Then the "window of weakness" would refer to an absence of us everyday retail traders, right?
3.
The put/call ratio looks much more even for Mar OpEx compared to Feb OpEx of 2.84:1. How does that affect the price direction?
4.
Where can I get access to charts like the ones you shared?
5.
I'm lost on how the potential liquidity crunch (ON RRP depletion) ties into this. I'm reading your "Market Pulse: Liquidity is Surging" newsletter as I write this, but my understanding of Bank Reserves, US Treasuries and how that influences MM and other major retail investors is lacking.
I trust the general concept that it means a depletion of liquidity, and depletion of liquidity means they bow out of the market - but I do not fully understand the motivation/decisions that would be made by Institutions. I'll re-read and find supplemental info to see if that sparks an understanding.
6.
On that same note, your other newsletter "The Banking System was Redesigned" explains that the Fed has gone from manipulating interest rates as a means to control liquidity, to now they directly control liquidity with Ample Reserves (infinite money). This sounds like the impending liquidity crunch would dictate the Fed initiates QE again, and thus is a non-issue? Like isn't that the exact scenario that Ample Reserves is meant to tackle?
1. MMs make money primarly through the bid-ask spread of options contracts and possibly other market flow optimizations. In general, they want to stay neutral in their market positioning, aka "delta neutral".
Because a lot of the index options trades are bearish (buy puts and sell calls), options MMs find themselves on the other side of the options trade (sell puts and buy calls) so to remain delta neutral, they end up being net short the spot and futures markets to offset their long options positions.
2. Yup low volume days with not much market movement as we near large OpEx's is very bullish since this gives vanna and charm a lot of power to gradually push the market up.
The window of weakness refers to a steep fall of thee vanna and charm flows after a bunch of options expiry, such as after monthly or quarterly OpExes.
3. Good point. I think this is a more "average" put-call ratio, but it really depends on how much of these contracts are sold calls and bought puts. There could be bought calls and sold puts in the mix. This is tricky with looking at open interest, since you can only have a best guess on how many of these contracts are the market expressing bullish trades or bearish trades (since you can open an options contract by selling it to an MM or buying it from an MM).
The main signal here we should look at is the size of the OpEx and the general tendency for the market to express bearishness in index options, so there should be lots of positive vanna and charm flows.
5. Liquidity crunch is more of a macro flows thing, and doesn't affect this as much. Vanna and charm flows are micro structural market flows that happen based on options market positioning. One way the liquidity crunch could affect this is if the market positions more bearishly than usual because people are expecting a macro liquidity crunch going into the March OpEx.
6. This sounds like the impending liquidity crunch would dictate the Fed initiates QE again, and thus is a non-issue? Like isn't that the exact scenario that Ample Reserves is meant to tackle?
Yes. But macro liquidity is a continuous phenomenon while Fed policy is discrete (e.g. FOMC meetings or random emergency measures). As such, there are significant windows of macro weakness between a liquidity problem emerging and the Fed's corresponding actions that if you can foresee the liquidity problem coming, you can take advantage of these windows.
So I got it backwards on the window of weakness, yeah? The Charm/Vanna flows are surging buying pressure up to and on the day of OpEx, then they disappear next monday since we're now far out from next OpEx.
With that buying pressure gone, "regular trades" (not sure what you'd call it) become the dominant market force again and can suddenly dictate a new direction -- as you outlined.
I really appreciate it. I don't mean to suck away too much of your time from your research and regular posts with all that - just trying to engage and put some rubber to the road with all this new info I'm absorbing.
Cheers, and thanks for all the effort you've put into FinanceTLDR. Game changing for me
I have several questions and they're kinda all over the place haha. I appreciate any time you can give to answer as many as you are able. I understand some are large questions and basically asking for another newsletter.
1.
How do MMs make money if they're usually short, and S&P usually rises?
2.
"If the market does not sell-off, then the large vanna and charm flows of March OpEx take over and it’ll be a monstrous tide that will skyrocket the market."
Would this be indicated by lower than normal trade volume that slowly rises into Mar Opex?
I'm taking the understanding that these Vanna & Charm trades are an undercurrent of trade volume that always exist (so long as these big investors want "insurance"). Then the "window of weakness" would refer to an absence of us everyday retail traders, right?
3.
The put/call ratio looks much more even for Mar OpEx compared to Feb OpEx of 2.84:1. How does that affect the price direction?
4.
Where can I get access to charts like the ones you shared?
5.
I'm lost on how the potential liquidity crunch (ON RRP depletion) ties into this. I'm reading your "Market Pulse: Liquidity is Surging" newsletter as I write this, but my understanding of Bank Reserves, US Treasuries and how that influences MM and other major retail investors is lacking.
I trust the general concept that it means a depletion of liquidity, and depletion of liquidity means they bow out of the market - but I do not fully understand the motivation/decisions that would be made by Institutions. I'll re-read and find supplemental info to see if that sparks an understanding.
6.
On that same note, your other newsletter "The Banking System was Redesigned" explains that the Fed has gone from manipulating interest rates as a means to control liquidity, to now they directly control liquidity with Ample Reserves (infinite money). This sounds like the impending liquidity crunch would dictate the Fed initiates QE again, and thus is a non-issue? Like isn't that the exact scenario that Ample Reserves is meant to tackle?
1. MMs make money primarly through the bid-ask spread of options contracts and possibly other market flow optimizations. In general, they want to stay neutral in their market positioning, aka "delta neutral".
Because a lot of the index options trades are bearish (buy puts and sell calls), options MMs find themselves on the other side of the options trade (sell puts and buy calls) so to remain delta neutral, they end up being net short the spot and futures markets to offset their long options positions.
2. Yup low volume days with not much market movement as we near large OpEx's is very bullish since this gives vanna and charm a lot of power to gradually push the market up.
The window of weakness refers to a steep fall of thee vanna and charm flows after a bunch of options expiry, such as after monthly or quarterly OpExes.
3. Good point. I think this is a more "average" put-call ratio, but it really depends on how much of these contracts are sold calls and bought puts. There could be bought calls and sold puts in the mix. This is tricky with looking at open interest, since you can only have a best guess on how many of these contracts are the market expressing bullish trades or bearish trades (since you can open an options contract by selling it to an MM or buying it from an MM).
The main signal here we should look at is the size of the OpEx and the general tendency for the market to express bearishness in index options, so there should be lots of positive vanna and charm flows.
4. I really like optioncharts.io
5. Liquidity crunch is more of a macro flows thing, and doesn't affect this as much. Vanna and charm flows are micro structural market flows that happen based on options market positioning. One way the liquidity crunch could affect this is if the market positions more bearishly than usual because people are expecting a macro liquidity crunch going into the March OpEx.
6. This sounds like the impending liquidity crunch would dictate the Fed initiates QE again, and thus is a non-issue? Like isn't that the exact scenario that Ample Reserves is meant to tackle?
Yes. But macro liquidity is a continuous phenomenon while Fed policy is discrete (e.g. FOMC meetings or random emergency measures). As such, there are significant windows of macro weakness between a liquidity problem emerging and the Fed's corresponding actions that if you can foresee the liquidity problem coming, you can take advantage of these windows.
Hope this is helpful, always happy to answer more questions.
Excellent break down thank you.
So I got it backwards on the window of weakness, yeah? The Charm/Vanna flows are surging buying pressure up to and on the day of OpEx, then they disappear next monday since we're now far out from next OpEx.
With that buying pressure gone, "regular trades" (not sure what you'd call it) become the dominant market force again and can suddenly dictate a new direction -- as you outlined.
Couldn’t have said it better myself. Good stuff.
This is indeed a long one but I like how you think. Will respond fully soon.
I really appreciate it. I don't mean to suck away too much of your time from your research and regular posts with all that - just trying to engage and put some rubber to the road with all this new info I'm absorbing.
Cheers, and thanks for all the effort you've put into FinanceTLDR. Game changing for me
Thank you, means a lot, hopefully I can keep delivering good value. I love this stuff, writing and markets.