The Last 3 Midterms Each Fell 10% Within a Day of Expiration. Cem Karsan on Why

0:00 Am I okay with this mic? Should I move it? I shouldn't touch it probably, huh? >> We're in an environment where things are so quiet you can hear a pin drop. It's the dol jumps of summer, but there could be some things coming along the way. Welcome to Tasty Crumbs. I'm Jamal Chandler. He's Jim Carzan. Mr. Carzison, how you doing? >> Doing well. Good to be here. Happy Monday. >> Yeah, man. Happy Monday. Um, I mean, I was looking this morning and, um, honestly, I would say the expected move probably exceeded what I thought was going to happen to be totally honest. I mean, uh, we had 36 points today. I didn't even see what the move was ahead of time, but I do know that we came in, we talked about the weekend effect last week and, uh, we definitely saw that play out a little bit today. We saw VIX

0:45 as low as 1418. Is that what the low print I saw on Friday? >> Yep. I mean, >> remember the Friday, the weekend effect makes that look lower on Fridays. You come in on a Monday and you see it pop. That's going to be a recurring thing here because we're on Mondays, but but uh >> which is nice. >> It's gonna it's going to look like the VIX is always up when I come on, which I, you know, that's kind of in line with >> I don't know if we really want to call it up today. You know what I mean? >> That's right. It's not really up. That's the thing. So, >> but uh you know, as we're as we're already on this convo, uh we got a couple of charts here. Let's let's let's fl let's go into them just just illustrating how low things absolutely are uh in the VIX environment. And so just looking at Vivix and VIX, I actually like to do this chart a lot of times as a ratio. And I think about it in terms of that it's essentially around six right now. Fair value for that over the last 10 years is about 5.8. So we're

1:31 just right on that measure. But uh this is not the ratio. This is them themselves, right? And we do know the long-term average is about 19 or so. Some people say 20 for VIX. I would say long-term average at least for for VIX can be somewhere around 100. We're well below those, right? Illustrating just how low things are. And if we go to the next slide, um we see this actually uh just looking at the volatility risk premium, which I know you're very well aware of, but uh that difference between VIX and 30-day historical V, I mean, is extremely low. I mean, just looking past looking back to to March where everything was a little bit fearful, we saw way higher. And at this level, we talk, you know, Jim, we we talk here to tasty people a lot about selling volatility. I'm the first one to say this is not the

2:16 environment I want to sell vol. I don't want to have any strangles. Sure, you could be short short uh, you know, downside if you want with that idea of of eventually taking on a stock position, but it's not high volatility. It's not high premium. It doesn't matter if it's an it's an individual name. It doesn't matter if it's index, it's lowvall right now. And so these are the hard trading environments. >> Yeah. And what I'll highlight is a lot of the time, this counterintuitive, but when uh implied ball or the VIX is low, that actual spread of realized to implied actually tends to be a little higher because uh ball is usually low for historically for a reason or like the pinning effects drive less realized fall. And we're actually seeing low premium and low ball uh right as you're coming out of the summer. Uh and we'll

3:02 get to a little bit more of other signs. It's not just that it's low so you should buy it. It's not just because we're coming out of the summer so you should buy it. It's because it's low with a lot of signs under the hood that it's too cheap uh as we come out of the summer and as you pointed even that risk premium is quite low. >> But the interesting thing though is like and you're right V is low. Uh we've said we've illustrated that and V is low in indexes but the interesting thing is is that um there is still high implied premium in some individual names. I know you're not an individual name guy, but how do you how do you not get trapped in that if you're trying to reach for alpha, trying to reach for something to trade right now and you see an individual name, let's just highlight like an individual LRCX or some type of most of them are technics, right, that are might be high implied V. How do you

3:48 not reach for that and sell that right now saying I got to trade something? >> Well, so so first of all, dispersion, we'll get to that here in a little bit here, has been at record levels. We talked about in May how this summer was going to have the highest dispersion ever. Sure enough, it did. We actually talked about that the momentum names and the names that you're talking about largely would would explode involved while the index would stay muted for all the reasons we've kind of gone into here, which is if the index is pinned, you tend to get stuff put moving away from each other. So, that happened which then understandably expanded the vault there on the realized uh on the implied V for those names. What you're seeing lately is that starting to come down. So implied correlation or the implied ball between the two is starting to narrow right which is what tends to also happen

4:36 and we'll get to this uh in a in a chart here in a little bit uh you know also tends to drive uh reflexively than a more of a a VIX increase and a and a delta 1 kind of correlation correlated move. So, so I would I would say uh look if you're going to sell V somewhere to buy it somewhere I agree that it should be in those names, right? Uh where the V is higher, but you should net be longer ball where where it's cheap in other places. One of the better trades and uh if if you're going to play for kind of downside broadly is to actually sell the the call skew to buy the put skew in those names you're talking about. So, you don't have to play the V per se, uh,

5:21 like in these Momo names, uh, because there's been such a call squeeze and that call has squeezed up so much over time. Again, there were slightly better entry points few weeks ago, but it's still a great time to be selling that call in those names to buy the putvall. If you can do zero premium callers with with kind of um some of these names slowing down here as we're coming out the summer, that's really interesting if you ask me. Uh, not a bad That's a good idea. That's a good idea. You are You're coming around to the retail people. You starting to give them a little bit of what they want, man. Don't Don't Not not yet. Don't Don't get too happy with them yet. >> Sometimes we It's We do a little more than crumbs. Sometimes you get the whole pastry. >> Okay. I hear you. I hear you. Um, but you have uh I know you have at least a

6:06 couple of things here that outlines how you're feeling is what you think is about to come at some point in time in the future. Is there is there any you know you've laid out the scenario in which you feel like it might happen. Is there anything that uh makes you think that ceases might change? Cuz look, we've seen we've seen things change in this economy. We've seen the wool pulled over our eyes right in front of us and it didn't even matter. We've seen these inflation reports that potentially show there's not inflation, but yet we know it still exists in the system. We know that retailers aren't spending that much what we saw from retail sales the other day. So, I mean, does that give you cause to think this is still going to happen or uh you know what, maybe not? >> To be clear, uh there's there's three different parts in in prediction. We've talked about this before. Three kind of a three-legged stool. There's the flows,

6:52 right, which is very kind of shortterm. What's happening in the next week, month, quarter that really affects those things uh like daytoday. There is the macro, right, which is what everybody loves to talk about. is as causal usually after the move already happened but it is very important on a more kind of quarterly annual multi-annual basis right and then there's the administration and reflexively what is the Fed what is the treasury what are they doing right in order to kind of counteract things to get the market moving or or whatnot these are the three things we're going to talk about again and again the flows which there there's a just chart up there that that I want to kind of get to is has been incredibly uh you know from the from the VA perspective incredibly compressed. So things have been very supportive and constructive throughout the summer as

7:38 they tend to be if you go into summer in a good in a healthy way. Um particularly lately as the VS if the volumes have increased and as we talked about when that happens you tend to see correlation breakdown. And what you see here for the last three years from the flows perspective is whenever those balls get really really really compressed those that's kind of that VIX chart at the bottom you start to see these kind of lower levels along the way uh correlation starts to break down and after correlation really really that's the bottom part there start has really broken down like we've seen it now and this is a 20-day or one month moving average 20-day correlation breakdown and the underlying constituents of the S&P, right? >> When that really happens, once you've

8:24 gotten to the end of this, that generally means when it does happen that that V at the index level has been unnaturally kind of compressing what is otherwise what I would call idiosyncratic V or kind of real V, like things that are really moving the market. And when things are going on under the hood, you're getting big correlation breakdowns um and the index is pinned. Eventually, as that v for whatever reason, sometimes it's seasonality, it's it's the volume coming back at the end of summer like we talked about, which is why we've we've we've kind of pointed to that as a risk. As that starts to happen, that correlation breakdown, which you see, has been a fairly reliable, not right away always. Sometimes it's a couple weeks, sometimes it's, you know, even as

9:10 long as a month. But before too long, that drives the opposite, which is a ball expansion and more of a correlation one move, which then brings back that correlation. That's what this chart's telling you. And and people, some people be like, "Ah, data set of four. Come on." Like that's not And again, some people will be like, "Oh, it's last three years. Show us something longer." The truth is these effects are getting bigger and bigger as V flows get bigger and bigger. We've been talking about these for at least six years, right? But they are bigger than ever and they are becoming more determinative than ever. Okay? And so my point to you is this chart gives you a little bit of a keyhole into how that works. And where do you see us right now? Right. Right where that red circle is. So, right as we're coming out of this summer, right as there's a setup of of that index

9:57 vault compression like likely expanding as we've talked about for the reasons we've talked about that correlation breakdown has been really low and so that's a really nice setup for a delta 1 move and likely a move lower with VIX going higher. >> Yeah. But Jim, the thing I'm going to ask you though is like and this is the thing that people ask me all the time. I mean how do you know that uh what's going to happen here? But when we look, let's zoom in on the chart. >> Nobody ever said I know about probabilities. >> Maybe you don't know. But my point is >> signs and clues that are underneath the surface right? >> Looking at these days, right? Looking at April 2024. I'm pretty sure that's liberation day, right? I think. I can't even You know what? These things are starting to run together. Yes. Get a little hard to remember. Pretty sure July was also tariff related. July of 2024. uh October was uh sort of this breakdown with oil uh with with gold and

10:44 silver and some of those and that that's led to this environment where where volatility picked up big uh earlier this year was um obviously what we just went through in in in April and and then obviously we're getting here now. I mean it's almost narrative follows price. Narrative follows price. I'll give you an example. If the market hadn't declined on Liberation Day, would we still be talking about it? No, the reason people think that liberation day was is is so important, reason we talk about it because the market went down. Whenever something big happens, by the way, we have a huge kind of mess of straight of horses. Anybody even talking about the macro? If now the market had a big crash, now we'd be talking about the straight of hormones and how it was a problem. >> Mhm. >> It say you're trying to say that only these things are only talked about after

11:29 the fact. >> Correct. Correct. We talk about them beforehand and then it doesn't lead to anything. But everybody was talking about liberation by the market responded to something. >> Everybody was talking about liberation day before it happened. I honestly didn't think it was going to be as big of a deal. It is. And clearly I think the rest of the market didn't is my point, you know, and so it's easy to say right now vol is low. We we're due for a big bounceback coming soon. But what's the catalyst? >> I'm not the the catalyst. My point to you is often the catalysts are already present. Here's another great example. We've talked about this. We were sitting on shows. was I was talking to my clients actively in late December, early January about COVID was already a thing, >> right? >> All right. Did did the did it did the stressful event happen in December,

12:15 January or did it wait two two months two and a half months later? About two months later? It happened two months later. We've been the Street of Moves is not Nobody's worried about it as a as a crisis really yet or they were for a second and they've forgotten about it. But when the event happens, we'll say, "Oh, that's that was X or Y." My point is underneath the hood, macro moves very slowly. It has uh structural effects that degrade and and and present themselves as you see in the chart underneath the hood. But the flows eventually unlock. And when the flows unlock uh or or expand like the V expands, the flows become less supportive, risk that is underneath the hood is allowed to present itself. Right? We have all kinds of examples of

13:01 this throughout history. I could go on and on and on about this. Um the it is not the I'm not saying the macro doesn't matter, but if you want to know when the timing is right and whatnot, you need a macro setup. You need to understand the bigger structural risks and why things are are potentially dangerous. But then you have to sometimes wait quarters, maybe even a year before the actual net effect plays out. And in the meantime, you have to understand the flows, the administration and how uh the responses to things are playing out in between. Um so so but to answer your question, um what is it? Everybody wants to point to the macro effect or this earnings drove X or this CPI number drove Y. The reality is the majority of the actual shortterm meaning weekly, monthly,

13:47 quarterly timing of of how things play out is a function of supply and demand. It's a function of the flows and how those are hitting the market and how they're affecting outcomes. Um, and why right now is is it a potential problem? What that's what that chart up there is telling you is the stresses are already present under the hood. They're already building under the hood the flows are not allowing it to happen. So my question is your question really should be well if that's the case Jim you know how do we know we're not in you know July where it took uh you know it took a couple a month and a half for the stress to happen >> that's the real question >> and and and and >> because actually I don't think they already exist like I think something that is currently the case right now I think that not to to to imply that like

14:32 I first of all I think co versus you know some other some of these other things are completely different. there's generational stuff and then there's there's stuff that's happening currently, right? Like it's it's different. I don't think that that uh the thing that always takes us down is something that always existed. It usually ends up presenting itself in a different way or it ends up manifesting itself bigger and bigger, right? Like we don't necessarily like I agree it can always it can be a catalyst, but to me anything that comes out right now that really scares people is going to create a situation where VIX is going to jump to 18 or 20. I mean, look how low we are. like we're extreme. >> I agree with you right now, but I would say if that was a month ago, it would not be the case. My point to you is is fragility and the creation of an opportunity for markets to respond to things is a function of the flows and

15:19 the setup, right? Um >> Okay. Yeah. Yeah. Yeah. I think I think we both agree on that. >> And by the way, I'm not saying a macro event. This is not saying that oh macro never matters the short term. Nuclear bomb s is about the surprise. It's about the speed and how surprising it is for markets for for how how much it can affect things. So like a nuclear bomb goes off in nuclear New York City tomorrow and nobody's expecting it. Yes, you're going to have a massive risk. >> Well, it sounds like you're conf you're conflicted about what macro is. >> No, no, I'm not at all because you said you said obviously, you know, COVID was a macro thing to some degree, right? I mean, it it affected the macro economy. >> Yes. But it did not it did not surprise the market. People were actually hedged and prepared for it. That is why it took longer. That's why it was difficult for

16:04 it to play out reflexively. If people are hedge for an event saying knowledge is all dampening. If people know something is happening, they prepare for it. It is very hard for that for markets to react to that. You have to wash out the supply and demand that exists out there. So, uh a great example, you know, again is COVID. People were prepared for it. So you need to kind of squeeze the people who are trying to short it and buy V before you could roll it over. Um there there are plenty of examples like this oil recently with straight moves. You know, nobody would have expected that to happen. Well, because everybody thought it was obvious oil was going higher. Um and uh that became a reflexive trade that now is taking a while to play out, right? Uh knowledge

16:50 is vault dampening. The more people are prepared for things, the less likely they are to happen on a supply and demand basis. Doesn't mean they're eventually not going to happen unless reflexively the policy or the reality of the situation changes, but the reality is usually things that are stressful take that that people are prepared for largely uh take a while to play out. They eventually do matter. Market is a weighing machine in the long term. It is a voting machine in the short term, right? What does that mean? That's Benjamin Graham's quote. That means in the short term, it's just about buyers and sellers. The price is determined by buyers and sellers. And that price is just a matter of voting buy, sell versus the weighing machine. Eventually, the

17:37 realities of the situation come out and and play a role and and to get things to where they they should be. But the path there could be dramatically different. You could go two years, right? I've seen this before where the outcome is clear that we will be down 40%. But you can go two years and the path might be a year and a half 40% rally to find followed by a 90% decline. Allah the tech bubble right or the great financial crisis. I've lived through both of those. Both of those markets we knew about those things way beforehand. We literally talked about them at length for a year and a half before each. Everybody was early. That's why it took so long to happen. That's why we got blowoff tops and fall compression that seemed

18:22 irrational. Doesn't mean they didn't happen. We knew about them beforehand, right? If anything, it made them take longer and become a bigger bubble. Same is true here. So, the flows are critical. You have to understand the flows. The macro matters, but it matters over a much longer time frame. and the path there can be very very uh choppy and very different depending on how much it surprises the market and what positioning looks like. >> So you mentioned the flows. We're arguably at a point where the flows could be changing uh soon here. Tomorrow's Tuesday. Uh we know that's followed by Wednesday which is going to be VIX expiration, VIX as we finally like to refer to it for those of us who trade. And um of course later in this week we got a August expiration. We talked a little bit about that last week. But again, I mean this is this is a setup kind of what you're hinting to

19:09 here. there's possible chance for flows to change. Um, >> and it's not just the flows, I'll jump in here. It is also the fact that, well, this is flows related, too, but it is macro and flows meeting is we have a midterm election coming up in early November. And oddly, very few people are talking about it. And if you actually go look at the event, like the one day event priced in for that, in my opinion, it's incredibly low. Well, not to cut you off, but even bigger than that, not only people are talking about it, we don't see it in VIX futures, right? I mean, we usually see something like that in VIX futures. Why >> small relative to the event risk? I think that's very true. I think the market is starting to wake up to that slowly. you're starting to see a move there. But I've highlighted on here,

19:54 this is not only a reason to buy postelection V because you're going to get that event V appreciation, but um but broadly V is too low in general. And the increase in that V is likely to decrease the what I call the V supply, the amount of implied V that dealers have right now. Dealer dealers are still quite long of implied vault because it is low and it has because volumes are low and they haven't been taking out taken out of it fully. They are quite long of vault. And what will likely happen is as we move out of the summer and into September, which is already a increasing time, there's already the signs from a flow basis seasonally that that's going to start happening through the correlation everything else we're

20:40 seeing. But on top of that, that midterm volume being low is going to if people start to buy that now, it starts to increase, you're likely to see stress. This is what this chart kind of speaks to. This chart shows the last um last elections going all the way back to 2002, so about 20 years here of elections and what the outcomes have been starting as of like a day or two ago, right? Mhm. >> And yes, some perform reasonably well, right? Um but if you were to take this and say, "Hey, this is the the next especially until about 20 days left, about a month left, until early October, would you think that's a good riskreward based if this is your data set?" And I

21:26 generally say no. No, not at all. There's meaningful risk there. There's two uh out outcomes out of out of the six, right? Where um you know, you'd see 20 say which ones you highlighting here 2018. >> What's that? >> Which ones you highlighting here? You say you'd see two. Which ones you talking? >> Well, I'm talking about the the poor outcomes there, which are, you know, 2022 and uh what is that? The orange 2000 >> 2002, >> right? But if you look at even like 2014, uh 2018, those aren't particularly good outcomes, especially here for the next 40 trading days, which is about two months, right? Um you know, you have you have about four of them there that are that are quite weak here for the next two months. And uh as we go to uh three months, right? Uh it still doesn't look

22:11 all that great. Um so my point to you is, you know, good time for caution. this why this isn't just looking at a data set and saying hey I mean the reason this is happening is a lot of the things I talked about when you start moving towards the election coming out of the summer what you see is not only that normal seasonality but an even greater level of pressure from implied vol stress because VA is likely to go higher um just as a function of the midterms coming uh into picture and people not wanting to be short the VA if anything being longer V for the risks around that time uh importantly I would say also not you know the more more recently the elections have been more dangerous from a vault perspective right because we're in a more populous period there's a lot more at stake and so not only is it

22:57 embedded macro risk at at its base at its core but but these elections embody that risk and and kind of magnify it so so between the the the coming out of the summer lowvall signs of correlation breakdown which tend to precede these issues coming out into a midterm that's underpriced in terms of implied volatility that historically tends to drive your probabilities of a V increase or meaning. That's the point I'm trying to make. This is not determinative. It is and it doesn't even mean by the way we could see V go higher without a meaningful decline. But but uh but again I'll highlight the one last fact that don't you don't see on this. These are all presidential elections. But if you go to the last three midterms, right, the last three midterms, which is uh 20,

23:42 >> 22, >> 22, 2018, and 14, right? All three of the last midterms have had a 10% decline or bigger that started either at August or SEP expiration within a day of expiration or a day of expiration. Okay. three. All of them 10% or more declines. All of them starting within a day of expiration or expiration. That is a that's kind of a weird coincidence. I know. Again, small data. >> Hold on. Yeah. Well, that's a that's a good call out by the way. There there has been. But there's also been a little bit changes in those times, right? Like I'm the worst at politics, but remind me 2014 to that 2014 was >> keep wanting to go back to macro. I'm talking about flows. >> No, no, no. But but just the change the

24:29 reason why there were those those downtrends I was trying my point of trying to get because there were changes there were changes because of supply >> but there were changes between 2014 to to the next president right from 2014 that midterm to the next president >> and then 2018 from midterms to be clear and they're all pre midterms so the move we're talking about is is without knowing any change in fact of what may or may not be happening at the midterm right I'm talking about August or September. >> I'm just trying to find a pattern in what you're saying. I actually agree with you on this. >> Okay, go ahead. >> My point is is that I think didn't the presidents change from those midterms to the actual general election in all three of those, right? >> Went from Trump to Biden and Biden to Trump and >> Oh, yeah. Midterms almost always. >> This one is about to change. This one may or may not change. We'll see, I

25:15 guess. Right. >> So, that's an interesting dynamic is what I'm trying to say. >> I hear you. midterms are more important and have a tendency and I agree with you to to to hurt the incumbent president for for there for there to be a move. Everybody comes in with this and I said this when Trump came in everybody was like woo things are going to change the world's going to be way better. Everybody was exuberant. I was like okay wait a year or two you know easy every time. This is what happens. People get excited and then it's just more the same if not worse. And so, um, this is no different. Midterms tend to go against the incumbent. So, yes, there is a point to that. That's fair. Um, but I think the the bigger point of like why now? Why not? If that's the case, you could argue, well, it should have started

26:01 earlier in the year or right, you know, why why at this point? Why August expiration? Why SEP OPEX? Why does it so consistently have a 10% decline within a day um of of these these events? And my point to you is it is because of the flows. It is because uh these risks exist that I agree with that you're highlighting. It is a loss of control by the administration which tends to create more risk. But the unleashing of the decline, the risk that presents itself presents itself in these specific windows as a function of the flows. Right? And I will highlight in the the 2014 and 2018 declines happened in

26:47 September at expiration, but the 2022 decline happened in a at August expiration. So, okay, it's only one data point, but it does seem to be moving sooner. And then a reason I'll say it seems like it's moving sooner. 2024 which is not a midterm it's a presidential election but same dynamics of elections happen in early August right so people are aware of this they are they are starting to frontr run these realities right and as they do it tends to bring any decline or stress forward so could it happen and wait till September again yes could it not happen at all yes um but uh I would say that you know with the VIX expansion likely here. Um I would be looking very closely

27:34 here at August OPEX. Um and right where we are now is a very very important transition period. >> You know, if we don't get like 5% declines in the next three months, people are going to completely roast you. But if we do, hey, but no, if we do, I'm going to help you take the victory lap. How about that? >> I want to be clear, the easy trade is going long, right? Coming on here and being rah rah, Tom Lee, whoever, always bullish. >> That's the easy trade. It's easy to be always, you know, be right, you know, 80% of the time, particularly when you're buying the dip, >> you kind of go mildly bullish. I'm mildly think it's a good time to get a decline, you're like, I'm much more bullish. AND EVERYBODY'S LIKE, THIS GUY'S A GENIUS. >> NO, NO. That hard part is actually calling the shorts. And when you do get those right and by the way, I don't expect to get them all right. Right. >> I expect to get about, you know, 60% of

28:21 them wrong. And that's that's amazing, right? if I'm getting uh you know or 40 to 60% like anywhere in the middle is is amazing and we have a much better track record that than that I would say go look at the media go decide for yourself. Yeah. >> Um you know make your own make your own trades make your own bets. But uh this is the hard part of the trade. >> I love it Jim with the humble brag. Uh I think we've established some pretty good things here today. We established V's pretty low but there's chances of it moving. Um we both feel like it's a little weird that uh the midterm election is being a little underpriced now. Um but we have highlighted the idea of selling upside to potentially buy downside heading into this is probably a uh pretty decent >> in the momentum names. I want to be clear. >> Yeah. In the momentum names, right? In the momentum names where that skew is is uh is is a little bit more to the

29:06 upside. So those are those are potential trades here. So >> and the reason I wanted to say that by the way is because index vol index skew is quite high. So yeah, if you do the if you sell the call, buy the put in the indexes, I'm I'm not saying that won't potentially work on a in a big decline, but the price are getting significantly worse. So given this correlation break, right, the call squeeze relative to put in that part of the market, especially if we're going to see a more of a delta one move, >> doing that kind of reverse call or risk reversal the other way in those names is particularly appealing. >> Jim dropping crumbs. I'm dropping crumbs along with them, folks. This has been another Tasty Crumbs Jim Carzan. I'm Jamal Chandler. Uh, join us every Monday at 3:00 p.m. Central time. We'll be here bringing the heat. Thanks for watching.