OpEx, Then Fireworks
Historic Surge in Oil
We just saw the largest weekly percentage gain for oil in history. The market made the mistake on Monday of buying the dip in equities and selling the rip in oil. It was pricing the initial attacks on Iran just like the “Midnight Hammer” attacks last June, i.e a 1-day event. The market failed to realize when you assassinate the leader of the country… and the next 5 who are in-line… tensions generally don’t fizzle-out the next day.
S&P 500 Stuck in a Range
Despite the surge in oil prices, the S&P 500 has barely moved. This is the tightest range for this point of the year in the history of the S&P 500 going back to 1928.
Quarterly Options Expiration (OpEx) is this upcoming Friday. It has been a large driver of the lack of movement in the index. Colossal option volumes mean that dealers on the opposite side of the trade have a TON of hedges. When the market rallies they sell their long-hedges, when the market falls they buy their short-hedges. Keeping the index flat despite violence beneath the surface. However, once OpEx passes, tons of options expire, tons of hedges get closed, and then the market can REALLY move.
S&P 500 Hanging by a Thread
We got the first inclination that the range might finally be breaking, right on cue. Friday was the first time the S&P 500 has closed more than 2% away from the 6900 strike in over 52 trading sessions!
”The spread between VIX and SPX 1-month realized volatility (a broad proxy for the volatility risk premium) is now in the 99th percentile. Either the VIX is pricing in too much premium or realized volatility is about to explode higher.” - Tier1 Alpha
To put it simply… fireworks are coming. Whether that is means a surging market or a crashing market is a completely separate question.
… but let’s investigate.
Private Credit Time-Bomb
While the market ‘could’ surge higher in the coming weeks, it is likely to be short-lived. We think the more likely scenario is a sharp sell-off.
To put it simply, private credit is a ticking time bomb. Every true market crash is normally a combination of leverage, illiquidity, and concentration. Private credit has all 3 in spades.
As the chart above shows, public markets (CDX IG, dark blue above) are not pricing this tail-risk because it is only private credit proxies that are selling off (think OWL stock), not the private space itself.
Real Economy Under Pressure
While Iran and oil stole all the headlines, we had the worst jobs prints since 2020 on Friday (excluding October Government shutdown). February nonfarm payrolls came in at -92k vs. a +55 estimate.
This is less to say that a break in the S&P 500 range will down, and more to say that ‘if’ it is down, you already have a fragile fundamental economy that will be then faced with falling stocks prices. Generally, a horrible recipe.
Putting it All Together
The S&P 500 is in a historically tight range
This range is largely driven by the growth of options, and dealer hedging
OpEx in a few days means we likely break higher or lower
While we may break higher, this is an opportunity to put on shorts
Oil is overbought in the near-term but Iran is NOT a 1-week conflict
Private Credit is a nightmare with zero upside and the tail-risks are huge
The real economy is extremely fragile and the deterioration will accelerate if stocks fall