The underlying market structure is more important than you think
Market structure is an important driver of the price action. We all agree that excess liquidity is an important item but we need to understand better its impacts. I deeply believe that we are in a derivative bubble where cash price action has mainly become a derivative of the derivatives.
It can keep going as is for a long time but ,as a warning sign, we can observe that the bulk of derivatives volume is concentrating on shorter maturities.
We have “behavorial” recurrent anomalies which concentrate huge options volumes. The recent Tesla case is iconic. Tesla was responsible for about 50% of the SPX gain that day and about 50% of the option volume of the market.
Cash market volume is grinding higher
IPOs are +41% of the flow and the ratio Trade volume/listed issue is about 130% in the Americas (mostly USA but I do not have the exact breakdown)
Derivative volume is just amazing , has increased about 400% in 3 years and equity related represent + 64%
Options market makers concentrate in a small group of 5-6 companies and on several occasions we have seen stress arising due to intense speculative activities (ex: GameStop etc..)
Market concentration is also a result of liquidity. In fact …liquidity needs ever growing liquidity to sustain itslef. The 8 biggest stocks in the S&P 500 have a market cap of $11.7 trillion. That’s as much as the combined market cap of the bottom 394 companies in the index.
The derivative cloud is the most important driver as previously shown. (green = Calls Volume and Red = PUTs
Another way to look at it : Upper panel – Green = SPX index / Light yellow = 9 days Volatility Vix / Black = 6 month Vix futures contracts
Bottom panels – Green = Index Put/Call moving average (MA) / orange = Skew index MA (Skew is “expensiveness of options..) / Pink = Equities Put/Call MA
We have an interesting situation. Intense activity from, I believe hedgers, using Index (green ) Put options and even greater speculative activity on individual stock options (pink line) showing a staggering low reading for 2021 (Calls volume).
I am no option specialist but such market dynamics is either a structural change or a “temporary” anomaly. The 6 months Vix futures index has not been able to break down below 20-22 level. However, 9 days Vix and 6months spread, since 2016, shows wide and wild fluctuations which have usually resolved by volatility explosion.
How could this resolve? So far, buyers of VIX have been losing hard cash trying to hedge. Vix Sellers got hurt back in the mini 2018 mini crash. Index Put buyers are paying hard cash to keep going (Skew) and equities Call buyers think the party will keep going on. One possibility is hedgers getting tired and decide to reduce risk but…. park in cash?
The ratio UP/DOWN volume for the S&P 500 index (black line) has never shown such a behavior. The light green/gray line is the SPX index. If cash investors were to decide to come back and commit to the market we could see a spectacular meltup. Do they have the incentives to do so?
What we can observe is that the US market is still the only game in town. The ratio ITOT (US Total market) vs VT (Total World) keep grinding higher. I only hear about the “superiority” of the US market & economy comparing to its peers. Sometimes it sounds a bit like a cow always watching on the other side of the fence because the grass seems greener and more abundant.
This liquidity paradigm is best viewed as this: The U.S. stock market is larger than the next 11 combined
Basically the US Market is over-owned and fit the saying ” All roads lead to Rome”
Equity inflows in 2021 are topping the last two decades combined and stockbuybacks volume is gigantic too.
and IPOs volume has been phenomenal in years. Trump SPAC, ticker DWAC is maybe an iconic case.
The most important question is: Looking forward, will it keep going the same way?
