Year End Surge

They faked me out.  Monday Dec. 20 was bear bait and I took it and got too bearish.  It was just a springboard to new all time highs.  Sold the long way too early, and missed out on almost 150 SPX points in less than a week.  Big mistake, but this move to all time highs and heading towards 4800 does set up a good risk/reward short for January.  I took a starter position short SPX yesterday, with plans on adding later this week.  

With investors now focused on catching the year end rally and more up moves in January, you are seeing a lot of front running of seasonal trends and a reluctance to sell from 

1. Long term investors unwilling to sell due to tax implications of capital gains in 2021.

2. Year end portfolio window dressing from hedge funds.

3. Short term year end rally chasers.

There is also a big systematic JP Morgan equity fund that does the same quarterly zero cost collar at the end of each quarter.  With their short call position deep in the money and with a delta of 1, while their out of money put spread has a delta of 0, they will reset their collar at higher strikes for both, and with the accompanying dealer hedging, dealers will end up having to buy back a significant portion of their SPX short position, probably around $10B worth of SPX futures buying that needs to be done on December 31 at the close.  

This isn't a big secret, as options dealers and institutions that are well aware of these year end flows are going to front run this event.  In liquid times with regular trading volumes, $10B of SPX futures isn't so big that it moves the market a big amount, but during illiquid periods like now, they can have an inordinate effect on short term moves.  

Looking beyond the short term, into January, there will be quite a bit of pent up selling due to capital gains tax reasons.  Also, January is a strong month for fund inflows, but a very weak month for stock buybacks.  So if you consider that a wash, then the capital gains selling pressure early in January should favor the bearish side.  With bullishness rising quickly and short term players now leaning more bullishly, it sets up a situation where short term traders are offsides and selling into any January weakness, exacerbating the down move. 

Not looking for a break down to under 4500, but I see a definite possibility of a gap fill retest towards SPX 4560, which is more than 200 points below current pumped up levels.  At SPX 4800,  I would give much higher odds of SPX going to 4560 in January than 5000, even though 5000 is closer.  Don't want to add too early to the short, letting the year end flows play out a bit more, but I am getting ready to put on a sizeable SPX short this week.  

Going long Treasuries will also work, in my view, if the SPX sells off in early January, and is probably the safer play considering the liquidity flows from funds in January, but it gives you less bang for your buck, as the reward is greater from shorting SPX at all time highs.  I would not be surprised to see 10 year yields go to 1.30-1.35% in January.  

Its another gap up in the works, the strength is immense, so waiting for the dust to settle a bit before adding the short.  Who knows how far they take this thing, this market is so unhinged from past market behavior that you can't be self-limiting in your outlook.