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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). It is updated each Monday and is followed by a detailed probability table, 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 Trades” section below.

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

Probability Dashboard

Research and Analysis

Decisive OpEx

After riding the market successfully on the long side for several months, the time has come to switch the model portfolio’s exposure to neutral and then to short during the coming days. Supportive forces, coming from option market makers as they unwind their hedges, will peter out by week’s end. On Friday, the last chunk of the US election hedge (put options) will roll off the books, which will leave the market hanging in thin air, unpinned from long gamma exposure.

Initially, remaining gamma is likely to exert a mean-reverting influence on the strong relief rally we saw last week following the dissolution of uncertainty about the US elections and the quelled riots in Washington. The highest concentration of SPX option gamma at the 3800 strike will act like a magnet during the week. (The price swing around 3800 last Friday afternoon was a perfect example of how this often plays out.)

Therefore, I switched my portfolio’s market exposure to neutral by selling my last long position as we clipped my maximum target on Friday. Another good opportunity to sell should be on Monday morning. (The long-term ETF position remains untouched and is completely hedged by a put option bought last Thursday.)

Monthly option expiration on January 15th will open a window of potential weakness for about one week. The market is likely to attempt a breakout, but “unpinning” of price implies that an acceleration to the upside is as much a possibility as a break to the downside. 
An overstretched rally and excessive speculation make a downside move the path of least resistance.

The downside scenario is the one I will position for during the week, with a plan to add more short positions when a corrective move confirms itself by breaking through support at zero gamma and the 20-day moving average.

As I want to stay prepared for both possible outcomes, however, I will keep initial short positioning at a small size while watching my next upside target in case we fail to see the anticipated downside acceleration.

Make sure to check back for updates in the “Current Trades” section, as entry and exit levels may change during the week, if initial targets are not reached on time.

Current 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 in green.

I added a hedge (3800) and took remaining profits at the maximum target (3830) at the end of last week. Depending on the strength of Monday’s open, I will add a short position at the upper range of my maximum target area (3850-3870) — I plan to adjust this entry level should the order fail to be filled until mid-week.

Update Tuesday January 12 — pre-market

Major Red Flag: On Monday we saw a reliable warning signal appearing for the first time. VIX was up over 10% while the S&P 500 was down by only a few points — a continued rising VIX in conjunction with a rising / neutral S&P 500 would be abnormal, and is often seen before the start of a correction.

In light of current expectations, I lower my entry level for the planned short position to 3800 today.
I now hold 50% of the trading portfolio in S&P 500 put options (25% hedges my long ETF and 25% tilts the portfolio’s market exposure short).

The “Buy The Gamma Dip” trading setup is active, but I will not enter new positions during a window of potential weakness from 1/11 to 1/25.

The basic idea is now changing to expect a larger correction in the beginning of the year. After taking profits at long targets, exposure will now tilt increasingly short. 

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 stable around Vix 20, and my market environment classification remains a “Quiet Bull Market Regime”.

Current Influential Market Drivers

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

• Breadth is making a comeback: A breadth composite shows recent highs to be back in the 90th percentile of historic breadth readings since 1928. Such broad strength is one of the main reason for a long-term positive outlook, but very high readings also point to increased chances for a short-term breather — this is further supported by odd intermittent weak days in breadth we saw recently.

• Increased certainty starts rally: Following the results of the Georgia runoff election and the quelled riots in Washington, the stock market rallied. However, new catalysts for such a relief rally are now few and far between. Something new would need to appear to sustain this rally much further (e.g. new stimulus expectations fueling the speculative boom, or beginning rumors of a renewed attack on Washington around the presidential inauguration as a fresh worry, which may be dissolved in the future).
• Futures positioning: The last restrained positioning metric has now swung bullish as well.

• Bubbly behavior: Risky assets (e.g. Tesla and Bitcoin) are showing clear signs of excessively speculative behavior. This is a dangerous situation that can turn on a dime, but is very difficult to time. I will watch out for a rising VIX / S&P 500 correlation: a positive correlation is a reliable warning signal pointing to excessive risk taking — we do not yet see this at the moment.
• Options speculation: Rising options skew points to an increased likelihood of a correction in the coming weeks or months. Quite often this is preceded by a blow-off rally, which may have started last week.

01/08 Gamma Exposure: @ 3820 = Long; Zero Gamma = 3730; Call Wall/Top Gamma Strike = 3800; Put Wall 3550; Absolute Gamma 3800 (details about gamma exposure).
The high concentration of gamma at the 3800 level will exert a magnetic pull going into the monthly OpEx on Friday, making this a likely pivot level for price swings (similar to last Friday’s price action).
Support at the zero gamma level is the decisive barrier that must break before we can see a larger pullback.

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.

A window of potential weakness over the next two weeks and a weekly close at the lower boundary of my maximum target area (3830-3870), gave us a good opportunity to shift model portfolio exposure to neutral. I expect that we will see a larger correction in the beginning of the year, and even if current momentum leads to another push higher, any gains we may see over the next weeks are very likely to be given back over the coming months.

I do not think the next correction will mark the end of the current bull market, because most long-term fundamental and technical indications are overwhelmingly positive. I will consider any drop between 7% – 15% an excellent buying opportunity. However, I still expect intermediate problems to be a significant feature of 2021, as the rally off the March 2020 bottom could soon be reaching an initial limit. Similar to 2010, after the post-GFC rally, we might see several corrective moves that can potentially overshoot my targets and would be difficult to navigate.

In the short run, I watch a strong support area around the zero gamma level (3720-3750) as a potential flip point, a break of which would indicate the beginning of the expected correction.

Main Fundamental market drivers

• Central banks and fiscal stimulus: The FED Balance Sheet’s rise is highly correlated with a climbing stock market — a positive coincident indicator worth keeping an eye on.
  The market’s reaction to the Georgia runoff election results is interesting, as a democratic win indicates a new wave of stimulus in the near future, but also a potential increase in corporate tax rates.
• 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.
• Meta Strategy indicators: All six of the fundamental strategy indicators have now recovered to give a green signal, and would need to flip back to red to materially change the positive post-pandemic outlook.

• 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 (becoming more mainstream by the minute) 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 signs of reacting to strict lockdown measures in some regions, but progress remains elusive in the US, the UK, Germany and other countries.
  • Vaccine optimism: Highly effective vaccines are rolled out, but the end of the tunnel is facing obstacles. A virus variant, which is likely to be more contagious, may cause infections to spike and lockdowns to continue over the coming months, while the complex vaccine distribution process is running into logistical problems almost everywhere.
  • 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 a 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*
3800	yes	enter short on retest		add short √
3730 – 3740	yes	last high, trend line resistance	min. target	reduce long √
3770 – 3800	yes		main target	reduce long √, add hedge √
3830 – 3870	yes		max. target	reduce long √, add short
3930 – 3980		long term projection, measured move	extreme target	add short

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

Short Targets	target reached	comment	target probability	derivatives exposure change*
Gamma Dip Table		entry level adjusts with new highs	random target	no position planned
3720 – 3750		20 dma, zero gamma, breakout level (will adjust with new highs)	min. target	add short on close below
3590 – 3620		last high, 60 dma	main target
3490 – 3550		initial correction target (will likely adjust with new highs)	main target
3250 – 3350		large correction target	max. target

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% (backtest from 2013 to 2020; real time results from 05/20 — in some cases I will take the overall market assessment into account, if it is likely to skew success probabilities for individual trades lower); 
For simplicity, I usually use the same instrument as in my current derivatives long positions indicated in the model portfolio below.
Position size: One current individual position, split into two entry points (25% regular or 15% reduced); check marks indicate filled trades.

High S&P (ES) 01/08	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
3835	3775	3750	50	3762,5	3695	3830	3830	3730

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: 5% – 10%; 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)

Starting at the beginning of 2021, I list a moderate portfolio version using leveraged ETFs next to the high-leverage derivatives portfolio. The moderate version will experience lower volatility and will not lead to net short exposure in a bull market, but it will partly hedge the Investment Portfolio at opportune times. (Look at the Current Portfolio Leverage Levels in the table below for easy comparison.)

Opportunities with Highly Asymmetric Potential

Current Idea: Long Silver for possible resumption of bull market. Break-even stop loss reached.

Recent trades: Silver long entry 1 ($24.70) and long entry 2 ($25.80 – $26)

Silver suffered a large drop on Friday due to a spike in interest rates, and I’m closing the position at break-even. I will re-asses the situation for new opportunities in the commodities sector.

Position size: 2x 1%-2% NAV; Risk: Break-Even Stop Loss

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