Ho-ly shit.

I was in the middle of doing my show on stocktwits TV when it happened (you can watch the video here). The ES dropped from 1125 to 1066 in a matter of a few minutes. I spent the entire show looking at ways to sell vol and fade the move as well as expected targets. I haven't watched a bit of news after the close, and only perused a few blogs after-- but most of the commentary is simply hindsight analysis and not looking at the factors behind it. There are many unpopular things to be said about this move, I might as well get them out-- so here are some unpopular beliefs that I hold about this move:

1. You could not have made money intraday

At least, the odds of it happening were low. This move was due to a lack of liquidity. The bids simply fell out of the market. I know many are thinking "if I only had shorted BIDU" or "if I only had got long AAPL at 200"-- that does not show the complexities of order flow. I know many who put buy orders in at a price and the stocks dropped below their limit, but they didn't get filled. The structural integrity of execution platforms were put to the limit-- IBKR locked up, Schwab locked up, AMT locked up.

There were also stop loss orders that some traders had, and the market blew past their order. If it's a stop market order, usually it hits the market at the bid-- but because there was no liquidity, there were instances in which the stock blew through their stop and reversed back above their stop price before they could get a decent fill.

It was the same thing in the options market. Anyone who says they successfully scalped options in that 30 min period is a liar. The market makers saw liquidity dried up, so they blew out the bid/ask spread in options because they don't want to take the other side of the trade.

The only place I think provided enough liquidity were the futures markets. But even trying to get a market order hit was very, very difficult.

2. This move is not like 2008

Too many comparisons are being drawn with the crash of 2008. I don't think this is an apt comparison. Rather, I think the 1987 crash is much more indicitave of the price action we saw. In 1987 the markets became very illiquid and program trading got a little out of hand. So if you think we're going to test the lows, look at the price action post-1987.

3. The Move was not based on fundamentals

There is a bit of a debt crisis going on in the EU right now as the PIIGS (Portugal, Italy, Ireland, Greece, Spain) are seeing extreme weakness. There's also weakness in commodities, the carry trade, etc.

Let me make this very clear: this move had nothing to do with Greece, oil spills, dollar strength, or corporate earnings. You have to go deeper.

4. The Move was not based on technicals

You thought I was heading to technicals? Nope. Basic technical analysis seeks to identify supply and demand as seen from a time series analysis of price. We had some topping patterns and major moving averages that put the expected move of this pullback to around 113. Basic technical analysis, however, assumes a market. When we don't get proper order flow, six-sigma events can occur.

5. The Move was based on market structure.

You have to dig below what most people call "technical analysis" and actually look at how the market is structured and who is participating in it. Large, institutional players seek to allocate capital through various assets to try and optimize their portfolio. Hedge funds look to speculate (or actually hedge) on future market movement. Quant firms seek mean reversion and rebates by providing liquidity. The robustness of the system is illusory, however, when someone modifies the market structure. Generally, a bid will form based on mean reversion or as volatility arbs come in line. That didn't happen today and it showed how fragile the structure can be-- the sheer magnitude of this range is comparable only 3 other times in the history of modern markets.

6. High Frequency Trading broke, then saved the market

This will probably be the most controversial thing I'll say. Quant firms have been keeping the market in a fairly low volatility state as they seek mean reversion and arbitrage strategies. By doing this they provide liquidity in the market for institutional players and funds. Their risk models are based on statistical distributions, behavioral finance, and other voodoo. When these models go out of wack, they can exacerbate the situation-- that did occur in 2008 when liquidity dropped out of the system.

However, I feel that program trading (eventually) provided the liquidity for the snapback of this rally. If it weren't for quants betting on extreme mean reversion, we would have held a much deeper selloff comparable to 1987. What evidence do I have of this? The sheer snapback of the price in such a short amount of time. It certainly wasn't fundamental traders who all of a sudden found "value" in the market with a trailing P/E. The only sort of quick analysis that provides that kind of price action are done by non-humans at quantitative firms, and they saved the market from something much, much worse.



7. Vol still remains a sale

Before this event, we'd seen very, very low volatility readings across the board. Implied SPX volatility came in around 15, and realized (actual) volatility was in the single digits. Because of this event, we will have disaster imprinting stuck in the mind of discretionary traders and investors; also, we will see risk models adjusted to a higher assumed volatility. That means premiums will stay elevated across the board in domestic equities. A constant bidup in premiums means the environment will be ripe for vol selling, regardless of direction. Strategies that didn't work so well in the first half of the year will improve going into the second.