Goldman’s Trading Team Sees Early Signs of an “Explosive” Move

As a leading derivatives trader at Goldman, Brian Garrett wrote earlier today in his weekend review: “What a week.” And what’s coming next looks even bigger…

Here are the highlights from the veteran trader:

On Thursday, we had one of the worst sessions since June, and yet the S&P still closed just a few points below its all-time highs — for those not running the marathon and looking to make good use of that extra daylight saving hour.

What looked like the beginning of a recovery rally last weekend has been met with another round of macro-driven selling this week (just when you think investors can’t sell any more macro products — they do). And with only 10% of the S&P reporting this week, we’ll have to look elsewhere for catalysts. Meanwhile, Goldman’s futures team notes a build-up of short positions in small caps (seen this before?), spot and call options are moving in the same direction (rare), and mega-cap call volumes are explosive (earnings + massive numbers).

1. Prime Brokerage (selling macro / buying micro) – Investors are selling U.S. equities this week (recall, just last weekend we saw early signs of short covering). The selling is concentrated in macro products (ETFs), while individual stocks are being net bought. The earnings season is clearly driving the pickup in single-stock trading.

2. “One-delta” selling – Last weekend it looked like an upward market move was starting, but this week investors and hedge funds are selling stocks (–$3.5 billion and –$1.6 billion, respectively). The most notable activity comes from “long only” investors selling META shares. This shows just how difficult it is to make money in the current market — even when a company reports better-than-expected earnings, its stock price doesn’t rise significantly, with META outperforming the S&P by only 0.32% instead of the usual 0.98%.

3. Futures (rotation) – The team notes that short positions in small-cap futures are increasing significantly. Jerome’s comments that a December rate cut is not guaranteed are expected to affect the longer end of the market, and investors are following a similar strategy with the Russell 2000. From personal experience, this has happened before — those adding short positions should be cautious as the year-end approaches. For fans of seasonal trends: November is a very strong month for the Russell — over the past 15 years, small-cap stocks have seen only two negative Novembers, with an average monthly gain of +4.5%.

4. Derivatives (position chasing I) – The realized correlation between expected upside volatility (SPX, RTY, NDX) and the current levels of their respective indexes is +40%. Current positions are not long enough to provide adequate protection against concerns about relative performance. “When indexes rise, volatility rises too” is one of the derivatives team’s favorite stories — and it’s unfolding in real time (see chart).

5.Derivatives (position chasing II) – Call option volume for megacap companies reached 9.5 million contracts on Friday — marking the second most active session of the year so far.

…the option skew for these companies is extremely flat, which might be the only bearish signal in this note (chart).