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Amid Q4 Uncertainty, Traders’ Focus Turns to Data – Inflation, Location and Options

September 28, 2023 | By: Ivy Schmerken

Data on inflation and interest rates is a top priority for institutional investors and hedge funds navigating risk and the fog of uncertainty in the fourth quarter, according to panelists on a recent industry webinar. 

As hedge funds and institutional asset managers head into In Q4, which is historically known for market volatility, many are incorporating inflation data, consumer spending, and other macroeconomic statistics into their trading and investment strategies. 

While the Federal Reserve voted to hold rates steady in the target range of 5.25% to 5.5% at their Sept. 20 meeting, officials signaled they may raise rates one more time this year to combat inflation and attain the 2% target rate. “Our decisions will be based on assessments of the incoming data and the evolving outlook and risk,” said Fed Chairman Jerome Powell at its press briefing. But with the Fed keeping rates higher for longer, and leaving the door open to further rate hikes in November or December, uncertainty is weighing on financial markets. 

Speaking on the Wall Street Horizon Data Minds webinar, Melissa Brown, Managing Director, Applied Research at risk analytics provider Qontigo, said that concerns over inflation have abated, and that inflation has moderated from its record levels. However, with inflation “coming in at 3% or 4%, that is still above the Fed’s 2% target,” cautioned Brown. “I think the specter of additional interest rate increases still hangs over the market,” said Brown. If the Federal Reserve were to continue to raise interest rates to slow the economy, this could push the U.S. into recession, Brown said. 

In a live poll, 41% of attendees ranked the economic impact of rising interest rates as the top risk facing investors in Q4, followed by market volatility with 29% and geopolitical risk with 18%. Misinformation, data risk and cybercrime tied with regulation changes with each drawing 6% of vote on the Data Minds webinar, “Proactive Data Strategies for Navigating Market Uncertainty.” 

According to moderator Chris Petrescu, founder of CP Capital, a data-as-a-service consultancy, asset managers and hedge funds are looking to translate the monthly inflation numbers back into the impact on corporate earnings.  

In terms of specific companies that inflation will benefit or hurt, Brown said, in general, the beneficiaries are the price choppers, the companies that can appeal to consumers who want to spend a little bit less. 

“There’s evidence that grocery shoppers are not buying the highest end brands and are moving down to private-label store brands,” said Brown.  

At the same time, a variety of other data sets have become essential for hedge funds looking to navigate risks such as options data stemming from the boom in retail investor participation, said panelists.   

Todd Schmucker, Director of Data Strategy at Walleye Capital, a $5 billion multi-strategy hedge fund, said that “consumer transaction data sets, credit card data, and spending data have become table stakes for the buy side over the last five to seven years.” 

Consumer Trends in Foot Traffic Data 

With ‘alternative data’ becoming mainstream, some investors are subscribing to location data to get a better handle on how inflation is affecting consumer behavior. In the data world, firms are looking at consumer trends to see if there are any shifts such as going to discount stores or buying private label/store brands, rather than mainstream brands.  

“One of the main areas where investors are looking is at where people are showing up, the kind of products they are buying, and what kind of websites they are looking at,” said Ed Lavery, VP, Investor Intelligence at Placer.ai, a location data analytics provider, which tracks all foot-traffic in the U.S.   

Despite expectations that discount stores would benefit with higher income households shifting downward to store brands, Lavery said this is not seen in the location data. In general, consumers are spending the same amount that they were beforehand, but they are buying different products, or they are buying the same product but fewer items. Consumers will still spend $100 but instead of buying four items, they walk out with three items. 

Location data can identify the regional effects that inflation is having on businesses. “A key point for investors is pinpointing the exposure of a business to a specific location or region that is being impacted by inflation.” Location data does not assume that inflation is affecting every area of the country the same way. “When looking at the performance of companies, retailers and restaurants on the east and west coast haven’t been impacted as much as the businesses in the Midwest and south,” said Lavery. This kind of “granular visibility” is not found in traditional financial data, he said.  

Options Data as Table Stakes 

On the market volatility front, another data source that institutions are tracking is options data. Many are focusing on the surge in short-dated options contracts with weekly and same-day expirations.  

According to Petrescu, options data is becoming mainstream for equity shops. “If you are an equities hedge fund, you need to know what is going on in the options market. You need to understand these flows, even if you know about broad strokes of retail vs. institutional vs. market making options flows.”  

Options trading has skyrocketed, partly driven by individual investors using the leveraged instruments to place bets on stocks. A single options contract gives the investor the right, but not the obligation, to buy or sell 100 shares of stock. Options exchanges have traded over 40 million multi-listed options contracts a day not counting the index space, and another 2 million to 4 million contracts in the index space, according to Sean Feeney, Head of US Options at Nasdaq, which operates six of the 16 US options exchanges. 

Industry-wide, options trading has increased 120% over the last five years, and volumes have grown 6% to 7% year over year. The boom in options trading began in 2019 and accelerated in 2020 during the meme stock era with GameStop and AMC Entertainment. As the education level of these participants increased with access to data and tools, investors learned about derivatives and how to use them to meet their investment objectives. They also shifted their interest into macro-broad-based and ETF and index space into contracts like the SPY, QQQs and IWMs (iShares ETF). Options on the large top 10 equity names such as Amazon, Apple, Google, Microsoft and Nvidia have also seen significant growth, he said. 

However, some commentators are concerned that the spike in retail investors trading shorter-dated options contracts could inject risk in U.S. equity markets.  

On Sept. 12, the Wall Street Journal reported that amateur retail investors are using one-day options to gamble on stocks. The nickname ODTE, shorthand for ‘zero days to expiration,’ was coined and has become a hashtag that traders can track on social media. Shorter-dated options activity, expiring in five or fewer days, accounted for half of all options trading activity in August, according to data provider SpotGamma.  Individual investors accounted for 27% of all options activity as of June, up from 23 % in 2020, as tracked by Bloomberg Intelligence.  

On the webinar, Feeney offered a different explanation for the rise of shorter-dated options. Going back 15 years, options expired on the third Friday of the month only. In 2011, weekly options were introduced. From 2016-2018, exchanges added options with expiries in the top symbols every week. Last year, exchanges started to list non-Friday expiries in many of the broad-based index options. Rounding out the cycle further, there is now an option expiration every day, said Feeney.  

“Over time, the duration of option trades has been getting shorter and shorter both from a retail and institutional perspective,” said Feeney. “As a result, there’s been a lot of trading on the day of expiration, mainly because there’s more expirations that exist. “If you go back on the Fridays, in the top 10 names – including the Google, Microsoft, Tesla, Nvidia, and Netflix, traded on the expiration day, classically this has been in the tenor of the option expiring,” said Feeney. “Naturally with more product, we’re going to see a bit more volume in that expiration cycle.” 

However, Feeney rejected the notion that ODTE was creating systemic risk and blamed the negative representation on media rhetoric. “When we look at those products and where the interest lies and any systemic risk that exists by virtue of those products’ existence, we don’t see it,” he said.  “The retail community tends to be net long convexity and net long options, whereas institutions use them for yield generation, and they tend to be net short options and that balance tends to balance things over time.” 

Given the surge in options trading, Petrescu said, “It’s certainly one of these data types that was always in the shadows, and I think it’s becoming more table stakes like corporate events and credit card data for consumer spending.”    

A portfolio manager in the consumer space or technology, media, telecom (TMT) sector, needs to have at least one of those data sets in some form, either raw data or aggregated form, said Schmucker of Walleye Capital. 

Looking ahead, Schmucker said he is anticipating new data sets will emerge such as industrials or other sectors which have not heavily trafficked in by those who use alternative data where the consumer and TMT sector have been dominant. 

Panelists agreed that portfolio managers may not “love a certain data set,” such as a consumer or TMT feed because there is a lot more crowding in that area to extract returns, but they must pay for it because it moves the market, and they need to know the market sentiment as soon as they can. 

As specific data sets become available, it’s incumbent on asset managers to incorporate new sources.   Petrescu said fund managers in names such as Tesla need to have a feed on car production. “Whether you are in the name for six months or two years, it’s a certain data point you would need on that stock,” he said.  

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