2016-12-14 12pm EDT  |  #stocks #gamma #Federal Reserve

Word on the street is that there is $5 billion dollars of short stock market gamma up here at these lofty levels. For those who don’t practice the dark arts of option trading, that means as the stock market rises, the dealers who are short these options, have to buy about a billion dollars of stocks every time the S&P rises 5 points.

That’s a big position, and combined with the Trumphoria, it is making it difficult for traders to hedge all their growing short delta. Stocks continue to explode higher, and traders chasing gamma is turning the rally into a gong show.

Have a look at yesterday’s trading in the Nasdaq future:

There was absolutely no fundamental news to move the index 60 handles in a 10 minute melt up at the open, but that’s what we are getting these days.

I don’t watch CNBC but the twitter traders I follow report the CNBC anchors’ giddiness has hit all time new unbearable levels.

Well, I have a warning for all those exuberant bulls. We are melting up in a monster gamma chase, but gamma runs both ways. Hedging option traders need to buy massive slugs of stocks are they rise, but they will have to sell the same on the way down. Now, I know, I know… Stocks never go down. But imagine if they did.

Today is the FOMC meeting and although most traders expect the Fed to raise rates, the vast majority are not expecting any sort of hawkish shift.

I am worried about the US economy. The large backup in rates along with the rise of the US dollar will crimp economic growth in the coming quarters much more than the market believes. Yet although I am skeptical about future growth, this is a non-consensus opinion.

For the past few years the Federal Reserve board members have been overly optimistic about economic growth, and I don’t see any reason for it to change this meeting. In fact, given the screaming stock market along with the rising inflation expectations, I suspect many FOMC board members are more than a little bit worried this might get out of hand.

Let’s not forget the FOMC has been the tightest Central Bank out there. Now that inflation expectations are finally heading their way, and the stock market is forecasting all sorts of future growth, why do traders expect the Fed to simply say, “go ahead - we were too hawkish for the past two years, but now that you guys are all excited, we will go slow.”

It will be a mistake, but I suspect the Federal Reserve will err much more hawkish at today’s meeting than anyone expects.

I don’t know if it will be from a higher than expected ridiculous dot forecast, or whether Yellen will use the Q&A to warn market participants, but I believe the risks are firmly titled towards the Fed disappointing markets, not the other way round.

Not only that, from a market sentiment level, given the absurd amount of bullishness out there, even if the Fed does not surprise, it will most likely be an “all baked in” situation.

I just don’t see how the stock market bulls win up here. We are up on a stick due to gamma chasing, and although it can always go higher, at this point you should be really worried about a quick turnaround no one is expecting.

Don’t ever forget - gamma runs both ways…

Thanks for reading,
Kevin Muir
the MacroTourist