Quants turn to single stocks to revive intraday trend strategy
Retail trading boom has made intraday single-stock strategies more viable
Quant investors are constructing intraday trend strategies for single stocks in an effort to capitalise on the boom in retail options trading.
Intraday trend strategies, which trade into trends as they form during the day and unwind near the close, are usually offered on indexes such as the S&P 500.
Extending the approach to single names is the “new frontier”, says Sandrine Ungari, head of cross-asset quant research at Societe Generale, one of several banks looking into the idea.
The strategy aims to ride the coat tails of dealer hedging activity. In simple terms, when market-makers are short volatility – and so, short gamma – their hedging exacerbates market trends. When firms are long volatility, the picture reverses and they tend to trade against the trend.
Exploiting this behaviour was a winning strategy in early 2020. A basket of 20 strategies returned 17% in the first two months of the Covid-19 pandemic, starting in February 2020, according to PremiaLab, a quant data company. The same 20 strategies, though, have lost almost 5% since April 2020.
Quants blame the poor performance on the changing dynamics of dealer hedging. Net gamma positioning since mid-2020 has been mostly positive, according to estimates from Societe Generale, throwing the engine of intraday trends into reverse.
Index strategies have become costlier to keep on the books – the negative carry for intraday trends on the S&P 500 has roughly doubled since the early days of the pandemic – creating a need for fresh variations on the theme.
Quants have already worked up modifications to make the approach more economical and rolled out new versions in other markets such as the Nasdaq and, more recently, commodities. Single stocks offer scope for further innovations, such as the creation of long/short strategies – going long stocks that are trending and short those likely to mean-revert.
Buy-siders welcome the idea as a source of diversification. And recent research bolsters the view it can work. “It’s exploding the dynamics,” says one bank quant. “We can do more things if we look into the single-stock world.”
The work on single-stock intraday strategies is in the early stages and practitioners Risk.net spoke to declined to discuss specific plans, or whether their firms were yet running the strategy live.
Gamma swarms
A recent study suggests the same dynamics that propel intraday trends in indexes are at play in single names, too.
Gamma hedging from options market-makers, alongside dealers that offer total return swaps as part of leveraged ETFs, causes individual stocks to trend or mean-revert sharply near the close.
“The story is really stock-specific,” says Andrea Barbon, a professor at the Swiss Institute of Banking and Finance at the University of St Gallen. “On the same day some stocks have a positive [gamma] bias and some stocks negative. It may be the case that different option dealers have different positions on two options so that price pressures go in different directions.”
An investor running a long/short intraday trend strategy could make as much as 11% annualised, according to the study. On paper the strategy achieved a Sharpe ratio of five before transaction costs.
Barbon and his colleagues calculated the imbalances of delta hedgers half an hour before market close. They found gamma exposures were high enough on about 5% of stocks to make hedgers trade more than 15% of average daily volume in late trading.
“We document large price pressure on end-of-day returns when market-makers engage in delta hedging their option portfolios and rebalance their positional exposure from total return swaps replicating leveraged ETFs,” their working paper states.
There are some extreme events where the options effect takes over. GameStop was a clear example
Andrea Barbon, University of St Gallen
The sort of call-buying co-ordinated through internet message boards seen in the GameStop episode and others may even amplify the effects.
Day-trading message-board users engaging in such activities call this a gamma swarm.
“There are some extreme events where the options effect [on end-of-day pricing] takes over,” Barbon says. “GameStop was a clear example. These very big effects happen when people are co-ordinating a bet and take the effect of options into account.”
Trading volumes for equity options have grown by nearly 40% in the past year, according to data from OCC, mostly thanks to a boom in retail day trading.
Serge Tabachnik, head of research in the multi-asset group at Lombard Odier, says long/short intraday trend strategies are “potentially very interesting” because of the diversification they offer alongside mainstream implementations on the S&P.
Much of the volatility of single names in the S&P 500 is explained by the volatility of the index, he notes. So, by trading intraday trend on a basket of individual equities, investors could avoid the crowding that arguably has made the strategy more expensive in vanilla form.
It could have other benefits also. Quants at SG were prompted to look into intraday momentum on single names after the Archegos collapse in March underlined the need for defensive strategies that could profit from the liquidation of portfolios of specific stocks.
Trend carefully
Forging the strategy in real life, though, may not be straightforward.
The dynamics of intraday trends in single names are less clear than in indexes. “The cost of carry and performance are different,” Ungari says.
Predicting hedging flows on individual stocks is hard. Barbon and his colleagues had access to historical data from options exchanges, but such data is unavailable in real time. To trade the strategy live, quants would need a good proxy on the positioning of dealers, he says.
Market participants and some third-party data providers do supply estimates of gamma positioning. But all estimates rely on assumptions about who is taking which side of trades.
Another hurdle is to find enough stocks with enough liquidity. The 10 biggest stocks in the S&P 500 account for up to a fifth of the dollar amount transacted daily. Trading in smaller stocks is fragmented across many different venues.
Replicating the index with a smaller number of constituents is possible. But intraday trend on single names could quickly become a crowded trade. “It’s a thinner market compared with index futures. It may be a diversifier that gets saturated very quickly,” says Tabachnik.
Yet another consideration is how to avoid being on the wrong side of meme stock rallies or slumps that get too big and hence too risky.
“For single names, investors have to have stop-loss mechanisms in place to mitigate the impact of intraday trend reversals, which can be stronger on more volatile stocks,” says Arnaud Jobert, co-head of investible indexes at JP Morgan.
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