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• Options Activity: OTM calls (esp. 20-30 delta) saw another day of profit-taking, more actively Friday than Thursday. Call sellers would ask for more premium in calls than presently exists. Long OTM put options volume, however, picked up further as investors perceive increased risk associated with US-Iran tensions.
• Valuations: Calls underpriced as traders cover long positions to lock in profits. OTM puts were bid up as investors continued to hedge against unpredictable geopolitical events.
• Volatility: A significant uptick in the 1-week GJR-GARCH forecast. Vol-of-vol remains range bound. Term structure and its slope, however, remains positive.
• Auction Market Process: Following Thursday’s initiative breakout, overnight geopolitical events resulted in an early session down-auction, although price settled at the high volume node, suggesting uncertainty in the price discovery process with 3235 acting as the market’s best estimate of fairest price.
• Bonds: Minutes of the Fed’s December meeting, released on Friday, reported confidence in the labor force participation rate and suggested it would hold rates low until the US economy generates more inflation.
• Macro: Mideast tensions rose on the US airstrike killing Iranian military commander Qassem Soleimani. (Jan 2: The PBoC cut the reserve requirement ratio 50 basis points and pumped $115 Bn into Financials – fueling rallies in London, Frankfurt, Paris, and New York.)
• Calendar: Fri, Jan 3: The Dec PMI® registered 47.2 percent, PMI®’s lowest reading since June 2009, when it registered 46.3 percent. Full report at https://tinyurl.com/sfhg62q | Upcoming: Mon, Jan 6 – IHS Markit Purchasing Managers’ Index™ (PMI™) Data
Taken Together: Heightened geopolitical risk in a market supported by liquidity injections by the Fed and marking new highs. Increased flows into the Yen, gold, and bonds. Profit-taking and increased allocations to protective puts in the options market. A more pessimistic volatility forecast by GJR-GARCH, a reversal in m(vol) Γ ATM, and a loss of upside momentum. These are the sort of conditions that result in an auction that either retraces to its last node or spends its time rotating – i.e. going net nowhere.