Getting caught in this wash, rinse, and repeat game could end up costing you a lot – here’s what to do

Shah Gilani|October 27, 2022

You’ve heard it by now… I guarantee it.

Analysts, market watchers, and empty suits galore are calling this the market bottom.

Now that the market’s been up a little the past few days, it seems reasonable.

They’re not mistaken.

The market’s bottomed and ripe for a rally.

Unfortunately, this is just another dead-cat bounce, more formally known as a bear market rally.

If you’re thinking that now’s the time to buy in because a sustained rally is coming, I have news for you.

And it’s bad.

Here’s what’s really happening and how to know when the real bottom is here…

The Stock Market Version of Groundhog Day

There are lots of reasons why the market’s bouncing off its October 13 lows.

First and foremost, the turnaround on that day set the stage for the upside move we’re seeing now.

After the S&P 500 hit bottom back on June 17 at an intraday low of 3,636, a furious rally ensued, and a lot of people thought the June low was the bottom. Of course it wasn’t.

The market rallied all the way up to an intraday high of 4,325 on August 16. That amounted to a 18.94% run for the roses.

Then, stocks fell right back down and made another intraday low at 3,520 on October 13.

The reason that looked like the real bottom was because, after making an ugly low, the S&P 500 actually closed up on the day, rising 149 points to close near its high of the day at 3,669.

That got people thinking.

It looked like real buyers had bought the dip that day with enough of them coming in to make a firm statement that now the real bottom was in.

But, that’s not who bought the bottom, they weren’t real investors committing real capital buying cheap stocks because the worst was behind us and a new bull market had started.

Nothing of the Sort

What happened that day was institutions, hedge funds and a bunch of smart traders with lots of capital, who had been gaming options market-makers, doubled down on their game.

The game is simple.

Players buy very short-dated options, for example they bought a ton of put options on the SPX, the S&P 500, and on the QQQ ETF, which is a proxy for the Nasdaq 100, or NDX, as the market was sliding. The market-maker dealers who sold all those puts had to hedge their downside exposure by shorting futures.

The act of shorting SPX futures (which are just a bet on the future level of the S&P) naturally puts downward pressure on the S&P, helping drive the players puts in-the-money (ITM).

Just when the market looked like it was going into a free fall on October 13, the players took profits on their puts, which were nicely in-the-money.

And then they bought calls, a lot of calls, very short-dated calls, with one or two days to expiration.

Taking profits on the puts they owned meant selling them.

And guess who was buying them back?

The market-maker dealers who had sold them in the first place.

As those market-makers bought back puts, they didn’t need the hedges they’d set up against all those puts they sold, so they bought back the futures they were short.

That buying of futures, that short-covering helped lift the market. But that’s not what really turned it around that day.

The players buying calls turned it around. Buying tens of millions of dollars’ worth of call options on the SPX and on the QQQs meant the market-maker dealers now selling all those calls had to hedge themselves in the opposite direction and buy futures as their hedge against the calls they were selling.

By buying futures, they lifted the market all the way into the close.

That’s what happened on that October day. It was a mechanical rally induced by players gaming market-maker dealers into first covering their short futures positions then buying tons of futures to hedge all the calls they’d sold.

This game is going on all the time now.

It’s what moves the market when most people are scratching their heads wondering what just happened, how did the market selloff so quickly and rally just as quickly?

Now you know what’s going on.

The rally we’re seeing isn’t based on fundamentals. It’s based on traders gaming market-makers to move the market. On the upside they force other short-positioned traders to cover, lifting stocks more, helping the calls they keep buying go in-the-money and trading out of them for big profits.

As they buy more calls and the dealers hedge the calls they sell them, they buy more futures, and everyone thinks we’re going to keep rallying.

So, it looks like the bottom’s in. And that brings in sidelined money.

If enough sidelined money comes in and moves the market higher, you can be sure the players are buying more calls, in a wash, rinse, and repeat game they make millions playing.

But because the Fed’s not done raising rates, and earnings, especially of big tech companies are heading in the wrong direction, and the prospect of a recession is nearing 100% according to analysts and economists, there’s no real committed buying.

This rally will peter out and as soon as it starts to slow down those game playing institutions, hedge funds and big traders will sell their call options and start buying tons of puts again, and the market-maker dealers will start shorting futures and the market will head back down.

I’m going to go over five stocks you need to get rid of immediately and before markets DO head down again today at 2 p.m. ET.

Click here, and my team will notify you when we’re live.

Welcome to the new normal.

The real bottom will be in when the market’s down 5% or more for three days or more. That will be a capitulation bottom and the real time to start buying.

You’ve been warned.

Sincerely,

Shah Gilani