An unlocked sample of my weekly Meta Strategy Derivatives Portfolio newsletter. The current edition as well as an archive of previous editions can be found in the Member Area. Premium members have access to all reports and will receive the newsletter in a weekly email every Monday. Subscribe here.

Meta Strategy Derivatives Portfolio – Probability Map Update

This table maps my current data-driven estimate of the probabilities for future returns of the S&P 500 over the short term (1-8 weeks), medium term (3-6 months) and long term (6-18 months). It is updated each Monday with key market drivers, studies, price targets, model portfolios and trade ideas are all listed below the probability map.

For background information please read this article.
A quick guide on how to read this table and how to translate probabilities into a concrete portfolio exposure can be found here.

Significant developments since the last update

Eventually too much? 
The S&P 500 is blasting towards long term target areas and the chances that we are seeing too much of a good thing are rising yet again. 

In the light of the recent tendency of the stock market to largely ignore warning signs, I very cautiously add some short positions to hedge the gain in the portfolio’s long term S&P500 ETF position. I am now neutral to slightly net short (with more „reasonable” market behavior I would usually be decisively short at this point).

• “Buy The Gamma Dip” trade setup deactivated (update Wednesday): data shows increasing short gamma exposure in the individual stocks that are driving this rally causing an unstable upwards “crash”. This may cause the next correction to start very suddenly without a quick bounce back in its initial phase.
• Last week’s Gamma „unclenching“: a breakout to new highs led to a sustained up-move unhindered by volatility suppressing long gamma exposure.
• VIX / S&P positive correlation: rising volatility with rising stock prices was the biggest anomaly last week – one I pay special attention to as an early indication to an exhaustive end of a relentless & accelerating rally (e.g. in early 2018).
• Asymmetric trade ideas: the long Corn trade has seen great gains last week (long-term options are up well over 200% from the previous week’s low and time has come to take some profits – check back for intra-week updates below).
  Together with long Silver these ideas currently are the portfolio’s main profit sources while short- and long-term probabilities for equities continue to cancel each other out leaving no distinct edge.

August 31st Probability Assessment over the next 1-8 weeks 

Short / Neutral 40% : 60% (probability of positive : negative returns)
Conviction: Low
All index levels and probabilities are for the S&P 500 (including overnight futures) unless stated otherwise.

Probability ≠ Certainty: everything I state here are my personal ideas and best guesses, that I use to make my own investment decisions (I may hold positions discussed here). It is not investment advice. Everyone is responsible for their own investment decisions and potential losses.

Key Insights

(only change gradually and at major inflection points)

Current Market Environment (defined by Meta Strategy Indicators): Volatile Bull Market Regime

• Basic Premise: Market Environments tend to stick around – adjusting strategies to the current regime and trading with the trend has the best chances for success over the long term.
• Big Picture: two major scenarios. The Meta Strategy bull market regime indication makes the Bull Case the main playbook.
  • 1) Bear Case: The coronavirus shock becomes part of the top of a long bull market and this crash cascades into a longer economic downturn & severe bear market. We will see a new regime change should this scenario unfold.
  • 2) Bull Case: The coronavirus impact is strong, but temporary. Enormous stimulus acts like rocket fuel to propel economic growth to bounce back quickly.
  • Volatility has normalized, but the recent unusually positive VIX / S&P correlation is a new cause for concern. I expect choppy price action for a period of time after the relentless rally of recent months.

Current Influential Market Drivers

(details change frequently as new information is included continually)

• Technical resistance: I’m not a big fan of subjective trendlines (or slanted resistance lines), but a long-term view sometimes provides useful target areas where we can expect strong initial support or resistance. The range between 3530 – 3550 is such a resistance point. 

• Relentless momentum paired with a week of continuous up-gap openings: while positive over the longer term, similar momentum rallies have shown short-term mean reversion over the following 1-2 weeks. Specifically an additional acceleration with a series of 5 or more up-gaps in a row has often proven to be too much.
  However exuberant momentum is very hard to time – the safest entry is long after a significant correction.
• VIX / S&P positive correlation: rising volatility with rising stock prices was the biggest anomaly last week – one I pay special attention to as an early indication to an exhaustive end of a relentless & accelerating rally.
  This is paired with a longer term divergence between the S&P 500 Index (new highs) and the VIX Index (no new lows) and a narrowing dispersion of volatility (akin to the coiling of a spring before an eventual VIX spike).

• Recent studies still show short / medium term warning signals: lack of breadth, low short interest, low institutional buying activity (dark pools) & ever increasing options speculation.

• The Stock/Bond ratio reaches a new 4-year high: while this is often interpreted as a sign of exhaustion (as is extreme momentum) 90% of historical cases show higher prices in 6-months.
• Similarly positive over the medium / long term: momentum indications, new all-time-highs and the flow of money out of money market funds.
• 28.8. Gamma Exposure: @ 3505 = Long; Zero Gamma trigger = 3340; Call Wall/Top Gamma Strike = 3500; Put Wall 3000; Absolut Gamma 3500 (primer on gamma exposure). Market dips are prone to snap back through hedger’s buying activity and volatility is suppressed.
  In a new article I describe how rising options speculation and falling stock volumes make this hidden market force a stronger influence than ever before.

Studies Summary: Short term bearish, Medium term neutral, Long term bullish.

Conclusion and most probable scenario

We are in a bull market regime – the most profitable, „normal“ environment we see about 75% of the time.

Opposing results across different market studies effectively lead to a neutral outlook over the next few weeks. Current rising correlation between VIX and S&P500 tips the scale for my probability outlook to be short-term negative. 
In the light of the recent tendency of the stock market to largely ignore warning signs, I very cautiously add some short positions to hedge the gain in the portfolio’s long term S&P500 ETF position.

The most likely scenario is an overdue pullback followed by higher prices. A great long-entry point would be the first sharp correction in the new regime.

Main Fundamental market drivers

• Central Banks vs Recession = extraordinarily strong stimulus & biggest, sharpest GDP decline in history: This is the irresistible force meeting the immovable object.
  • Key question: economic slowdown vs. fiscal stimulus – what will be stronger? Evidence points to round #1 going to the FED and shows up in an increasing number of strongly improving fundamental indicators.
• Unemployment: consistently high initial claims are the weakest point in the recovery.
• Stock Valuations: are very high, capping prospects for a new, long bull market – specifically in big tech stocks. Unprecedented monetary stimulus may create the „Mother of All Meltups (MAMU)“ however.
• Coronavirus: after a full stop the world economy is restarting – economic data deteriorated to Great Depression levels and is now improving at a higher rate than expected.
  • New cases and infections in the US are slowly falling from a high level. Second wave fear is decreasing which could be a decisive factor in supporting the nascent economic recovery. The stock market is reflecting these recent positive developments.
    In Europe however the situation is now deteriorating with cases rising quickly from a lower level, but with less dramatic health consequences than in spring.
  • Overall the pandemic narrative is slowly becoming less influential.
  • Current Corona data

Further Outlook

• Bull Market Environment: signaled by the systematic Meta Strategy. This is the best trading environment because the bullish medium/long term outlook is aligned with the stock markets basic upwards tendency for high conviction setups.
• Exogenous Shock Bear Market: has ended in record time and I expect the fundamental picture to turn positive in the next months. We can now wait for signs of a new regime change from our Meta Strategy model rather than trying to predict highly uncertain long-term developments.

Target Areas for the Meta Strategy Derivatives Portfolio

Please check back during the week for new updates at key levels.

Long Targets	target reached	comment	target probability	derivatives exposure change*
3400	yes	all time high		add hedge / short √
3520 – 3550	yes	long term target, resistance area		add hedge / short** √
3600		long-term target		add short

*size of planned exposure changes = max. position / number of targets (details in planned portfolio adjustments)
** hedge / short position equals long S&P ETF for neutral to moderate short exposure at this point

Short Targets	target reached	comment	target probability	derivatives exposure change*
3360-3410 (close below)		breakdown below short-term trend / zero gamma		add short
3280 – 3310		support area, last minor high	min. target	reduce short
3150 – 3230		medium-term trend, retracement cluster	main target	close hedge, add long
3000 – 3060		long-term trend, significant low	max. target	add long

*size of planned exposure changes = position / number of targets (details below)

Current Trade Setups

Check back for updated tables during the week when indicated key levels are reached.

Buy The Gamma Dip: (High probability short-term trade – trade setup & rules)

Enter long S&P 500 at any random 1-2 ATR (30-day average true range = average daily market move) dip in an uptrend. Trade setup activates with long gamma exposure and a new S&P 500 intermediate high (check back for updated table at key levels during the week).
I add these very short-term positions independently of the portfolio exposure indicated in the target areas above.

Trade Idea: at long gamma exposure option market makers are forced to buy market dips to adjust hedges, often causing a quick snap back rally. The Zero Gamma Exposure level is an important support area.

Preferred Instruments: ES/MES Futures (adjust prices in table -8 points) or CFD; probability for success = 70%

High S&P	Entry 1 H-(ATR+15)	Entry 2 H-E1-0,5xATR	ATR (30)	Avrg Entry	Stop Loss	Profit Target 1	Profit Target 2	Risk
3550			46					1%-2% NAV

The Meta Strategy Derivatives Model Portfolio

Please check back during the week for new updates at key levels.

Full disclosure: these are the current positions and instruments I am invested in with the capital dedicated to the Meta Strategy Derivatives Portfolio.
A balanced exposure to the current probability estimate is achieved by combining long-term ETF positions with derivatives that are held short-term.

Positions may change at any time – roughly according to the target tables above, but exact entry and exit points may vary. Instruments are not a recommendation as there are many equally valid ways to express current probabilities; e.g. ETFs, volatility products, CFDs, futures and many more. Also the decision of how to set maximum leverage and risk levels fits me personally and every trader has to be mindful of their own risk tolerance.

Investment Portfolio: the Meta Strategy Aggressive ETF Portfolio (with 80% of the capital dedicated to the Meta Strategy Derivatives Portfolio)

• Meta Strategy long term exposure: 50% S&P 500 ETF & 50% Gold ETF according to the monthly Meta Strategy newsletter.
  • planned portfolio adjustments: switch to leveraged S&P ETF: sell S&P ETF at upper target area & buy leveraged ETF on pullback.
  • maximum risk (approximate distance to exit): S&P 500 ETF: 10% – 12%; Gold ETF: exit above entry
  • positions: a hypothetical 100k portfolio would hold 40k in SPY and 40k in GLD
  • comment: gold shows great relative strength and I will continue to hold the position as a diversifier and to safeguard against possible deteriorating conditions. Solid long-term outlook now justifies a switch to leveraged equity ETF.

Trading Portfolio: derivatives sleeve (20% of capital – the size of this is the decisive factor for the maximum level of portfolio leverage)

• 80% Cash (or up to 20% in asymmetric alternative trade ideas)
• 20% Put ES/SPY: buy Dec 3200/320 Put for 3%-4% NAV @ 3520-3550
• Covered short Call SPY: sell 1 Nov $345 Call per 100 SPY near 340 (yields about 3,3% in premium); hedges roughly half of the ETF movement and provides income when nothing significant happens.
  • recent trades: Buy ES/SPY Put; asymmetric ideas: long Silver re-entry; long Corn take profit on partial position (see updates below).
  • planned portfolio adjustments: Buy ES/SPY Put (Dec 3200 – 3%-4% NAV) at trendline resistance 3520-3550, add on breakdown below short-term trend. Then reduce hedge and add long / short volatility positions on pullback (3000 – 3250);
    Potential independent long position in „Buy the Gamma Dip“ trade setup.
    Alternatively, if ETF switch to leveraged ETF is planned: sell S&P ETF instead of buying put.
  • maximum risk: short call limits profit potential of ETF in exchange for premium; Put: 50% of premium; asymmetric ideas: individual trade risk
  • positions: a hypothetical 100k portfolio would hold 16k in Cash, 4k in ES/SPY Put & covered Calls on 40k SPY (one call per 34k = 100 SPY); additionally: asymmetric trade ideas (Silver, Corn).
  • comment: The short call position takes advantage of quiet time decay and earns a little bit of premium every day.
    Best new opportunity will be long after a pullback to the main target areas.

Current Portfolio Leverage Level (approximately, stocks only): short / neutral (this can be adjusted by dedicating a different percentage of available capital to the trading portfolio which will influence maximum leverage levels strongly)

Trading Opportunities with highly asymmetric potential

I will track these opportunities (identifying good entry & exit points each week) in this separate section to keep the model portfolio uncluttered – they can simply be added to the Trading Portfolio allocation keeping in mind position correlations and individual maximum exposure limits.

Working thesis
We are in a speculative environment that is now supported by a bullish long-term market trend. Strong momentum often holds for considerable time before turning around violently. I try to identify setups where a strong momentum move is clearly visible, but still has potential to keep on running. We are playing with fire and face one of the hardest questions in investing: for how long to follow the wisdom (insanity) of the crowd and when to turn contrarian? Small position size and risk control is paramount.

How to trade it
Most of the ideas are aligned with an anticipated or beginning parabolic move that will either happen fairly soon or else fail. I prefer playing these trades with directional long-term (3-6 months+ to expiration) OTM options: they will leverage the move and keep risk constrained to the amount of premium paid – a small position can go a long way in a parabolic move.

Long Silver (SLV): Silver is consolidating in a parabolic bull market. Precious metals have significant fundamental drivers behind them; they historically performed strongly after economic troubles, during heightened inflation expectations and loose monetary policy. 

I expect high volatility and steep pullbacks, but the basic idea is intact and an uptrend could last for several months (the 2011 high is a long way off). 

Current hypothesis: conditions are similar to 2010 – 2011 albeit with an even more extremely loose money supply. Hence the parabolic Silver bull market plays out faster and may overshoot to the upside this time. The current consolidation could mark a fraction (e.g. half-time) of the bull market.

• Update (please check back during the week for new updates at key levels) 
  SLV has now been consolidating for two weeks and shows tentative signs for a new up-trend along the 20-day moving average.  An accelerated breakout above $26,5 and $27,5 (daily close) would validate this thesis and provide additional entry points.
  We reached the first pullback target for SLV ($23-$24,5): re-entry area for a partial long position (50%). If the correction extends, the next target is $21-$22.
  I see this consolidation as a great opportunity to add on a 10%-25% dip lasting 1- 4 weeks.
  
  This trade is a rare opportunity and my favorite for the moment. 
• Position management: 
  Last week: Re-entry for second partial long position (now 1/2 of a full position) at -10%+ reached (SLV $23-$24,5), rolling up to the Jan $30 Call. 
  Add to long in consolidation (SLV $21-$25) or breakout ($26,5-$27,5) to build a full position over the next 1- 4 weeks. 
  
  Careful: decreasing volatility is impacting option prices in addition to a falling SLV price which may lead to orders being filled at higher price points in SLV than anticipated (this happened last week for example: a Call order aimed for SLV $24 was filled above $24,5). 
• SLV Entry: add on 10%-25% dip; Instrument: Jan $30 Call; Position size: 3%-4%; Risk 50%-100% of premium (1,5%-4% NAV); increase position size by re-investing realized profits and roll up call strikes & expiration dates.

Long Corn Futures Options: agricultural commodities are starting to follow the commodity up-trend.

Inflationary FED policy provides a tailwind for real assets. As one of the cheapest assets Corn has turned up from a multi-year bottom area and reclaimed its medium-term moving averages. This gives at better than even chance for continuing higher prices with a superior reward : risk ratio. 

The recent strong advance has cooled off “smart money“ hedger’s large long position – overall short positioning in the agricultural sector now points to a higher probability for a consolidation.

As we are also approaching the first target area taking profit on half the position is prudent – place a break-even stop loss on the remaining position to participate in a potential long bull market.

• Update (please check back during the week for new updates at key levels):
  Profit target (close 50% of position): 350
• Corn Entry: let the remaining position ride and watch for a breakout above 357 – a larger pullback would then be the next good entry opportunity for a call further up and out.
  Instrument: Dec $360 Call; Position size: small @ 1%; Risk 50%-100% of premium (0,5%-1% NAV).

Interesting things I read this week

• Unusual anomalies in volatility: rising VIX / SPX correlation and falling VIX dispersion.
• The case for precious metals by Crescat Capital.

Have a great trading week!

David

Disclaimer

This report is a description of my own investment approach and ideas and I personally invest in the Meta Strategy Derivatives Portfolio. The content of this letter is for entertainment purposes only and not meant to be investment advice to others.

I am not an investment advisor and I do not provide individual investment advice. None of the ideas in this letter are meant to be construed as professional financial advice.

Your investment decisions are solely your own responsibility and I am not legally or financially responsible for any losses you may incur from reading or using the content of this letter.

© 2020 David Steets, all rights reserved – please be fair and do not distribute without my permission