Cem Karsan is a rare market analyst who appears to have a real edge which stems from a deep understanding of how the options market affects share prices. More precisely, he understands the relationship among market makers, macroeconomic factors, options flows, market indices, and implied volatility.
As the head of Kai Volatility, Cem Karsan doesn’t take bullish or bearish stances, per se, rather he pays close attention to market structure and how options expirations affects flows.
So what does Cem Karsan forecast for the market now?
Cem Karsan Seasonal Market Effects
Seasonal effects are sometimes viewed as “wuwu” because they are not very well understood. But Cem cuts through the noise and explains the causes and effects in a matter of fact way.
During the last 6 weeks of the year, time-weighted volume differs compared to the rest of the year because during the holidays – Thanksgiving, Christmas Day, New Year’s Day – the stock market is closed.
This in turn has very material effects on options decay, or more specifically theta, a component in options pricing – it is higher on trading days during the 6 week period through to the end of the year.
All that might sound like mumbo jumbo still, so let’s break it down in simple terms.
Market Makers must remain delta neutral, meaning they don’t want to bet the market is going to be bullish or bearish. By taking the other side of trades, and hedging their positions, market makers have an effect on underlying share prices. In particular, as expiration approaches they must unwind their hedges.
For example, if market participants have sold puts, market makers but go long put options and, to stay neutral, buy stock. This creates a real demand for the underlying shares, pushing prices higher.
Cem Karsan Market Outlook
So what does Cem see for the market now? He sees a window of weakness in the markets during the final two weeks of September but made it clear that he does not expect markets to fall materially during this time.
With that said, if the stock market is to put in a poor performance for the year, the decline must start during this two week time frame, in his view.
Absent a selloff in the latter part of September, Cem sees a great deal of strength in markets from flows that simply cannot be stopped, and are structurally built into the system.
His forecast is for the stock market to rise potentially creating a blow-off top as the seasonal effects of the Santa Claus rally and the January Effect support prices through to the beginning of the year.
How long will the rally last, if it does materialize?
Cem says it’s best to jot down the date January 17 2024, right before January’s options expiration. If the market does have a blow-off top and sucks investors in with bullish sentiment rising to extremes, that’s likely the date, or close to it, when it will peak.
What Happens After The Market Peaks?
Thereafter, history would suggest that investors get defensive and should expect the market to be very weak.
In other words, if sentiment hits a bullish extreme by mid-January and share prices have soared across the indices, that time would be optimal to build cash reserves, get defensive, perhaps buy put options, or simply sell stocks in order to avoid giving back gains.
Cem does add a word to the wise about how challenging it is to pick the tops and bottoms because the more this information about structural flows is known, the more market participants position themselves in advance to prepare for them, which reflexively diminishes their effects.
Nevertheless, time and again seasonal spikes around the Thanksgiving to New Year’s period have rewarded investors, and it would be foolhardy to bet against them in the 3rd year of a Presidential election cycle when history has favored the bulls.
In 2016, Lee Bohl, a Schwab research analysts discovered that the third year, on average between 1933 and 1916, performed approximately 200% better than any other year in the 4-year cycle. The first and fourth years both averaged 6.7% while the second year posted average gains of 5.8%. And the third year? On average, the S&P 500 was up 16.3%.
In short, don’t bet against the market this year. If it falls, now is the time. Failure to decline significantly between now and the start of October, according to Cem, signals high likelihood for a rally into year end.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.