A decline in U.S. stocks is forcing commodity trading advisors (CTAs) to reduce risk and close long positions.
Bank of America warns that another 3% drop in the S&P 500 could trigger an additional wave of systematic selling.
Following the recent market decline, many CTAs have reduced their bullish long equity positions, although their overall market exposure remains positive.
According to BofA analysis, more aggressive stop-loss strategies likely led to a reduction in long positions in the S&P 500, while Nasdaq 100 positions saw additional reductions from models with moderate stop-loss thresholds. "Within the NDX, the remaining long base is now concentrated primarily in the least risk-sensitive models, while the S&P positioning continues to reflect a mix of long positions with medium and low sensitivity," BofA said in a research note.
As the equity market recovered on Thursday, the SG CTA Index closed positive. BofA analysts note that this is consistent with CTA maintaining long exposure to major US equity benchmarks.
However, given Friday's recovery, they point out that "another decline in the S&P 500 of approximately 3% and the Nasdaq 100 of approximately 5% could trigger additional systematic selling."
CTA's positioning on the Russell 2000 and Nikkei Index remains overweight. As price trends intensify, Europe should also continue to see a gradual influx of buying. The largest exposure is concentrated in shorter-dated futures, while CTAs' positioning in US Treasury bond futures remains short. This week's decline in yields has brought buying triggers closer to covering short positions. BofA analysts believe that short-covering by trend-following strategies could occur if yields continue to decline, which could be facilitated by the Fed's dovish stance next week.
Oil prices have fallen in three of the last four weeks. According to BofA's model, CTAs' long oil positions are currently being tested. The most cautious CTAs may have closed their positions via stop-losses this week, but others will follow as the decline continues.
"CTAs may also sell gold as trends weaken and stop-losses on long positions are triggered. The fastest trend-following strategies have been short gold for the past several months, but medium- and long-term trend-following strategies are also seeing a downward trend," the analysts added. After the June 5 shock, SPX gamma has become more restrained, although long exposure remains. Before the shock, SPX option gamma reached the 99th percentile, but since June 11, it has normalized to $1 billion, which corresponds to the 28th percentile since 2014.
BofA analysts note that most expirations over the next month contribute positively to SPX gamma at current spot levels. Longer-dated options continue to be the predominantly offsetting source of negative gamma. They also add that SPX gamma could remain positive in the 7,320–7,625 range, assuming no new flows next week.