01/07/2021 — Market Misunderstanding
I’m not surprised that the S&P futures are up 40 points only 24 hours after an armed insurrection swarmed, and momentarily took control of the US Capitol building. A few friends of mine contacted me to ask about what effect all of this had on the market. They assumed that this kind of turmoil would send panic throughout, resulting in a harsh down move. When I told them that the market pulled back, a bit, they seemed astonished.
Before the debacle began, the Dow sat comfortably upon the day’s 700 point gain. The invasion set off a seemingly tame pullback of 300 points, which to someone not abreast of the day to that point boggled the mind. Even when explained, my friends couldn’t comprehend how the financial markets kept their apparent composure. Surely, a storming of The Capitol warranted a swift and severe reflection of the situation at hand.
The reality of market behavior tells a much different story when carefully examined. Although a hyperbolic example, you can’t get long the market at the beginning of November with the strategy of cashing-in on all the expected upcoming shopping, and then be disappointed when the plan fails. Christmas never catches anyone unawares. The fact that the riots induced any selloff whatsoever serves as a reminder that it is technically possible for there to be no Christmas. There is a greater than zero possibility that the powers-that-be cancel Christmas. I have no Earthly idea what that scenario might entail, but it is possible.
Sliding further along the spectrum away from zero and away from a cancelled Christmas is the possibility that the “Loons on the Lawn” succeed in wresting control from authorities with the intent on affecting crazy change. That reality would send the financial markets reeling, perhaps triggering circuit breakers and trading pauses — but how likely is that to occur? Its probability rests near zero. The market, although not able to price in something as sure as Christmas sales, knew that this display of criminality would end with several arrests, a great news story, and little else. No reason to panic, or even to retrace the gains of the day.
What did the market do instead? It readied itself. Knowing that there was even an infinitesimal chance of disaster, it quickly pulled back, and followed with a lot of sideways trading. Although we can’t get into the mind of a non-sentient concept like the market, we can take a look at some of the thoughts and behaviors of the micro-components that compose it — the traders.
Just before the chaos, I had sold five, two-day (expire two days from present) puts. These stragglers (I call bids that have considerable space between them and their next non-zero bid, stragglers) seemed ripe for selling and becoming part of a couple-hundred point put spread for zero cash outlay. Thirty minutes later, when the militia-mopes scaled the walls and startled the nation, those who had overextended themselves on the rally immediately scrambled to find a safer, more tenable position, hence the immediate selloff. Not being part of that group, I avoided having to cut and run. I certainly regretted selling five naked puts, but they were always meant to be the small leg of a spread, and they were quite far away from current trading levels.
Nevertheless, watching the news reports left me with a sense of unease. I knew that this disruption would quit or be quelled — or so I thought. The lingering uncertainty led me to cover a put ahead of my five short units just to help “take the edge off” should anything really start to go wrong. I was part of the sideways trading. The little dips and pops that didn’t lead to anything were a macro reflection of a lot of micro readjustments just in case the situation really headed south.
Most of my friends didn’t see that the VIX had quickly risen to nearly 27 in just a few short minutes. On the surface the market appeared calm, but underneath it felt nauseous. What I really wanted to do was sell some volatility. I couldn’t. I still had Friday’s theta (time decay) calories to burn off from Monday’s poorly-timed sales.
Other traders who held a bit of volatility in their pockets from before the move wisely jettisoned little bits of it. They dared not hold on to it too tightly and miss an opportunity to profit. Surely some held all their volatility, perhaps hoping that this JV insurrection had teeth, and that they would cash-in on volatility rising to 30 or 40. No matter what the moves were individually, the market as a whole acted in a way that it thought was rational. It noticed a real threat, but quickly assessed the likelihood of real damage and waited until it passed. After that, it resumed its steady climb for reasons that I still can only ascribe to a perpetual zero interest rate.
I think most read the news and watch clips of the madness, misunderstanding the true purpose of the market. It isn’t required to respond to turmoil as a human might. It has no obligation to care about the four people who died yesterday. The market exists in a constant state of analysis and adjustment, not one of emotion and excitement. Yes, the participants whose behavior govern these movements experience the range of human emotions, but the grand sum that is the market does not.
The purpose of the market is to dispassionately quantify the present and prepare for the future. It has already forgotten yesterday.