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Meta Strategy Derivatives Portfolio – Probability Map Update

The dashboard shows 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), followed by a detailed probability map table. These are updated each Monday and are followed by a review of key market drivers, relevant studies, price targets, model portfolios, and trading ideas.
Please check back for updates around key price levels during the week in the “Current Exposure” section below.

Further intra-week commentary: follow me on Twitter: @indievesting.
For background information, please read this article.

Probability Dashboard

Research and Analysis

Pullback Mode

It was good to see the market trade, almost right away, in accordance with recent warning signs, which showed it was facing increased vulnerability. Such a timely counter-trend reaction is certainly not always the norm, if we remember the monthslong low volatility advance of 2017, or the relentless crash and rally this spring. 

After dropping roughly 2,5% from its recent high the S&P 500 saw a vigorous bounce off the top of our main target area, which is defined by the zero gamma level, short-term trend (the 20-day moving average), and the last major high in September (3590 – 3640).

We are still facing a short window of seasonal weakness through this week’s quarterly option expiration, as we can expect major influences from the options market during this period. It may pin the market around the zero gamma level or pull it up to major open interest areas around 3650 or 3700; However, a strong drop would likely be accelerated by the increased volatility of the short-gamma territory below.

I don’t have a strong conviction for a move in either direction during this time window, but intuitively I think that the current target area is likely to hold. I would not be surprised by a series of tests of this strong confluence of support, much like we saw from 10/15 through 10/23/2020 — a good opportunity to further build long positions.

In contrast to pre-election weakness in October, I currently see higher chances that bullish year-end tendencies may re-assert themselves quite soon — even if the pullback stays quite shallow. 

Recent sentiment extremes could continue to build into the new year, which would then likely be followed by a strong correction.

Current Exposure, Trades, and intra-week Updates

A summary of changes and planned activity. (Find detailed price target tables, risk management, and model portfolios below.)
Updates, as announced in the Member Area, will be listed here as green text.

After taking profits on a majority of my long position, the market immediately pulled back. I added one long position on a dip to the upper boundary of our main support area (3590 – 3640).
I plan to add one more long position at a re-test of the support area. Should we instead close above minor resistance overhead (3670 – 3680), I plan to add long there on a re-test.

Update December 16, pre-market: (position details in the model portfolio section below.)
We closed above the first resistance area yesterday, and I will now add a S&P 500 call postion on a re-test at 3680, as I just missed buying into Monday’s dip towards the main support area.
The Zero Gamma level has moved up significantly to 3645.
Silver has also closed just above its correction channel and after strong open today is a buy from $24.5 to $24.7.

Update December 18, pre-market: (position details in the model portfolio section below.)
I am still waiting for a re-test of 3680 to add long — I have corrected a mistake in the table below: it is now listing the correct breakout level at 3670 – 3680.
The Zero Gamma level has moved up further to 3670, and is now coinciding with the breakout entry.
A new “Buy the Gamma Dip” setup is now active with a fresh high in the S&P 500.
After a successful entry Silver is displaying strong momentum, making a resumption of the bull market more likely. I now put a break even stop loss in place. Thursday’s close above the key $26 level gives an additional entry opportunity on a retest.

The basic idea is to buy dips in year-end strength, take partial profits at long targets, and keep the risk of derivatives positions controlled with a break-even stop loss or appropriate position sizes.

Probability ≠ Certainty: All that I state here are my personal ideas and best guesses, which 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

(These change gradually and at major inflection points)

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

• Basic Premise: Market Environments tend to stick around, so adjusting strategies to the current regime and trading with the trend have the best odds for success over the long term.
• Market Regime: We can now wait for signs of a new regime change from the Meta Strategy model rather than try to predict highly uncertain long-term developments.
• Big Picture Bullish Scenario: The coronavirus impact is strong, but temporary. Enormous stimulus acts like rocket fuel to propel economic growth and asset prices. (This scenario remains in place as my main investment thesis until the Meta Strategy signals a new Bear Market Regime.)
• Volatility is reacting to the current pullback, but my market environment classification remains a stable “Quiet Bull Market Regime”, unless we break through the strong support zone from 3590 to 3640.

Current Influential Market Drivers

(These details change frequently, as new information is included continually)

• Strong trend and market breadth: Very strong trend and breadth signals continue to be the main bullish backdrop, as I have highlighted in each of my last reports.
  Such an environment does not usually turn on a dime. More likely, weakness will become visible underneath the surface (e.g. new index highs carried by fewer and fewer stocks), preceding a serious price decline. 
  But the current short-term pullback is very normal in light of the extreme readings we were beginning to see last week — several studies highlighted a short-term “too much” last week, adding to other warning signs. (E.g. combined breadth strength: 90 % of stocks, 100% of industries, sectors, and countries above 200-day ma; New highs in all major indices simultaneously.) This points to some more room for the pullback to continue during the week, likely followed by new highs.
  For this week, I show an independent backtest for a momentum signal from the McClellan summation index of the NYSE, which led to positively skewed returns over all time frames in the past.

• Nasdaq’s extraordinary run is finally broken: A multi-day low immediately following an all-time high paired with very high RSI readings points to continued weakness for a week or so, usually followed by continued strength fairly soon.
• Seasonality: The December of an election year has a very strong track record, and the majority of those gains tend to happen in the second half of the month, carrying over into January.

• Bubble detectors flash red: An increasing vibe of 1999 is in the air, with frenzied tech IPOs, and a telling magazine cover on the current issue of Money Week . But a bubble is hard to define, and it is even harder to time its top.

• Sentiment and option speculation: The pullback from recent highs hardly made a dent in indicators, like Small Trader Call Buying levels, or the Options Speculation Index, while the extremely low Equity Put/Call Ratio is normalizing very quickly. Overall there is some way to go to flush out excessive sentiment. However, it is historically not uncommon to see a continuing build-up into the new year (likely followed by a strong correction).

• Liquidity flows from the options market: A large amount of gamma exposure expires in next Friday’s quarterly OpEx, which will open a window of increased vulnerability, that may resolve in either direction as the market becomes “unpinned” from the strong influences of long gamma exposure. 
  Traditionally, the market tends to be supported into the new year, as dealer hedges continue to unwind with the passing of time and falling volatility. But increased danger for high volatility below the zero gamma level remains as the other side of the coin.
  Additional support comes from new and reinvested capital at the end of the year.
• 12/11 Gamma Exposure: @ 3660 = Long; Zero Gamma = 3620; Call Wall/Top Gamma Strike = 3700; Put Wall 3650; Absolute Gamma 3650 (details about gamma exposure).
  The zero gamma level provides support, and price dips into that region can be bought with well defined risk (stop loss below 3580). The “Buy the Gamma Dip” setup (see below) takes advantage of this pattern, and last Friday was a good example how this can work out.

Conclusion and most probable scenario

We are now in a Quiet Bull Market Regime, the most common environment, which is usually the best time for my trading approach. I am confident to take on high conviction trading positions that lead to maximum portfolio leverage (and high volatility) at times.

The uptrend is showing minor weakness, as was to be expected to happen at some point in the face of exuberant sentiment. 

My primary scenario is that momentum has been impressive enough, so that any weakness should remain temporary, and the uptrend should resume, supported by traditionally bullish year-end tendencies. I react to the current pullback by going long opportunistically during the coming week’s potential window of weakness, as excessive sentiment normalizes.

I continue to watch the zero gamma level as a potential flip point, in case my main thesis turns out to be wrong, as deflating euphoria could also derail the rally further.

Main Fundamental market drivers

• Central banks and fiscal stimulus: Money supply is gaining in velocity, which is highly correlated with a rising stock market. A stimulus bill in limbo may influence market direction, depending on how it is resolved.
• Economic recovery is slowing: New global lockdown measures to combat rising Coronavirus infections make the possibility of a contracting GDP in Q4 a real danger. But overall an improving economy is a long-term tailwind for stocks.

• Stock valuations: Valuations are high, capping prospects for a new, long bull market, specifically in big tech stocks. Unprecedented monetary and fiscal stimulus, however, may create the “Mother of All Meltups (MAMU)”.
• The pandemic as a “Great Disruption”: Another interesting thesis is the potential return of the “Roaring 20’s” through the high-tech revolution of the 2020s.
• Coronavirus: After a full stop, the world economy is restarting, with economic data improving from Great Depression levels. But the winter wave is causing a new slowdown.
  • New cases and infections are showing some signs of reacting to new lockdown measures globally — the stronger the lockdown, the better the result.
  • Vaccine optimism: recent news about a viable vaccine is increasingly positive. This is the one thing everyone is looking for to get us out of this mess.
  • Current Corona data

Further Outlook

• Bull Market Environment: signaled by the systematic Meta Strategy. This is the best trading environment because a bullish medium/long term outlook is aligned with the stock market’s basic upwards tendency, allowing for high-conviction setups.
• Exogenous Shock Bear Market: has ended in record time, and the fundamental picture has now turned positive (a switch from red to a green Meta Strategy signal). We can wait for signs of the next regime change from our Meta Strategy model rather than try 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*
3670 – 3680	yes	breakout area, on close above		add long**
3715	yes	last high	min. target
3730 – 3750		upper trendline resistance	main target	reduce long
3830 – 3880			max. target	reduce long
3920 – 4000		long term projection, measured move	extreme target

*Size of planned exposure changes: individual position sizes normally are 25% of the trading portfolio capital.
**To enter long after breaking through resistance I generally use this method: after a daily close above the resistance area, enter on a re-test. A check mark indicates a successful breakout, re-test & entry.

Short Targets	target reached	comment	target probability	derivatives exposure change*
Gamma Dip Table	yes	entry level adjusts with new highs	random target	long entry √
3590 – 3640		last high, strong support	main target	long entry
3500 – 3550		major support	max. target	long entry
3410 – 3460		strong support

*Size of planned exposure changes: individual position sizes normally are 25% of the trading portfolio capital.

CURRENT TRADE SETUPS

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

Setup levels adjust with new highs — please check back for updated table during the week when indicated key levels are reached or new highs are made.

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.

I add these short-term positions independently of the portfolio exposure indicated in the target areas above, or use the setup to fine tune the entry into portfolio long positions, when levels coincide with my trading portfolio’s target areas – be careful not to overshoot maximum exposure levels. Depending on how close I am to my desired overall exposure, I may give priority to the exits in the target tables 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 — it can be used to calibrate entry points; the stop loss level should be placed well below zero gamma.

Preferred Instruments: ES/MES Futures, options or CFD; probability for success = 70%; check marks indicate filled trades.

High S&P (ES) 12/9	Entry 1 H-(ATR+10)	Entry 2 H-E1-0,5xATR	ATR (30)	Avrg Entry	Stop Loss	Profit Target 1	Profit Target 2	Zero Gamma
3715	3640 √	3607,5	65	3623,75	3537,5	3710 √	3750	3620

New setup active Dec. 17th:

High S&P (ES) 12/17	Entry 1 H-(ATR+10)	Entry 2 H-E1-0,5xATR	ATR (30)	Avrg Entry	Stop Loss	Profit Target 1	Profit Target 2	Zero Gamma
3725	3665	3640	50	3652,5	3585	3720	3750	3670

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 2x leveraged ETF & 50% Gold ETF according to the monthly Meta Strategy newsletter.
  • planned portfolio adjustments: switch from gold to equities in the coming months on gold strength paired with weakness in stocks.
  • maximum risk (approximate distance entry to exit): S&P 500 2x leveraged ETF: 15% – 20%; Gold ETF: exit above entry
  • positions: a hypothetical 100k portfolio would hold 40k in SSO and 40k in GLD

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

• 50% Cash (or up to 20% in asymmetric alternative trade ideas)
• 50% S&P 500 Call Options (ES/SPY June 3800/380 Call Options); mental break even stop loss on entire position.
• recent trades: added 25% S&P 500 calls at target (3630)
• planned portfolio adjustments: take advantage of rallies and pullbacks to roll options further up and out in expiration.
  Add long (25% ES/SPY June 3800/380 Call Options) on retest of major support area (3590 – 3640), or on resumption of uptrend above next resistance level (3670 – 3680).
• maximum risk: 50%-100% of option premium — always size positions so you can tolerate a worst-case loss of the entire option premium!
• positions: a hypothetical 100k portfolio would hold 10k in Cash and 10k in S&P 500 Call Options; individual position sizes normally are 25% of the trading portfolio capital. In practice I often split these into smaller portions to enter / exit at several points within the indicated target areas.

Current Portfolio Leverage Level (approximately, stocks only): 3x long (this can be adjusted by dedicating a different percentage of available capital to the trading portfolio which will influence maximum leverage levels strongly)

Opportunities with Highly Asymmetric Potential

New Ideas
Recent trade: Gold position closed at profit target (1860).

I will continue to monitor precious metals for a resumption of their bull market.
The next signal on my radar is in Silver, when it closes above its correction channel (currently $24.5).

Trade idea: Long SI $28 May’21 call option (or SLV equivalent) on close above $24.5.
Position size: 1% – 2% NAV; Risk: 50% – 100% of option premium; Stop Loss: Close below upper channel trend-line.

Update: After a successful entry on Wednesday Silver is displaying strong momentum, making a resumption of the bull market more likely. I now put a break even stop loss in place. A close above the key $26 level gives an additional entry opportunity on a retest.

Have a safe 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