When Will The Market Top?

Billionaire Jim Simons was interviewed about how he built an algorithm that essentially cracked the market. He said the first thing to do is identify subtle influences in the market that can be used to forecast price. One of those variables is price itself.

At first glance it seems like price cannot possibly predict future prices, but he observed that numerous prices together form a trend, and while not always right, trend tends to continue and so can be used to generate outsized returns.

He went on to note that many other subtle factors can influence price action too, and collectively they have formed the basis of his firm that now employs one hundred pHDs who specialize in machine learnings and statistics as well as probability theory.

The cryptic comment that other forces influence price leaves the audience hoping to hear more but Simons didn’t elaborate further. However, another astute market observer, Cem Karsan, may well have done so and if he’s right the top in the market may very well be today.

When Will The Stock Market Top?

According to Cem Karsan, the stock market may top on January 17, 2024 as bullish seasonal flows give way to bearish macro flows.

The seasonal flows began in early November and continued all the way through to January 17, the date at which VIX options expire (VIXperation).

January is a key date because LEAPS options can be purchased from a couple of years ago for that month and so it turns out to be one of the largest options expiration months in the whole calendar.

Bullish flows from market makers hedging subside post-expiration. Those flows are a function of all sorts of unique features of the last few months of the year. For example, the number of trading days is fewer than at any other time of the year due to all the holidays and so the effects of options theta are accelerated.

When VIXperation has passed, the buoyancy of those flows tends to subside and bearish macroeconomic news comes to the forefront and takes precedence.

One of those bearish forces is simply the optionality investors have to choose between stocks and bonds. In a low interest rate environment, bonds were not attractive but these days they offer a very enticing alternative to stocks.

Will The Market Fall Now?

If history rhymes, the performance back in 2020 is perhaps most notable. That’s because the market ran higher into January in spite of news coming out that a health scare was rapidly approaching US shores.

Remarkably, though the first headlines hit the airwaves at the end of 2019, it wasn’t until February that the market really tumbled and the trough in the market coincided with the weekly expiration date in March 2020.

So, will the market fall now? Looking back 4 years, the market didn’t fall precipitously right after Vixperation but rather it took a few weeks as the bearish flows took over from the bullish flows. Similarly, investors could expect a gradual transition in the coming weeks culminating in a more pronounced downward trend if history repeats.

The cadence of the market since the start of the year has revealed some bearish undertones but it’s largely bounced back and overall stayed flat into this weekly expiration. Concerns now are rising that as those positive flows recede their buoyancy won’t support the market heading into the next few weeks and, in particular, February and March.

Karsan might describe that time frame as a window of weakness. And if we know anything about the market it’s that it climbs slowly up the stairs and falls quickly down the elevator shaft. 

How To Play a Bearish Trend

When markets are still in upbeat mode and sentiment is positive, volatility tends to be muted and so implied volatility, a component in the pricing of options tends to sit at the lower end of its range.

Usually it spikes when traders are concerned about some bearish news but by then buying put options is too costly to merit purchasing with abandon because the downside is often largely priced in.

However, when complacency is high as it is now, implied volatility is at the lower end of the historical range and so buying put options with over 90-120 days of time value offers the potential to benefit not only from a correction but also a spike in implied volatility.

If you look to the major indices like the S&P 500 and consider SPX options they can be quite expensive at-the-money over those time durations so a better strategy is frequently to buy out-of-the-money options and sell them even further out-of-the-money.

For example, with the S&P 500 at 4,765, buying the 4,615 puts and selling the 4,315 puts offers a cheaper alternative that could still profit from a decline in price and spike in implied volatility but won’t be nearly as costly if the trend continues bullish. 

That strategy of buying puts at one strike price and selling them at lower strike prices is called a bear put spread. It’s not the only way to benefit from a share price decline, though. 

These days you can find any number of ways of betting on a market decline including buying exchange-traded funds, such as the ProShares UltraPro Short QQQ ETF (SQQQ). Given the NASDAQ performed better than the other major market indices over the past year, it also has the potential to underperform by the greatest amount on a pullback.

 

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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.