Not what, but how

The key for the Fed today is not what they do, but how they do it.   The expectation for a 0.25% hike today is universal, and there seems virtually no scope for any sort of surprise on that front.  Where the uncertainty lies is on how the committee chooses to frame its decision, most importantly with regards to expectations for the future.

Readers may recall that at the time of the last (err....only) rate hike, the median FOMC dot plot forecast projected a further 4 hikes this year.  That clearly hasn't happened.   Ever since global markets took a stumble in the first couple months of the year, the Fed has taken a softly, softly approach to both its reaction to economic developments and its assessment of optimal policy settings moving forwards.

While the Fed is of course (cough, cough) apolitical, the surge in consumer and business confidence since the election, alongside a significant run up in risky asset prices, might ordinarily warrant an upgrade to the ho-hum forecast of 2% growth and inflation around target.  Then again, despite the apparent ecstasy in some corners of the business and economic universe, Trump hasn't actually assumed office yet, let alone delivered on his cornucopia of promised goodies.  Senate support for the infrastructure bill, for example, appears lukewarm at best.

It's therefore pretty easy to see the Fed standing pat on its growth forecasts.  Might there be some slight upward shift to the inflation forecasts?  Perhaps, though again any meaningful change will require an uptick in spot inflation (which may indeed be coming) or an actual change in delivered fiscal policy, not promised.

We're so used to the Fed delivering dovish surprises....is there another in the pipeline for today?  Well, the current one year forward median projection for the Fed funds is 1.125%...two hikes for next year.   There's not much room to ratchet that lower without a shock of bad news.

The two year forward projection is 1.875%, representing an aggregate of 5 hikes over the next two years (the second of which will not involve the current leadership.)  Is it possible to knock that lower?   Sure, though not by a whole lot.   In any case, it's also not clear that the market will listen in
its current ebullient mood.


What is interesting, however, is that for the first time since the end of the taper, market pricing has exceeded the median dot projection looking out two years.   While this is interesting in and of itself, term structure based policy models would view this as providing more leeway to tighten policy in the future.  While it also suggests that the market is ripe for disappointment, it's been pretty clear that developments in fixed income markets have been predicated on expectations for fiscal policy and the real economy, not monetary policy.   As such, markets may be willing to look through the "same old, same old" from Yellen and co.  After all, on short to medium term horizons the market has tended to trade on a momentum basis relative to Fed projections- taking developments bullishly when less than the dot plot is priced, and bearishly when more is priced.


One thing that does give Macro Man pause, however, is the technical picture in bonds.  US 10 year notes are exhibiting the sweetest example of divergence that you'll ever see, with yields making higher highs ever as momentum makes lower highs.  That's a classic example of a trend in exhaustion mode and ripe for a pullback.   Add in the looming prospect of pension rebalancing (quarterly and annual) and you could see a decent bid emerge for bonds in the coming weeks.

Macro Man has therefore dipped his toe this week and bought some Treasury duration.   While the Fed may seem unlikely to provide a catalyst, they may not actually need to for the trade to work.   With positioning extended and momentum waning, it's a classic set up for a bit of mean reversion.  There's never a guarantee, of course, but given that yields have held in there this week even as equities soar, just imagine what they might do if stocks ever have the temerity to tumble!

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Leftback
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December 14, 2016 at 1:34 PM ×

Smiling. Nicely explained, especially the recent move by Mr Market to be ahead of the Fed, which is very striking.

This might be an unusual Fed day, in so far as normally there is a dip in the morning, then at 2pm nothing happens, but Dame Janet appears and coos dovishly, after which punters buy the dip, shorts are squeezed and the market closes higher.

This time around there is a lot of very extreme positioning (bonds and the dollar are just two examples). Recently spoos and the vix have risen in tandem, which usually would indicate call buying, and indeed put/call ratios are extremely low as we head into options expiration, while margin debt remains very high. So there seem to be a whole lot of one-sided trades out there (long USD, SPX, XLF and crude; short TLT, JPY, gold and vol, to cite eight examples), with a great deal of leverage. What could possibly go wrong?

It's not always the case that MM and LB are on the same bus* at the same time. Usually, LB gets on the bus a few stops early on the dock road in the East End with the drunk skinheads and lager louts and has to endure an uncomfortable ride for a few miles, whereas MM seems to time things a little better. This bus ride to Bond Street is no exception.

*No jokes about the other bus, please. This is a mature blog.

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Leftback
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December 14, 2016 at 1:45 PM ×

Retail sales up 0.1%, [missed expectations of 0.3%.] Auto sales actually declined.... 12 month PPI is now at 1.3%. Crude topped out at $54 and is reversing as production cuts run into the wall of over-supply. C'mon, man, how is all that inflationary???

Don't forget that Dame Janet has been telling us that she is going to "run hot", so it's going to be lower for longer, folks. Cue a big reversal in the USD and yields. Today isn't about The Donald and reflationary infrastructure bills that may never pass on the floor of the House, it's all about real data and the thoughts of La Paloma Blanca.

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hipper
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December 14, 2016 at 2:32 PM ×

Was wondering about the bond-equity rotation theme. People say it's bullish, but how is it bullish if earnings yield goes down and benchmark risk free yield (10y) goes up as then risk premiums go down just even faster?

Also warming up to LBs muni bond idea for idle cash and perhaps some GDX as USD hedge. Additional question btw: does it make any sense for foreigners to buy those tax exempt funds, as I understood that tax exemptions don't apply to those payments the funds themselves receive but rather the payments funds send to the shareholders i.e personal tax brackets, which is a non issue for foreigners? And naturally the discounts are always larger for taxable bond funds as well.

It's really hard to conceive how yields could go back to the 4-6% Fed fantasy land, if for nothing else then just the sheer amount of private debt. Or they could, but sustainability is another thing. If the low hanging fruit of globalization during the last decades was higher growth and lower inflation due to supply moving where it's cheap and flowing freely to areas of high demand, then what happens when those revert? Inflation perhaps but it doesn't sound real but more artificial growth. Maybe tax revenues rise a bit but I'll just guess not enough to sustain that high yield levels. Steve Keen was actually talking about it in a recent podcast as well, bullish dollar and still relatively better US growth than others. Although when you look at competitors relatively "better" is hardly an achievement and also considering further potential EZ disintegration.

Ok sure there are infrastructure programs but everyone probably remembers the last time there were large infrastructure programs in the largest countries in the 1930s. It sounds kind of an end of the line ticket when you can figure out nothing else to do for the economy, and whatever shovel projects can be mustered up today aren't probably nearly as productive as the golden gate bridge or Autobahns.

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Leftback
admin
December 14, 2016 at 4:26 PM ×

Not to flog a dead horse, but US IP was down, it is down Y/Y for over a year now {there's your stronger dollar, btw}.

Yields are not going back to 4-6% fantasy land, b/c growth isn't going there either, not until the demographic depression ends, which is decades away for most developed economies. Aggregate demand is missing, AWOL, and isn't coming back soon.

The whole bonds to equity, value to cyclicals rotation meme was a big con. As usual, the Street pulled it off with aplomb, and the media joined in, but it was a con. The next rotation in equities is going to be cyclicals to utilities. Reality trades will once again "trump" the reflation trades.

@hipper, munis have already bounced and are well off the bottom (e.g. MUB), but especially the lower grade munis, check out the IQI ETF, for example. That is a smarter class of fixed income investor in there, usually.

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Anonymous
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December 14, 2016 at 5:52 PM ×

LB is right about yields not rising to 4+% (due to demographics etc)

He's wrong about the rotation into equities tho. It's already happening, and is a key driver behind this rally. Equities are going to extend this rally quite simply because the Fed will do whatever it takes to drive them higher, and will keep doing so until long after you've all retired.

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Unknown
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December 14, 2016 at 6:04 PM ×

When the dots move up your call may not be so pretty

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BuYsToCkS
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December 14, 2016 at 6:11 PM ×

F*ck the dots. No one ever took notice of those anyway; they were a puerile game for central bankers who spend too much time surfing for cheap german porn, and not enough time interacting with reality.

The buy programs are already commencing in equities, starting to accumulate before a massive algo ramp during the FOMC. Yellen will hike 25bps max and then dribble and mumble incoherently about any further hikes being "data dependent". Thus no more hikes for another year. One and done baby.

Come 2017, with the Dow Jones at 30k, people here will say, "I'm going to short spooz with 500 cts and then proceed to blow their accounts" ;) Now you know the future, go position accordingly.

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Nico G
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December 14, 2016 at 6:40 PM ×

Dow Jones 30k now hey

our cherished FM, 12yo, jbtfders Buystocks are the Kardashians of the forum. Young, hot, brash in your face, craving for attention, opportunists with absolutely no substance. Intellectually vapid with a serious big Afro American penis envy.

you could compare every market correction with the Paris robbery. A bit of rough reality thrown at you and you go silent. Not that i wish anyone to be robbed but some are clearly asking for it. This was Nico's celebrity special, live from Waikiki !


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hipper
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December 14, 2016 at 7:39 PM ×

Yup LB dipped a toe in BBN with intention to get deeper, being aware the happy clappy escape velocity story might be circling around for a while (a lot) longer. Looks like front end is buying the 3 hikes but long end undecided? We'll see what bucky does, EMs crushed and basic commodities a bit hurting. I don't know about DM equities but mind say's they are close to running their course. The funny thing is all Fed expectations since September seem basically unchanged, only the scale of them has been widened to downside and upside. If this continues it might not be good for REITs as yield curve flattens, specifically borrowing costs go up? But after all just an initial reaction. But it at least seems there was an attempt to provide a hawkish surprise but with basically unchanged projections I don't really get it.

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AB
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December 14, 2016 at 7:58 PM ×

Yellen: "... while we don't want to overshoot our inflation target..."

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AB
admin
December 14, 2016 at 7:59 PM ×

She also said that she never supported a "hot economy", but rather thought it should be researched.

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Anonymous
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December 14, 2016 at 8:14 PM ×

@Nico G
Priceless comment.
Must qualify for "Best in 2016".
Keep them coming.

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AB
admin
December 14, 2016 at 8:23 PM ×

Nico, you have the dip you expected. You buying?

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BuYsToCkS
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December 14, 2016 at 8:41 PM ×

Nico you old paper trader, we bought the dip post-FOMC and the DJIA is up +120 pts as I type. Nasdaq has shaken off all the fall, and buyers are stepping in. Equities are BID.

Sorry that you and your boyfriends here couldn't delight in the JBTFD failing... still at least you can watch some professionals (i.e. me) at work. Watch & learn son!

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Anonymous
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December 14, 2016 at 9:01 PM ×

@BuYsToCkS,

Are we looking at the same stock market?

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Nico G
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December 14, 2016 at 9:02 PM ×

AB

this ain't a dip yet - folks need to let that rate normalisation sink in. Call me crazy, but to me equities cannot go up with Fed QE and go more up once QE is reversed it is one or the other, and one already happened.

i love you BuysTicks ! i love your market comments 'as you type', they are terrific, that sense of urgency ! i'm sure you sound like Jack Bauer in real life, you probably trade without a helmet, i would never mess with you

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Shoeless
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December 14, 2016 at 9:04 PM ×

BuYsToCkS:

Key outside day down on the DJIA. I'll give you a few minutes to research that particular technical measure.

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Leftback
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December 14, 2016 at 9:08 PM ×

Driving the dollar higher here with talk of three hikes in 2017 really seems like something of a potential policy error, especially with signs of US economic data weakening, especially in manufacturing, auto sales and housing. The mortgage backed ETF MBB made fresh lows after this statement, and the 10y broke above 2.50%. This doesn't augur well for the mortgage market.

Will the FOMC now decide to use Fedspeak to walk back the three hikes to jawbone the greenback lower? Perhaps this is just another of the annual FOMC screw-ups. The market was already ahead of itself, and now the Fed has gone out even beyond that with its oddly hawkish projection, which will of course have to be revised lower during 2017, as they always have been.

Hard to see what else could possibly move the dollar up from here, certainly it will not be the real economic data. It will be interesting to see what the FX markets do with this overnight. Just to show what the rest of the fixed income world thought about this, the muni ETF MUB (and BBN) barely moved, JNK sold off modestly and IQI was actually up on the day.

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johno
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December 14, 2016 at 9:21 PM ×

Well, today was better than a kick in the head, which is about all I'd been getting since Nov 8.

LB, I'd agree with your assessment on rates not going to 4-6% fantasy land, except it's possible we have a burst of credit/money creation that allows debts to roll for a time at those higher levels. If that happens, all the secular stagnation bets will be wiped out before they come good. There's the end point and the path. I think the path is much higher rates for now. We'll see ...

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Nico G
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December 14, 2016 at 9:27 PM ×

LB be careful if the Fed would not normalise rates on every bout of euphoria post election they'd be naked on the next turn. I guess pretty much everyone agrees that Trump will have to deal with a horrid financial crisis. Not if but when (I'm firm on Q1 17). The Fed certainly knows that and they need to hike as much as they can before the real bond crash hits the fan. Expect another hike at next meeting.

You are right Fed revised lower in 2016 but they did it for political reasons, i bet my house on fire they wanted to keep markets afloat and not jeopardise Obama record until US elections hell, it was meant to help Dems get elected. With a Trump term soon to commence there is no revision down the road, if anything they are showing Trump that they can do their job that they can be big hawks and ironically, it will make things much more difficult for him.

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BuYsToCkS
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December 14, 2016 at 9:29 PM ×

Anon 9:01, Prob not. I'm looking at the real market, unlike half the paper traders here lol.

Shoeless, let me tell you about the DJIA. It's been rising for 27 days ! After a circa 2500 pt rise, a hundred pt fall is called a minor pullback. I'll give you a few minutes to research that particular technical measure pal.

Nico, I luv u 2 pal. Without you guys, who would take the other end of my trades and pay my mortgage? ;)

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Shoeless
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December 14, 2016 at 9:42 PM ×

BuYsToCkS, you bought the dip, which is the only trade I have any record on this site of you actually doing, so I will monitor your progress on that particular purchase with as much enthusiasm as I can muster for an internet jockey such as yourself.

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Nico G
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December 14, 2016 at 9:49 PM ×

the Dow. let's see - Dow Jones with components trading at x30 right? let's see what a 10Y yield going at 4% next year does to their balance sheets

if you buy dips to pay your mortgages you now have me worried son. I hope no beginner is reading and getting influenced by your posts

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maelstrom
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December 14, 2016 at 9:51 PM ×

At times the comments section on this blog reminds me of my first year on the trading desk. Loud, brash, emotional, pissing contests all over the place, jumping in with opinions on every topic, trying to standout in a room full of big egos. Isn't investing grand! Turned out it was all a show. A way to distract from our own insecurities. Some grew to be extremely thoughtful investors, others stayed the same. Age had little to do with it. I must say I do enjoy the banter from time to time, even if I mostly shake my head. "Stong opinions, loosely held", don't forget the last part.

RE: the curve. Sold our TBF position today for a nice gain. I do think the long end has a little more room to run, but not enough to keep me hanging on. That being said, I'm still not ready to buy out there. I see much better value in the 3-7 year range for now, and that's where we re-allocated.

RE: equities. I cringe to say we remain long US large and small, as we have been since the Feb dip. I cringe not because this has been a bad trade, but because I hate to feed the trolls. Given the market narrative we've observed all year (broadly negative, no strong catalyst) our goal was to remain long until we saw clear signals that the economy was turning. I have not seen anything convincing to date. So we beat on, but I fear it is towards the green light...we've been adding to REITs recently, some good value there I think (though not many agree with me), it is only relative value to be totally honest.

RE: vol. I think I last commented in July when we sold our XIV position. At the time F1-F2 contango was too high to make going long vol a good risk/reward. That rare opportunity arrive only briefly in September. We got short Vol again the day before the election as I was fairly confident in a Hillary win and subsequent market rally. Obviously I was dead wrong but trade worked wonderfully anyway and we exited before thanksgiving. Clearly we got lucky here, and I point this out because sometimes that's all it boils down to, and its important to realize this. No Vol position currently, contango is again too high to be long.

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Anonymous
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December 14, 2016 at 9:53 PM ×

Buy stocks but not because of stupid internet posting:

Buy stocks because:

1) options expiry week momentum: call overwriters, such as large pensions who have entered into vol-selling strategies in a desperate hunt for yield in recent years, will be rolling short-calls this week with expiry approaching. Because of the prior rise in SPX, the net-delta of the call-roll (they trade unhedged) will be to buy.
2) negative autocorrelation, or 'daily vs weekly variance' ... typically in the SPX, realized daily variance is higher than weekly ... ie, days of up then down then up moves, vs week-on-week moves being net smaller
3) positioning: up to you on what you believe here, but your Winton, Man AHL, your 300 bln CTA universe levered 7x and maybe max risk of 15% in one trade, your BAML Fund Manager Survey cash balance rule, etc and additionally the year-end seasonals have historically come into play in very late Dec (e.g. 2013)

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Anonymous
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December 14, 2016 at 9:53 PM ×

I will second shoeless, if BuYsToCkS had talked about buy DOW 27 days AGO, I would respectfully call it a wonderful trade. Now it is simply pathetic.

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Nico G
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December 14, 2016 at 10:02 PM ×

"Because of the prior rise in SPX, the net-delta of the call-roll (they trade unhedged) will be to buy."

unhedged and delta in the same sentence.... do you even read the gibberish that you lay here?

There is no delta indeed in that strategy. They do not buy back the front month (fees) they let it expire and sell next cycle. Fees is the name of the game here and frankly it's much cheaper to sell VIX futures

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BuYsToCkS
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December 14, 2016 at 10:19 PM × This comment has been removed by a blog administrator.
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Anonymous
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December 14, 2016 at 10:19 PM ×

frankly, do you deal with any US banks eq derivs desks, Nico G? They don't want the non-normality of the settlement risk/opening print. Fees is indeed the name of the game, which is why their salespeople get them to do the rolls ('friendly advice'). Vix futures and what you are really alluding to, systematic one-month OTC variance swap selling, is only done by advanced Canadian pensions, not someone like the University of Hawaii system, or the funds they hire on their behalf.

I can see why practitioners are reluctant to comment here regularly.

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Anonymous
admin
December 14, 2016 at 10:25 PM ×

Anon 10:19 - Ignore Nico, he's heading up amateur hour here.

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Macro Man
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December 14, 2016 at 10:52 PM ×

@Buystocks, if you can't be civil you don't belong here. No one is interested in bragging ex post about the trades you "did" and how much money you've "made". Unless you and your ilk want to say "I am buying now at x" and "I am taking profit now at y", your brand of cheerleading is probably best performed at www.harryhindsight.com

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koolbong
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December 14, 2016 at 10:58 PM ×

I daresay I miss 12yo... unlike the rest of the I-bought-Spoos-when-they-were-150-points-lower crowd his comments were tinged with genuine humour...

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Nico G
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December 14, 2016 at 11:36 PM ×

me too

Anon 10:19

i spent (a long time ago) my first 2 years as a quant marketmaking options at the biggest shop in Europe so yes, practitioner like you (?)

if you're saying US eq derivs desks follow up and help their clients roll their short call at a 'friendly fee' that is a remarkable service, but in reality any big desk will have sold and bought and sold that strike 20 times over the course of the month i.e. they will not have kept the mirror position of their client. Even if it's a monster OTC/block trade you are talking about, the vol book will have been hedged by a myriad of opposite positions call or put, and calendar spreads. I do not know settlement risk in the US but nothing can be worse than writing extremely short term gamma approaching expiry, right? Which is what you would do helping a client to unwind with a market trading around the strike. If the mirror position is gone why bother writing new 1 day or 3-day ATM calls and dealing with potentially ruinous 'sell under, buy above' neg gamma hedging when the client can just let his position expire.

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BuYsToCkS
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December 14, 2016 at 11:43 PM ×

Macro Man, no need to be a dick. I'm just answering the comments put by your pals. If you've ever managed multiple positions thru FOMC I think you'd realize no one has time to post buy here/sell there on some inane blog when running a large book. Further, I think you'll find the hindsight brigade are your pals Nico etc who pretend to sell a generational bull market and make money! Talking of which, why not delete some of their posts which are less than civil.

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Nico G
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December 14, 2016 at 11:48 PM ×

PS: because of the aforementioned problem regarding the short leg, call or put spreads are almost impossible to unwind before expiry which paints a VERY different picture than the crystal clear strategies sold in expensive academia books. If you want to take a profit on an option spread, you will probably have to hedge it and wait until expiry. Covering the short gamma above (call) or below (put) would eat up your profit since the eq derivs desks are NOT your friend.

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Nico G
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December 14, 2016 at 11:52 PM ×

BallsTuck,

if you have PLANNED your trades and your exit strategy there is indeed nothing else to do around FOMC besides feeding not-so-droll trolls like you. You might have read - not experienced yet - that successful trading is the most boring job on the planet

you are in MM house here he can be a dick all he wants once it's established that you are not bringing any value to his blog

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BuYsToCkS
admin
December 15, 2016 at 12:06 AM ×

Póso malákas íse? Look, when you graduate from playing on your retail demo account, maybe we'll ask your opinion ok?

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Macro Man
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December 15, 2016 at 12:22 AM ×

@ Buystocks you are the one coming here to pollute this space with profanity and inanity. "If you've ever run multiple positions over FOMC"....LOL. Better piss off to harryhindsight.com quickly...I think they're implementing a minimum age of 16 in the next week or so.

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Anonymous
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December 15, 2016 at 2:34 AM ×

Nico, for the call overwriter, there's no delta but there is for the dealer. Whether it goes to expiry or roll, if the market has gone up to close to (for rolls) or above (for expiry) the existing calls' strike, the dealer may or will be buyer of shares at expiry/roll so yeah Anonymous 9.53 is more right than wrong (depends on distance to strike when overwriting and I can't comment on that on US stocks).

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Leftback
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December 15, 2016 at 2:48 AM ×

Some of the 12y-os seem to have invented their own "pretend" market, based on their running commentary today. There are two more trading days left this week and it will be interesting to see whether the anons are right side up or upside down by Friday's close. The analogous week in December 2015 had very similar dynamics, a Fed rate hike, moving dots and Dame Janet's chatter, then options expiration. That week wasn't such a great one for the dip buyers by the end.

Most of us here think the dot plots are absurd, but really, someone on the FOMC actually thinks there will be SIX hikes in 2017? What can they possibly be smoking? The same person (presumably) predicts another SIX hikes in 2018 and a terminal FFR of nearly 4%. This is the Escape Velocity fantasy recurring again. The market should quickly be able to eliminate that wild card forecast as a complete fantasy. Even the consensus median FFR terminal rate of 3% seems optimistic, in the number and the rapidity with which it will be reached (2020ish). One voter sees a single hike in 2017, and then no hikes at all for a further two years….. Kocherlakota? Our guess is that this is pessimistic, but perhaps not by much. One 25 bp hike a year, for 4 years, would take us close to a terminal rate of 2% in 2020, and that's probably realistic - if we avoid another recession in between.

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AW
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December 15, 2016 at 5:57 AM ×

Is 'Negative Autocorrelation' just Anticorrelation? I'm guessing you are saying desks are short this dispersion effect and having to chase gamma's while the long side does not..? Confused by all these practitioners as usual.

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Nico G
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December 15, 2016 at 7:23 AM ×

anon 2:34 the dealer sold his delta on day one, and adjusts day per day the way of the gamma. He is gamma positive, he will not exacerbate markets movement like that other anon seemed to imply (not right or wrong he is just worrying about the wrong things). Anyway who cares, the dealer has another 100 positions long/short on all strikes on that expiry on both calls and puts (and if he trades other than listed, and adds exotic its even more), in the end his global gamma hedging does NOT affect market on expiry simply because as a professional he has made sure he is not running any stupid discrepancy/expiry risk. I did this for two years, there's maths behind your Greeks matrix that tell you what to do, its not hard at all

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Anonymous
admin
December 15, 2016 at 8:18 AM ×

anon 2:34 here. Agreed the +ve gamma hedge is not impacting the market or very marginally (anecdotally, the market is rather -ve gamma as LB also noted with dealers selling upside calls through the rally overall).

But we're talking about the roll, not the gamma hedging (or at least that's how I took anon 9:53 comment).
Most of the time, the expiring option will be OTM so no delta impact on expiry and the dealer just have to sell, as you said, to hedge the new call.

The point is that, after the kind of rally we had, the call overwriter sees the option he sold is now ITM and needs to close it *w/o delivering shares* (selling shares is generally not the point of overwriting) and will sell a new call.

So the fund (or practically, the dealer on behalf of the fund) needs to buy back the delta of the expiring call as they don't want to deliver and sell the delta of the new call but net, the flow will be buyer of shares.

Now this is in the case the fund does his roll on expiry day (and/or the market is way above the strike).

btw, not to engage into a silly contest, this is internet after all but have been trading or managing eq derivatives books for 16yrs

final note: I won't answer further here (privately if you want) as it's probably too detailed/technical for a macro forum

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