Nomura Warns Of Build-Up In "Combustible Fuel For A Mechanical Short Squeeze" Across Op-Ex Facing a massive $3.3TLN of options notional, including $1.3TLN of single stock options, expiring on Friday, Nomura's Charlie McElligott warned yesterday that "it’s a doozy of epic “short Gamma, short Delta”... But, SpotGamma notes that the shift lower in markets over the past several days has increased the concentration of put-heavy gamma tied to Fridays OPEX. We now see >=30% of S&P, and >=20% of QQQ rolling off on 1/21. You can see below that as long as the S&P is <=4600 the expiration brings a reduction in negative gamma (via the closure of puts). This suggests this index expiration is generally supportive of S&P prices. This view is supported by McElligott, who said in a note this morning that: "I am beginning to think that despite the volatility into / around Op-Ex 'Gamma unclench' and as we continue to see liquidation-type de-risking in futures, that there is very much a potential path for a counter-trend rally in Equities in the coming-days." And given the tumble in liquidity, that move could be aggressive... The Nomura strategist notes that a lot of the “short Gamma” set to come off this expiry is from downside hedges, which are ITM and increasingly likely to be monetized the longer we don’t break down (still dependent on whether rolled-out or not, of course), while also noting that the broad need to hedge / size of hedges is reduced from the selling-down of underlying positions; accordingly, it did indeed look like there was “monetization” of some downside yday, as “negative / short $DELTA” in QQQ and IWM actually incrementally DECREASED DoD, despite spot another -1% / -1.5% lower. In the meantime, “extreme negative / short Delta” across all option expiries is at risk of becoming a combustible “fuel” for a mechanical squeeze if spot rallies…while we see over -$107B of front-week $DELTA alone! This “squeeze risk” too builds when taken in conjunction with the aforementioned fresh CTA “shorts” in NQ and RTY there providing additional mechanical covering “buy stops” not too far above spot as well - along with various other Global Eq futs “shorts” in the model And it appears the squeeze could have started as the broad US indices ripped higher from the open this morning... But, as SpotGamma notes, given all of the above, we still expect traders to hold hedge protection through Wednesdays FOMC. Markets still have to contend with a continued reduction in single stock deltas, which foreshadows more “volatile chop” into 1/26. For next week SpotGamma suggests that the clearing of Fridays OPEX positions (Index puts + long call hedges) could set up a bullish move post FOMC – assuming Powell doesn’t upset expectations. The passing of FOMC often leads to a further reduction in “event hedges” and a reduction in implied volatility (leading to supportive vanna flows). However, as McElligott warns, it is critical that S&P Futs continues to hold above its own CTA Trend model “flip” level, as the current S&P “+100% Long” signal would turn to “-37% Short” on a break and close below today’s sell-trigger at 4507 as the 3m window would turn “short”. And similarly, a reclaiming in Spooz of its 100DMA (4571 for ES) either today or in coming-days would further strengthen the case that LOCALLY, “the floor is in” for a potential Post Fed rally next week. Tyler Durden Thu, 01/20/2022 - 13:45