#954 - Is The Options Market Flashing Bear Signals? With Cem Karsan

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0:34Is the option market sending a bearish signal? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Jem Carson, founder of Kai Volatility. Hi there. How you doing? Hey, good. Good to be back. How have you been? I'm a little chilly, but okay, but I'm guessing not as cold as you guys are in Chicago. Yeah, it's funny. I just got back from Houston, Texas. My parents live down there, and I got stuck there. And it's not because of the negative 10 degrees in Chicago. Chicago, it's because of the 31 degrees in Houston, Texas, because that is way, a way tougher thing to deal with than the negative.

1:11We're used to it in Chicago. We got it all worked out. But that may sound brutal to people. But yeah, Houston was a mess. Cars running into each other, planes unable to get off the tarmac. Understandably so. Right. It's not supposed to be that cold. It's all through the South. My brother was saying that there's a ski place to go to the Carolinas. believe it or not, there is a ski place in the Carolinas. And they've just got a ton of snow. And of course, people in the Northeast and Vermont are sort of praying to get some. So everything's turned upside down. But yeah, and we're in for it for a little while, it looks like.

1:44So it's crazy. I saw them say in Texas, conserve your energy and electricity. And I was like, wait a minute, that happens in like the brutal heat wave in the summer. They're screwed on both sides here. They can't get your break. Yeah, no, the houses aren't made for it. The roads aren't made for it, nothing. It was quite a mess. Well, we're hoping for all our viewers who may be freezing in Texas and other southern areas that you guys get some relief pretty soon. So if we take a look at it, it's sort of interesting. We take a look across the market, stocks down across the board, small caps bearing the brunt of it, coming back a tiny, tiny bit here at the end, but down about 1%.

2:23S &P and NASDAQ about a half a percent. We saw the 10-year bond yield firmly back above 4%, US dollar up, crypto down. You know, the last time you were on, we should have rolled the clip. We should have cut a clip from it. But the last time you were on, you flagged mid-January as a really important window when we might see a change in market dynamics. In fact, you talked about January 17th as being a really important day. And it looks like things are playing out exactly as you had anticipated. Walk us through what you are seeing and what you think is going on here with markets. So you hear all the narrative and, you know, it's because of this and earnings and this number.

3:11But the reality is that overwhelming majority of day to day, week to week, month to month, I would argue quarter over quarter movement has nothing to do with any of that, or at least very little to do with it. It is structural flows that particularly this time of year, right, November, December, January, February, are very big and meaningful and different for different reasons and easier to predict during this timeframe because of that, because those flows are things that we can understand and measure and take into consideration. And they were bigger than even in this macro environment where flows and things are moving up from a liquidity perspective quite aggressively, even bigger than those.

3:56So they overwhelm those things. And that's what we saw coming all the way back in September, by the way. So September, we call the October-November decline to the day November 1 kind of reversal rallied to January 17th. So it's not just calling this January 17th. We've been calling all the dates from there and to the dates, by the way. And I'm not saying that to kind of brag, but this is the power I'm trying to display to people of flows and understand these things is critical to managing money in any form over any period, in my personal view, of multi-year, maybe even five-year performance. Yeah.

4:32And you did. And so I think everybody gets so focused on the other minutiae. Yeah, you have been saying that. You've been tracking, sort of like opening the window, the door for us and talking about these flows. Jimmy, you said something really important. And And it's funny, I was thinking about this because I think people are trying to hold multiple things in their head at the same time. So I was thinking about you talking about January 17th. And again, like this is multiple times you've been on with us, you know, predicting almost to the day that these things happen. And when you're talking about flows, you just call them structural flows.

5:05And you said something that was in my mind. How do we balance that with what we hear about when we're tracking global liquidity, right? Central bank global liquidity. And I think, you know, are they different things? Are they forces that are working in opposition of each other or do they work together at the same time? And I think you just said something that they that these structural flows that you watch were even bigger and overwhelmed. What I'm guessing you meant by this sort of central bank global liquidity. Is that correct? Can you talk about that a little bit? Because I think it's so. Yeah, they're not always in opposition, Maggie.

5:41Right. They can be together. The point here is the market over any meaningful short time is just a matter of buyers and sellers. It's a voting machine. We've talked about this, right? It is a number of people who want to buy versus the number of people who want to sell at what scale. And if you approach it that way, that's where the rubber meets the road. If you don't, too many people divorce themselves from that simple fact. And it's funny, like 99 % of what you hear on CNBC or Bloomberg or wherever, right is not about supply and demand it's about right some narrative some uh you know what's the economy doing what are earnings doing what are you know those may have a secondary effect on demand right retail sales today right that's what people are are saying is causing but tell me how does retail sales affect buying and selling in the market other than what opinion somebody might have on retail.

6:39Now, do those things matter over a year, multi-year, three-year, four-year? Sure. But those things can change over that period too. And there's reflexivity in the system that can overwhelm that between now and then anyway. So I'm not saying don't look at those things, look at them, understand them, have a broad view. To back up and talk about the weighing machine, which is what we're talking about now, the bigger picture of what's happening. If you've got the big picture about monetary policy dominance and the Fed put being strong in there for 30 years, you were a very wealthy person. You bought the dips in 2008 and 2000.

7:23You were aggressive on growth. You bet on China. You did all the stuff. But that's the big weighing machine. And if you got that right, you won. But guess what? You also lost 70 % in 2008 on the dip. You lost 70%, And so, you know, depending on what you were in in 2000, 2001. So if you're betting on short-term timeframes, it's the flows that matter. It is all of the supply and demand voting machine that matters. It's liquidity. But if you're betting on 10-year outcomes, weighing machine matters, and you should focus on that stuff. And I'm not saying that stuff doesn't matter, right? But that better be your timeframe.

7:58And if you're going to watch it and feel bad when the market's on 70 % and not pay attention to flows, then you're playing the wrong game. Both matter. But again, there's a lot of path and noise in between here and 10 years from now. And the weighing machine could be very, very different outcomes. Just think of the tech bubble, right? We went to insane valuations before we dropped 90 % in tech. Yeah, you might have been right about tech being overvalued, but were you willing to take that five-year sojourn on the, you know, getting squeezed out? And then, you know, were you still in it at that point, right?

8:37So what game are you playing? Are you trying to bet on a weekly, monthly, quarterly, annual outcome? Or are you looking at 10 years, 20 years, 30 years? And if you're betting at anything less than, again, there's a lot of research done on this, anything less than 10 years, fundamentals are essentially irrelevant to your outcome. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet.

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10:08I think this is so hugely important. And let's face it, even 10 years, even if you have a long time horizon, long-term focus, you can't really, none of us can really afford those massive drawdowns. Or we should try to avoid them because it takes a really long time to build them back up. Nobody wants to see all the work they've done and the wealth they've accumulated evaporate. So I think it's really hard to put that aside. And I think what you're talking about is something that no one tells you, right? Everybody, like none of the traditional sort of outlets or media or conversation really honestly focuses on this stuff.

10:46And so I think it's incredibly important. So when you look across the structural flows that you watch so closely, what's happening? What is the story that that's telling you that we should pay attention to? There's a lot of components. Let's kind of dive under the hood a bit. You know, seasonality is particularly strong. We talked about this last time. What do I mean by seasonality? The buying pressure, which is mechanical, is very strong in November and December and into mid-January as a function of reinvestment of capital. So we've just had the market increase by 25 % in value. Again, that's$400,$500 trillion globally of assets.

11:38You can argue maybe it's not 25 % for all the assets, but maybe it's 15%. That is 50, depending on the math, you're doing$60 trillion of new money. That's got to go back to work. Some of that goes back to work throughout the year, but the beginning of the year is a big moment, and some portion of that goes back to work. A ton of open interest in the vol space in December, way bigger than any other expiration because it's leaps and it's been on the calendar. All these structured products are tied to end of the year. All of these things start to decay aggressively into the end of the year. And if the market isn't declining enough and the market is up and stable, they have a momentum factor.

12:16All the dealers who are short stock have to buy back that stock. and time is shorter in that period because of all the holidays, right, and all the people taking time off and things just get going. And then it's there's this end of year chase, like, oh no, this is coming and I'm falling behind. I better get on board. And that can be a bit of a, you know, cascade effect and can cause momentum upon momentum. That really doesn't end to mid January because it becomes weaker as we get past the beginning of the year and as we get towards mid-January, as we've seen. But it doesn't end to mid-January because January is actually the biggest options expiration for single stocks.

13:01And so there's still a lot of open interest that had to get off the board and had to get squeezed out, particularly in tech. And we highlighted this last time. A lot of people probably missed it, but this was probably one of the better opportunities. the last week or week and a half, you saw that sudden, like tech was doing poorly at the beginning of the year and then pop. It kind of popped back into that week really until today. And the reason for that is because all that, that's how you can see Vana and Charm across the market. Where was the Vana and Charm? Primarily focused in single stock tech.

13:33And that represents opportunity too. It's not just up or down that these flows tell you. It's where in the market are the flows and where are those drivers coming? And they were in tech. And guess what? Ended today. So of what's likely to happen, a resumption of the beginning trend that we just saw early in the year, and a bigger trend kind of that we think is coming this year, which is a reversal in that tech versus kind of the rest of the market this year. But anyway, these are kind of a general view. Now, January 17th, it's not over yet. Officially, Jan 19th is the end of that options expiration.

14:06But by the time you get past Monday, this last Monday, all that weekend and all that extra time is kind of coming out aggressively. And you're getting to that last point where people are like, okay, do I want to be holding this? Do I want to be rolling my hedges? Do I want to be taking this off? The majority of that bond and charm has come out. The reason Wednesday tends to be kind of that day, and it's not just that day. I mean, I circled down the calendar, it's the most probable, but that doesn't mean the day before, the day after, right? It's not also probable. But the reason that day is because of expiration.

14:38And that's when these VIX options expire. And that's where the majority of the vol supply kind of starts to get dissipated. On top of that, now we've seen other flows coming in that are very kind of loosening the vol kind of supply, which is a good sign for decline as well. We're waiting to see under the hood if this will happen, right? Or I'm out here talking about it for three months. I'm reflexively dampening this, right? The more I'm right, people can be like, you know, and that's true, right? Because people who are smart in the market are beginning to listen and watch and bet accordingly.

15:12And that has a reflexive effect. But, you know, there also has been a decent amount of VIX call buying, a significant size the last several days, as well as several, you know, put spreads and whatnot in the S &P. Those things begin to loosen vol. And we've seen the vol go up broadly, particularly in the back of the curve, meaning several months out, not just kind of short dated. And that is actually what you need to see into this decline for it eventually to continue. If vol doesn't get loosened up immediately, does become more off for the next several days, that reduces the probabilities of an extension.

15:52Again, markets are weak. There is a lack of positive flows to balance the macro negative flows. But that doesn't necessarily mean we're going to crash. Okay. And I think that's an important thing to remember. And the more I've talked about, the more that's fall damping. I personally view that, you know, the more people position short here, right, the more likely it is to be more stair step down, fall compressing, right? That's probably the more likely scenario here for the next two weeks, I would say. A decline then could accelerate if this fall does continue. If the buyers come in, we continue to loosen the fall supply here.

16:33You could get a significant decline, but it's kind of like a decline with vol higher begets more. And you need to begin to see that now to see an extension, which I think is very important for people to understand. It's hard for people to watch that. And, you know, you go down and watch these vol markets, fixed strike vol. I mention this all the time, not just the VIX. The VIX is going up, but what's happening to fixed strike vol? And that's actually going up now, which is a very good sign for a continuation of this decline. We'll see if that continues the next week. The next week is very important.

17:06If it doesn't, I would expect Feb 2nd or 3rd or 4th, right, after the end of the month, which has some negative kind of flows potentially here as well. And then that Vonne Charm continues back for Feb a little bit. I could see a stair-step situation, basically, with some retracement if this thing doesn't get going soon in a more meaningful way. And if that were to happen, And then I think next February 14th or so would be potentially more dangerous. This two-month period is very dangerous. We've been very clear that wasn't the case the last three months since November 1st. Be bullish. Be constructive.

17:43Now the probabilities of a decline are significantly higher, whether it happens right away here, like we're seeing, which we think is you have a window here. You should be betting on it. But we're watching it carefully, particularly the vol aspect of it. And if it doesn't happen here again, after Feb 2nd, you've got to be constructive again until Feb 14th for a couple of weeks and then try and bet on the short side again. Using vol here is a is a particularly interesting way to do make the bet because it has gotten so low, A, and B, because a lot of that vol supply is now starting to wane as well.

18:20So if you see that fixed strike vol that you're talking about, as I flip my madly scribbing my notes down, if you see that going up, why would that happen? What are the conditions or what is causing that to go up? What is that saying? More buyers than sellers. Right. Again, it's that supply and demand machine. More buyers of fixed strike vol. Of vol, right? Yes, fixed strike vol. And that is because they are anticipating things are going to get worse. Is that right? What is fixed strike vol? Fixed strike vol is the pricing of options. So if the pricing of options shifts up, if the implied volatility of the option chain increases, and particularly when you look not one or two days, but really further up, that is a very good sign that dealers are getting taken out of their supply.

19:14And that's a kind of a proxy for it. You can do what we do is manage and look at that dealer positioning, more closely. But as a proxy of it, if vol is going higher, that means it's being bought, right? And dealers are getting shorter, right? That's why it's going higher. And if fixed-trade vol starts to go higher and accelerates higher in any way, that can really loosen what I've called like the Dutch boy with his thumb in the dice. Yeah, the pinning, right, that you talked about. That pinning of the vol. And so structurally, the flows, supply and demand are imbalanced now, There's not as much buying pressure as we've seen, significantly less.

19:53And the overhang we know is bad from liquidity on a macro scale. So with that imbalance, the vol is very important because if the vol is well-supplied, people can manage that short and kind of – but if it starts to accelerate and get dangerous, right, things start to move more quickly and vol itself is well-supplied, it can really accelerate and get messy. And so understanding that is very important to understanding kind of the risk and the speed of what can transpire here. And the more that's supplied, it can hold things in place where things don't get too ugly. It can wait till we get to a point where those flows come back and things can get a little bit more.

20:28But the point here is that those positive flows that were so structurally positive for those three, you know, November, December, mid-January, two and a half months are now gone. And that's the big part that people need to see. And the structural overhang is still there. And if not, if anything getting worse and reflexively, policy is now starting to say, oh, no, markets have rallied. inflation is a little hot. Maybe we need to keep rates higher and issue more debt and all the things that we've been talking about, which are bad liquidity-wise. So that imbalance is worse at the end of the day. Now, how that transpires will be a function of the ball, whether it's able to hold things at bay between now and the next window in February.

21:10But again, here's your shot. Here's the window. This is the one we circled. And you watch it closely. And the more buying, I will say, of the more big orders you see of vol coming and hedges you see coming into the market, the more reflexively dangerous this market can get because it can really start to take dealers out of their vol. And I think that's something we're watching very carefully that everybody should. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:45Listen, I hope anybody who is on the platform is bookmarking this and getting your notes out because this is incredibly important stuff and it's kind of giving you some knowledge and wisdom and an eye on the market that you need and you haven't had. It's just fantastic. So we've got some questions in here. I was thinking bloody Valentine's Day. Oliver's like not a dangerous Valentine's Day, I'll have to cancel the roses. That's exactly what I was thinking of. We're going to be able to remember that date. Some really good questions and comments. I just want to ask one more thing, and maybe I'm asking what some people are already thinking about, but just to circle back to this relationship between these flows.

22:25If this is the setup on the structural flow, if we see... One of the folks that look at global liquidity, central bank liquidity, talking about China, right? Maybe China is injecting more liquidity than we thought because their economy is weaker than we thought. Hard to know what's going on, not a lot of reliable information, not easy to track what's going on with China. But if we were to see that come in, is that an offsetting force against some of the structural flow dynamics that you just explained? How do you fit that in the puzzle? 100%. I mean, you have to look at the macro liquidity picture.

23:04You can't just sit here and assume it's bad. I mean, I've been talking about it generally, but that's because of the amount of issuance that's having to happen broadly and the amount of liquidity that's being pulled out of the system. The Fed is, even at its, it's still doing QT. It's talking about pausing QT or slowing it down, right? But it's still holding interest rates broadly where they are and still doing QT. and liquidity is also just more importantly being pulled from the system via the treasury. At the same time, we had a bit of a buffer. So we didn't really feel those effects as much, I would argue, because of reverse repo, right, and that facility on the short end and the focus on issuance on the short end.

23:53So we were able to source liquidity from there. The treasury was that we've seen, again, we talked about last month, But the canary in the coal mine, right, of SOFR and some of the things we're seeing each end of month now, November, December. We'll see how it is here at the end of January, too. But there's internal talk about that, too. That's why, you know, they're talking about cooling QT because they're worried about this liquidity situation as well. You know, we're getting to a point where that liquidity, which is poor and has been cushioned by reverse repo, is kind of running its way through and eating its way through that buffer.

24:28And I think that's a real risk for markets from a liquidity perspective. It could get really, you could get a cliff there right at the time some of these flows are no longer there on a positive. And now, question to your point is, well, what does that mean for reaction function of the Fed? Are they going to create a new facility? They always seem to, right? Are they going to, it's election year. Are they going to come stimulate again, you know, for political reasons? All of those things are important and relevant. And we are thinking about those and looking at them. But the point is right now, even if you assume some of those things are happening, this is a kind of dangerous mix, right?

25:09And a lot of those things very well might not happen unless the market kind of holds policymakers' feet to the fire, whether it's the Treasury or the Fed and fiscal policymakers as well. My best guess is we get a decline. Again, that's what I've been saying for a couple of months now. that we get a decline because there's an imbalance of supply and demand in the market. And eventually, they're already thinking about it. We'll see how fast they react. But eventually, there's a reaction for both Treasury and from the Fed and policymakers. And the bigger the decline, the more their response will be.