Expecting volatility before the EOY rally
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Yesterday was the October options expiry day, as we had another interesting week behind us. The market is clearly still in a very bullish mode, even though we saw some early signs of concern this week, in particular the fading of the Monday and Thursday rallies. The sellers haven’t given up quite yet.
We also got stellar NFLX earnings, with the stock jumping 11% on Friday, pulling most of NASDAQ along with it. Earnings season just started (only 14% SPX companies reported), and most of it was quite good. 79% reported a positive EPS surprise, and 64% a positive revenue surprise. But as you know, with earnings most growth expectations are coming from the Mag7 (see below), almost all of which will report in the next two weeks (TSLA next week, MSFT, GOOGL, AMZN, APPL, META all in the week after).
Talk about heavy concentration, huh?
The US election is 3 weeks away, as is the next FOMC meeting (Nov 7), hedging around the events is strong (option prices in that week are still relatively expensive), and for the next two weeks we are about to enter the so-called “window of weakness”, where the potential for a sell-off is typically higher than usual. In other words, the supportive flows are not as big as usual and we might get a correction as we enter the end of the month.
Before we go any further remind yourselves what this means by reading this piece again, explaining the importance of option flows and this definition:
A window of weakness basically means that if macro flows turn against the market for any given reason (like as a consequence of some major event), they are most likely to materialize during that window, where we don’t get the usual supporting market maker flows (e.g., even COVID for example did not start the major sell-off until after VIX expiration).
Does this happen every month? Obviously not, but it makes sense to prepare for it using hedges, knowing that the probability is higher, especially if we also see overbought conditions on the market, or are expecting a pullback due to negative macro data or whatever.
So we got Mag6 earnings (all except NVDA) coming up in the same window when supporting flows are lower than usual, while event vol is high due to the elections and the FOMC two days later.
What could all this mean?