06.19.22 | Combining Insights from The Implied Order Book and the Auction Market Process

Structure, Process, and The Options Order Book

In ‘The Implied Order Book,’ a white paper by @SqueezeMetrics, crash risk is explained as a function of how many investors have sold puts. Quoting the research, “Sold puts are, quite literally, a bunch of huge buy limit orders below the market…”

So, based on last week’s trading in $SPX puts … those that marked at or below bid … puts in regular monthlys … out to end-of-year 2022 … with lot sizes ≥ 10 and transaction sizes ≥ $1M … we can plot the amount of premium at stake … at price levels below market.  This could provide us some general feel for where price might encounter high liquidity, should a big order displace the market … moving the auction vertically … with conviction … out of balance … a dislocation of inventory.  From out of balance the market moves to balance … pausing to re-define fairest price.

Integrating options data and the auction market process emphasizes the intimate relationship they share.  Thursday and Friday saw two days of balance.  Should the market break below the auction bracket low (ABL) … to the downside … with a concomitant increase in volatility … the premium associated with those sold puts becomes important … as they, along with neighboring market stop loss orders,  increase crash risk.  And in a negative GEX environment, increases in implied volatility make GEX less significant and other liquidity taking factors take precedent.

Auction market theory submits that “initiating” breaks outside the balance area rarely fully retrace and commonly trade towards the next level of high liquidity.

Those key reference levels can be seen by plotting their values … and are illustrated in the chart above.

06.19.22 | Outflows in Energy Stocks Continued on Friday

DeMark Indicators

By June 9, D-Wave 5 which requires a 34-price bar high … completed. Coinciding with this, DeMark suggests that professional investors often recognize that long positions no longer posses a favorable risk/reward perspective and anticipate a trend reversal.

D-Wave 5 signals are strengthened by the presence of other exhaustion indicators. In this context, we have a completed Countdown 13 and a perfected Sell Setup 9. Sell setup perfected one day after printing the completion sequence … marking June 7 as XLE’s high.

DeMark has also emphasized the importance of looking for multi-time frame indications of exhaustion.  Here, too, we have confirmation of a completed rally and sell signal. (below)

Further Outflows Friday

With the exception of Occidental, here too, we see aggressive selling in energy stocks whose YTD performance has been stellar.

Institutional Investors Prefer Occidental Petroleum

While the world’s thirst for oil is unlikely to abate anytime soon, institutional investors have exhibited a distinct preference for OXY. Notwithstanding this pattern of accumulation, OXY is retracing and some might consider this buying on strength to be a contrarian indicator.  DeMark indicators have marked sell signals and are beginning D-Wave and Sequential setups for a future buy.

High Oil Prices, Strong Dollar, and Recession

While high oil prices can certainly contribute to recessionary pressures, a decline in global oil demand … related to high prices at the pump … may only (temporarily) weaken growth.  As there are multiple inputs into this equation which are linked to a myriad of geopolitical events that impact oil prices … a collapse in oil prices would be a dubious assertion.  Outflows in the context of profit taking appear more likely.

06.17.22 | Combining Dark Pools Liability Hedging with Tom DeMark’s Combo + D-Wave

A Simple Ensemble Model for Trading Volatility

The trading signals emanating from dark pools’ trading in VIXY continue to perform beautifully.  Were that not enough, the same long/short entries and exits are marked by the TD D-Wave + Combo overlay.


(The most recent vol signals have been on SELL … but a TD Sequential Buy Countdown is in process.)

Download image of database here.


A Novel Argument for Ensemble Models in Quantitative Trading

06.17.22 | Secular Bear, Left Tail, RVOL, Skew, and Sticky Strikes

The Current Market Environment

Secular inflation can actuate secular bear markets in equities … secular bull markets in commodities … secular volatility regimes and liquidity crises.

Until June 9, there was a rather muted volatility response to a bearish reversal in $SPX.  In some part, this was related to investors having been relatively well-hedged (long puts) and perhaps at the same time under-estimating the sea change about to come. 

The S&P 500 index is currently in a turbulent period and early phase of a brutish secular downtrend.  In this context, relative volatility (RVOL) will be the dominant consideration when estimating the implied volatility (IV) of (high gamma) ATM options.  Volatility in OTM strikes is likely to be excessive relative to that in ATM strikes.

This Is A Left Tail Event

Unexpected and significant changes in interest rates, high inflation, and equity volatility create tail events.

Tail risk represents the probability that the magnitude of returns on an asset or portfolio will exceed some threshold (usually 3 standard deviations) on a normal (Gaussian) distribution curve.  But financial markets are non-normal.

A “fat tail” refers to a probability distribution … a distribution that obscures  a fragile market experiencing extreme price movements … outliers … negative returns … accumulating asymmetrically about the mean .  The tail on the left is also associated with conditions marked by higher than normal volatility of volatility and in turn, lower than normal portfolio returns.

Fat tails, negative skew, and jumps have deleterious effects on portfolio returns.   Risk is located in the tail.

Taken together, fat left tail risk often shows up in down-trending auctions …marked by  brief recovery rallies, and punctuated by sudden precipitous sell-offs.  As SPX drops, RVOL and IV increase while skew widens as IVs become unstable.  IV skew reflects the market’s expectation of higher RVOL.  While it is difficult to establish relationships between asset prices and volatility in a skewed environment, higher skew generally portends a fatter left tail and an increased likelihood of high levels of IV during sell-offs.

Sticky Strikes and Sticky Skew

In quantitative trading, invariants are quantities that don’t change and are referred to as “sticky”.  So sticky skew suggests that as the index moves, the skew at a given level remains relatively unchanged … invariant.

When markets are expected to experience periods characterized by intermittent range-bound auctions, the volatility skew for an option can remain relatively unchanged “with strike”.  This behavior is referred to as the sticky strike rule.  (The “sticky strike” model preserves the Black-Scholes-Merton valuation archetype.)

It has been noted that as the market recently began making appreciable moves down, skew in short-dated options was unusually invariant … less effected by market behavior … “sticky”.  In other words, sticky skew is a way of thinking about the patterns of skew linked to market behavior.   An anomalous increase in short-dated sticky skew might be considered a harbinger for a market that trades in confined ranges … then experiences sudden harrowing jumps … while RVOL grinds higher.

Conclusion:  Intermediate-Term and Beyond

In summary, we have undeniably entered a bear market in equities … one characterized by a jumpy index … prone to acute and steep sell-offs.  For reasons aforementioned, RVOL should be a dominant consideration when complementing a portfolio with tail risk hedges.

During such times, tactical asset allocation with long volatilty hedges outperform.  In contrast, bonds have little to offer in the way of portfolio protection and as implied correlations rise, diversification benefits slump.


  1. Derman E. Regimes of Volatility (1999) Goldman Sachs Quantitative Strategies Research Notes
  2. Fat Tail Risk: What It Means and Why You Should Be Aware Of It | Nasdaq
  3. Taleb NN. Dynamic Hedging: Managing Vanilla and Exotic Options (1996) John Wiley & Sons