Dispersion Trade Strength Builds as Liquidity Pressures Begin to Rise
Stocks managed to rally again, with the S&P 500 rising to a new closing high. This may seem somewhat unusual given the broader macro backdrop. However, the dispersion trade we discussed yesterday remains very strong and continues to rotate across mega-cap names. In fact, the equal-weight RSP ETF is still roughly 3% off its highs.
Tesla had its opportunity to rally today, rising by more than 7%. Notably, it wasn’t just the stock price that increased—implied volatility also moved higher, reaching around 60% for the $390 calls expiring on April 24. The company is scheduled to report results on April 22.
As a reminder, we observed a similar pattern previously happen during the health rotation in February.
Unfortunately, a rising stock price alongside rising volatility is a key feature of implied volatility dispersion, and we are seeing this dynamic play out across the market.
The same pattern is evident in Meta, where implied volatility for the $670 calls expiring on May 1 is also increasing in tandem with the stock price.
This is the trade: rising implied volatility at the single-stock level combined with falling implied volatility at the index level—resulting in a classic implied volatility dispersion trade in action.
That is why the dispersion index has risen to 38.3 and is back near its highs. This is a pattern we tend to see every quarter.
Taiwan Semiconductor is set to report results in the morning, and its implied volatility has climbed to around 100%. There is also a significant amount of gamma concentrated in the $375-$380 range. Following the earnings release, the implied volatility that has surged into the event is likely to decline sharply—potentially by 40% to 50%. This would cause both call and put premiums to decay rapidly as volatility compresses.
This dynamic could result in the stock trading sharply lower after earnings, similar to the move seen in Micron following its report. This is largely due to the significantly higher amount of call delta relative to put delta, meaning call options carry substantially more premium at risk of decay.
With max pain around $350 and a put wall near $340, combined with the recent run-up in the stock, a pullback would not be surprising.
In my view, such a move would likely reflect the unwind of elevated implied volatility heading into the results. We will see how it plays out. It can provide a playbook for what comes in the other names we seeing the same in.
In the meantime, the liquidity squeeze began to emerge today, with the TGA rising to approximately $780 billion, up from around $760 billion yesterday.
While it may not be immediately visible in the broader market, it should be reflected in the overnight funding markets, with the overnight repo rate trading around 3.75%. This suggests that SOFR is likely to print near that level tomorrow, potentially at or even above the ceiling of the Fed funds corridor.
This was one reason why usage of the standing repo facility increased today to around $10 billion.
My expectation is that the TGA will exceed $1 trillion, which should result in reserves declining to around $2.8-$2.9 trillion. That would place us back at the lower end of what is considered ample reserves—a range that previously contributed to funding pressures in the fall.
While it is unclear whether the pressures will be as severe this time, today’s activity may have offered an early indication of how these dynamics could begin to unfold.
In the end, the market is in the midst of a seasonal dispersion trade and approaching a potential shift in liquidity trends, with considerable uncertainty on the horizon. It serves as a reminder to maintain perspective.
—Mike
Glossary by ChatGPT
Call Delta: A measure of how much a call option’s price is expected to change relative to a $1 move in the underlying stock.
Dispersion Trade: A strategy that exploits differences between index volatility and individual stock volatility.
Gamma: The rate of change of an option’s delta relative to movements in the underlying asset price.
Implied Volatility: The market’s expectation of future volatility embedded in an option’s price.
Liquidity Squeeze: A tightening of available cash or funding in financial markets, often leading to higher short-term rates.
Max Pain: The price level at which the greatest number of options expire worthless, often viewed as a magnet into expiration.
Overnight Repo Rate: The interest rate for short-term borrowing using repurchase agreements, reflecting liquidity conditions.
Put Wall: A strike price with significant open interest in put options, often acting as a support level.
SOFR (Secured Overnight Financing Rate): A benchmark interest rate based on overnight borrowing costs in the Treasury repo market.
Standing Repo Facility: A Federal Reserve tool that provides overnight liquidity to primary dealers in exchange for Treasury securities.
Treasury General Account (TGA): The U.S. government’s primary account at the Federal Reserve used for managing cash balances.
Disclosure
This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.