Cem Karsan On Volatility & A.I. Boom

Summary

Jeen Carson provides a monthly market update, focusing on three main points: his view that the 10-year Treasury yield will reach 5% by year-end, indicating his belief in an inflationary period ahead; the potential for market weakness in the Feb-March options expiration window, though he notes the difficulty in timing market moves; and his observation of rising volatility, benefiting certain stocks. Though seeing macroeconomic risks, he believes policymakers will likely favor stimulus over fighting inflation in an election year, risking loss of control of interest rates.

Takeaways

• 😀 It's never straightforward to predict market moves; must consider reflexivity of markets
• 😮 Need market volatility (V) to rise to enable market blow-off tops
• 😑 Windows of expected market weakness don't always occur as predicted
• 🤔 Long-dated calls can benefit from market rallies and offer downside protection
• 😥 Markets tend to squeeze shorts before major selloffs
• 😤 March Opex carries risks but upside if market strengthens past one week
• 👀 Market dispersion emerging, with tech weak recently while small caps strengthen
• 🤑 Nvidia earnings could spark short squeeze across risk assets if strong
• 🔮 Secular view unchanged - 5% 10-year yields likely by year-end
• 😰 Risk of 1970s-style stagflation if Fed doesn't get inflation under control

Q & A

What timeframe does Jen set for when we may start to see things falling apart in the markets?

Jen says we have about a week, a little bit less even, to start to see signs of things falling apart in the markets.

What does Jen say is the best way to trade this volatile market environment?

Jen recommends trading options rather than just being outright long or short the market. Specifically he suggests being long dated calls and shorting stock into rallies for the best risk/reward.

What happens if the markets don't decline around the Feb-March OpEx timeframe?

Jen says if we don't get a meaningful decline around the Feb-March OpEx, the probability increases that markets will squeeze significantly higher as shorts are forced to cover.

Why does Jen think the yield curve is steepening?

Jen believes the yield curve is steepening because if the Fed favors GDP growth over fighting inflation in an election year, long term inflation expectations will rise, causing the backend of the curve to sell off.

What is behind the structural inflation Jen sees?

Jen sees inflation being driven by de-globalization, populism, labor rights movements and other structural factors - not just cyclical economic factors.

What is the role of implied volatility in the potential for a market blowoff top?

Jen says you need to see implied volatility rise to get the type of blowoff top with a painful short squeeze to unravel the huge net short positioning.

What is the dispersion trade Jen mentions regarding the Russell outperformance?

As NASDAQ dealers short gamma must sell stock, this forces buying in other indices like the Russell to rebalance exposures.

What is behind the fat left tail risk Jen describes?

Around quarterly options expirations, due to the amount of open interest, if markets decline sharply, the resulting gamma from unwinding positions exaggerates the move down.

Why can't you just be outright short this market?

Jen says being outright short is dangerous because in blowoff tops, the market tends to squeeze shorts by moving faster upwards until exhaustion finally hits.

What is the trade Jen specifically recommends here?

Jen recommends being long dated calls to benefit from an upside squeeze while also shorting stock against those calls as a hedge to profit if we do get a meaningful decline.

Outlines

00:00

😀 Market recap and outlook for volatility

Jen Caron provides a market recap, noting continued volatility and a potential crash risk into March OpEx. He discusses positioning for a market top through long-dated calls and being prepared for whippy price action.

05:00

😊 Managing crash risk and assessing the market window

Caron assesses timing risk for a market decline, suggesting about 1 week remains for weakness. He notes the market could continue squeezing higher into March OpEx if weakness doesn't materialize, favoring long-dated calls.

10:01

😎 Macro views on inflation and policy implications

Caron shares his macro framework - expecting 5% 10-year yields by year-end amid a secular inflationary period with Fed policy staying easy. This could fuel further blowoff top rally ahead but longer-term risks.

Keywords

💡Volatility

Volatility refers to fluctuations in asset prices or returns. The video discusses trading volatility in the context of market cycles and investor psychology. For example, as volatility rises into an "Opex window", the left tail risk increases even though expected returns may not change.

💡Macro framework

The macro framework refers to the big picture analysis of markets and economies. The guest speaker provides a macro framework for understanding potential market weakness and a move higher in interest rates based on economic trends.

💡Market cycles

The video refers to historical market cycles like the 1999 tech bubble and 2008 financial crisis. It discusses how market tops often involve spikes in volatility as investors get "squeezed out" right before a crash.

💡Fat tail risk

Fat tails refer to low probability but extreme events, especially on the downside. As open interest builds into Opex cycles, fat tail risks increase even if a market melt-up is more likely.

💡Risk management

The speaker advocates risk management using options to control left tail risks. Rather than just going outright long or short, he suggests owning calls and shorting stock as a hedge.

💡Reflexivity

Reflexivity refers to market moves being self-reinforcing, especially into market tops as greed begets greed. The reflexive nature of markets makes calling precise turning points difficult.

💡Deglobalization

Deglobalization is presented as a structural driver of inflation, as supply chains shorten and labor bargaining power rises. This contributes to stagflation rather than a growth-driven rise in prices.

💡Stagflation

Stagflation refers to a period with both low growth and high inflation, which the video warns may be coming due to structural economic changes.

💡Curve steepening

The video predicts curve steepening, with short term rates falling but long term rates rising. This could occur if the Fed stays behind the curve on fighting expected inflation.

💡Blowoff top

A blowoff top refers to a vertical spike higher in markets as exuberance reaches an extreme before a crash. The video discusses conditions that could fuel this type of melt-up scenario in the near-term before an eventual downturn.

Highlights

Market sentiment becomes too extreme before a reversal

The market squeeze continues until it becomes too painful

Play volatility using options instead of just being long or short

Own long-dated calls and short stock as the best risk-reward

If the market doesn't decline soon, it could rally powerfully

There is still about a week for potential weakness

If Nvidia earnings blowout, it could fuel a market squeeze

The 5% 10-year yield target by year-end remains

We're entering a stagflationary period

Inflation has a structural component, not just cyclical

The Fed is favoring growth over fighting inflation

The yield curve is steepening due to stagflation concerns

The Fed could lose control of the long end of the curve

We could still see a blowoff top in markets near-term

Longer-term inflation risks are building

Transcripts

let's talk some trading volatility and

the macro framework of Mr jeen Caron

back with us for the monthly update he's

a senior managing partner at K

volatility advisors Jen welcome back

great to be here always fun all right

three main points in your framework from

the last few times we've talked about

starting with kind of the most macro

your view that we get back to 5% in the

tenure by the end of the year seems like

we're on our way there uh Feb to March

Opex being the most probable for a crash

and then structural pickup in V we've

getting that V stocks up but let's start

with the window of weakness here I mean

this looks like anything other than

weakness to me yeah it's to be clear

it's never easy if everybody thinks that

it's just going to play some script

again and again and it's going to be

that straightforward you know that's not

how these things work I want to

reiterate that you know during covid we

knew about covid everybody attributes

that big 30% Gap in one month to to that

big macro event and and clearly that was

the main factor but we knew about that

late December early January what

happened everybody's talking about it

everybody's preparing for it people were

shorting it what we saw into the hood

was market up vup market up vup and the

market went straight up until the day

after Feb Opex right frustrated

everybody everybody started throwing in

the towel and then you got a 30% decline

yeah now I'm not saying we're going to

follow that script again I'm out here

talking about it it's not going to be

that easy but the point here is think

about 1999 I started this business in

1998 what do we see then we saw market

ofup for almost a year almost a year

yeah everybody knew a top was coming

that it like you know 42 PE all the

stuff was crazy but people were prepared

for it reflexively what that meant is

that we were it was not going to be easy

and that we're going to squeeze at the

end the trade at the end the easier

trade and I've tried to hammer on that

in here is to buy upside ball longer

dated when this starts to happen because

in this situation people are getting

short people are uh selling calls

against positions and what that leads is

more fuel to that vire into the squeeze

up and you need to unpin V to get this

blowout top you need to se go up for a

while we're starting to see it we've

seen it for almost a month here did

since I mean look I know you look at up

you look at fix strike V Mia Layman I

look at the vix vix has been going up

since December while the Market's going

up this period here that you described

as the the highest probability of

weakness we didn't get that Jan window

to open up to the downside and so we

kept rallying you talked about the

possibility of Valentine's Day Massacre

so is that over or are we still in that

window of weakness I've said this before

instead of playing in two Dimensions try

and think about these calls which are

very cheap out of the money you can sell

stock against that is that you own a a

left tail massively if that happens

those calls disappear your short stock

into a decline the way to play this I've

been very clear I've giving you guys the

trade long dated calls short stock into

a rally of all goes up you have you're

making money into that rally long V and

then if you decline in any meaningful

way which eventually will come by the

way it will come right uh you know you

will get you'll get a profit on the

downside it's the best risk reward by

far you don't need to be short the

market or long the market play the best

probability odds and that's what we've

been preaching ball up market up

continues to happen it will continue to

happen in this market if we squeeze any

higher today we're trying to squeeze the

Russell and to your point each time

we've had these conversations even when

you do see the window of weakness you

have been clear that until it's obvious

to develop you don't start going

directly short you maybe try to dabble

or fade but have you been surprised by

how the AI stuff has maybe outweighed

some of these these VA uh principles is

that what's happening at all this Rush

this Gold Rush again 26 years of doing

this uh nothing surprises me anymore you

know I um I live through the tech bubble

I live through 08 we were the biggest

Market maker in the S&P 500 during the

great financial crisis crazy stuff

happens and it always goes further than

you think the markets are reflexive

Machine by definition it's always going

to be difficult because people are

betting rationally betting against

things when they don't make sense CPI up

into a declining Market 65% of

commercial real estate is

underwater right we have issues there

are big structural issues uh you know

the the problem is this thing will not

go down until people start throwing in

the towel and it what it'll do is it'll

go up faster and faster it'll squeeze

out people so it's so painful that

nobody can take it anymore and then

we'll go down that's how it works that's

how the machine works now that said

there are periods in structural times

when the wrists are bigger and we're

entering one of those right after a 25%

rip in the market over two and half

three months right yep so uh you know

Market of all up is a good sign that

things are getting more dangerous

don't play it just long or short play it

with options there's very cheap ball out

there if the Mark if the ball is going

to go up on the way up right take that

credit they're giving you take it you

get a chance to be long ball for close

to no burn do it the uh window I

remember you said last time if we don't

get a big move around this Feb to March

xpre then it seems like that would be

the market kind of taking a new leg

higher and then to not be even trying to

fade really in any way where does that

timeline end to where we kind of just go

all right you know we have to let this

Beast ride until we see evidence of real

material downside of people getting

exhausted to your point yeah so I want

to be clear um again think 99 uh we knew

that Tech was overvalued and uh the

NASDAQ proceeded in 99 into March 200

topped to Rally Almost 100% yeah and

then it dropped by 90 2% I think was the

final number so anything is possible if

you want an exact period right now you

have a about a week a little bit less

even right to to start to see things

falling apart I would say about a week

from now um if you don't get signs of

that right the the reality is th those

Vana and charm flows are very big in the

March Opex when I talk about these big

quarterly Opex is with all the open

interest the bigger the open interest

the the probabilities of us going up

increase as a percentage probability

during those Peri periods but the fat

left tail gets bigger it becomes a

distribution that is right uh

distributed with fat left tail that

doesn't mean the expected return changes

that means that the probabilities of an

increase go up right but the magnitude

of the decline gets bigger on on the

downside why is that all that open

interest is gamma if we decline into it

much like in that fbom March opic cycle

during Co it can explode and create a

massive issue right but if it doesn't if

we continue to pass through time and V

begins to decline or at least

consolidate what's going to happen all

of that short stock that dealers have

they have to buy back right and that

just perpetuates a bigger and bigger

squeeze into what's already got short

interest and people betting against it

so yes you could see a continuation not

just a continuation a big push higher

here into March Opex if you get past

this week and and there's no you know

it's a chicken a game of chicken right

now yeah right and and and so you can't

just bet up or down you got to bet where

the probabilities are that's why you

want to own long dayed calls I want to

say it again like if this doesn't go

down it's going to go up and it's going

to go up big right we're going to

squeeze higher and there is short

interest out there and people are now

getting squeezed out of that there's an

unpinning of all happening the moves

just like you saw we just did 100 points

down the S&P and 100 points up that's

what kind of looks like it's happening

to the Russell today because it seems

like I feel we can pretty easily argue

the fundamentals are the most precarious

in dub in the category of the Russell to

your point about the exposure to loans

underwater there's like 30% zombies in

there even after the inflation print the

fact that the rustles coming back as

strong as it is that to me seems like

we're in that kind of squeeze mode in a

way we've got Nvidia next week what

should we be looking for here yeah I

mean there's a trash Dash component

right that happens when these things

kind of start that's what today feels

like a little bit there's an added

component I do want to add in you know

during Opex right now the NASDAQ is a

place where all the customers have been

buying calls and dealers have been short

calls right that's because again that

squeeze that they've been able to take

advantage of what's happened the last

several days is as V starts to decrease

right uh in those calls and we've had a

slight underperformance now those calls

are decaying and the dealers are now

having to sell out their stock it's the

opposite effect that we see in uh in the

S&P and broadly in markets that if you

have that pressure and then the index is

getting pushed up what's going to happen

you're going to get a dispersion and the

Russell is now going to have to or other

entities are going to have to perform

instead so we're getting a dispersion

trade as we've seen the S&P v um

relatively as well contain there support

in there whereas on the NASDAQ you're

getting the opposite during this window

so I wouldn't read too much into it past

this week okay right uh if Nidia blows

out earnings could we see a continuation

into the squeeze if you're if we think a

market ofup is going to continue that

that would actually make sense I I

actually think everything could go up on

the next rally it could be a real short

squeeze that seems like that's what

we're trying to push to bring everything

else into the F Russell Bitcoin some of

the deep value Stuff Etc uh so up

markets up has been happening maybe a

weekish left for the window of

opportunity for weakness the last point

which is macro the 5% tenure by the end

of the year imagine you're feeling

pretty good about that after the move or

is this give back here yeah no 100%

again this is a secular view right we we

talked about this we're we're getting

continued signs of what we've been

talking about for years uh everybody

calls us a soft Landing in my book it's

not a soft Landing the the the cousin of

soft Landing is stagflation we're

getting a structural inflationary period

as we start to see things really uh go

into a massive slowdown at the same time

um you know everybody's confused now how

can we have this type of inflation but

have kind of the commercial real estate

issues and the slowdowns we're seeing

across the board because they're

unconnect they're not connected

inflation is not just a cyclical

component as we've been looking at for

the last 40 years it is a structural

rebalance that's happening from De

globalization from populism labor rights

all the things that we continue to talk

about and that will continue to be

sticky not to mention now oil's going

higher right those things are tied into

those geopolitical disconnections which

don't have necessarily have to do with

the cyclical ups and downs of the

economy and so that is a very important

point last thing I would say the

steepener right everybody we've been

talking about this would expect because

the last 40 years when rates go down the

whole curve shs down right but we're not

seeing that yeah we're seeing the

backend go higher why why is that

because what happened If the Fed chooses

in a stagflationary environment not to

deal with inflation not to be vulker but

to be Burns right to really go favor GDP

and and it's an election year that's

what's happening they're favoring growth

if they're going to do that in the short

term that means rates will come down but

what does that mean that means we get a

structurally more inflationary period

and ultimately on the back end they can

lose control of the curve and I think

that's what the Market's reading out

from this and that's why we're seeing

the steepener it's it's a stagflationary

environment and they're not being

proactive with it and that's a problem

long-term in the short term hey blowoff

top can come we can get a really

positive election here but watch out

going forward all right I like V Windows

gem but I also like macro gem so I like

the excitement great to catch up with

you sir always great to be here thanks

for having thanks very much uh and a

good followup to the analysis from last

month Jim Carson Senior managing partner

at Kai volatility

advisers