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After warning Wednesday night about hedges being lifted following the election, Tier1Alpha sees a scramble back into protection with the largest SPX put volume on record:
"Wednesdayโs massive hedge unwind likely left many investors considerably offside heading into the decline, triggering an aggressive bid for downside protection. Notably, SPX put volume reached its highest daily level on record, accompanied by a sharp increase in put/call skew and a jump of more than 5 vol points in fixed-strike volatility. Together, these reflected substantial demand for protection even as hedging costs became progressively more expensive throughout the selloff.
"On the dealer side, this created the opposite of Wednesdayโs setup, as renewed demand for protective puts left market makers with additional positive delta exposure that then needed to be offset by shorting futures, adding yet another source of selling pressure to an already vulnerable market."
Tier1Alpha says Wednesday's equity rally was boosted by hedge unwinds:
While there is no lack of interpretations of these relief rallies from a fundamental viewpoint, as usual, we approach them from a market structure perspective first. In this case, the common thread across these past occurrences comes down to the rapid unwinding of event-risk hedges, which can create substantial mechanical buying pressure regardless of whether the underlying uncertainty has actually been resolved.
We saw fairly clear evidence of this yesterday, with a sharp decline across multiple tenors of the volatility surface... Combined, these suggest that participants were aggressively reducing their demand for downside protection as election-related uncertainty began to fade.
...While the initial covering flows can provide a meaningful tailwind for equities, that source of mechanical demand is ultimately temporary. Once it has been exhausted, the market becomes increasingly sensitive to other sources of flow, which is essentially what we're left with today.
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