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Hedge Fund Manager Fill Zucchi Says Must Read

An Epic Battle Is Raging Beneath The Market Surface

Mohamed El-Erian Chimes In

Epic Battle Between Hedge Funds and Market Makers

ZeroHedge discusses the Epic Battle Between Hedge Funds and Dealers.

Short Explanation

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  • Speculators are buying out of the money calls on tech stocks at a massive rate.
  • As the stock rallies, the call sellers (generally the market makers) have to buy more and more of the underlying issue as a hedge leading to even higher call prices, even more call squeezing, even more delta-hedging and buying the underlying, which eventually spills over into more and more of the market, and so on until there is one massive marketwide meltup.
  • This resulted in the highest VIX print at a market all time high since, drumroll, the day the market peaked in March 2000, when the dot com bubble burst. 

  • Cross-asset guru McElligott, picked up on this saying that Gamma hedging has become "the most important flow in the market, with the convexity of said short-dated “lottery ticket” options creating an 'all-or-nothing' binary-options market behavior into weekly expiries, seen in these increasingly exponential ramps in names like TSLA."

  • With a large number of call contracts outstanding and “relative illiquidity” in some of these single-name shares, they have been forced to turn to proxies such as the S&P 500 and Nasdaq 100, according to Hennessy. In order to hedge, dealers have been buying implied volatility on these benchmarks too.

  • Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Over $1 billion of premium was spent and upwards of $20 billion in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years.

  • As the street got trapped being short vol, other names in the basket saw 3-4 standard deviation moves higher as well – on Wednesday FB rallied 8% (a 3 standard deviation move), NFLX rallied 11% (a 4 standard deviation move), and ADBE rallied 9% (a 3 standard deviation move).

ZeroHedge concludes:

"A few large hedge funds understood this and have added fuel to the fire by pushing implied higher and higher and putting further pressure on the likes of Citadel and Goldman. With this process helping drive names like Apple and Tesla, this also makes sense why Breadth has been so terrible."

"Over the next couple of days, implied vol during the day should be a phenomenal leading indicator."

When this unwinds it rates to be spectacular, perhaps even as much in the opposite direction.

I am not going to trade this. But if I did I would buy out of the money puts in small amounts until it worked.