In today’s market, flows are key. One market analyst, Cem Karsan, related flows and fundamentals with the following analogy. He says that flows are like the wind, which can push a plane in any direction, while fundamentals are like the engine, which determines the plane’s long-term direction.
In the context of trading, flows are the money that is flowing into or out of a particular market. This money can be driven by a variety of factors, such as news events, economic data, or investor sentiment. Fundamentals, on the other hand, are the underlying factors that are driving the price of an asset. These factors can include things like earnings growth, dividends, and book value.
Karsan’s analogy highlights the importance of both flows and fundamentals in trading. Flows can be very powerful in the short term, but they can also be fleeting. Fundamentals, on the other hand, are more stable and provide a better indication of the long-term direction of a market.
To use the analogy, imagine that you are flying a plane. The wind (flows) can push your plane in any direction, but the engine (fundamentals) determines your long-term direction. If you want to reach your destination, you need to pay attention to both the wind and the engine.
The same is true for trading. If you want to be successful, you need to pay attention to both flows and fundamentals. Flows can help you identify short-term opportunities, but fundamentals will help you make better long-term decisions.
So how do flows relate to today’s market?
- The quarterly options expiration is a key time stamp for the market.
- The melt-up has been accompanied by volatility rising, meaning that owning calls instead of stock led to a double whammy of profits in recent weeks.
- Short traders have been getting squeezed has added to the move up.
A Key Turning Point
June options expiration is a key time stamp for the market. The magnitude of the recent move up have largely been a function of flows, according to Karsan. He highlights key aspects of the quarterly options expiration including higher skew and vol pinning into the last two weeks of window of strength is the perfect recipe for a melt-up.
More specifically, the melt-up has been accompanied by volatility rising, meaning that owning calls instead of stock led to a double whammy of profits in recent weeks.
Add to the recipe short traders getting squeezed and the move up has become both fast and furious. But for a blow-off top, three things are needed he says:
- Changes in sentiment and positioning: Specifically when people start explaining away why it makes sense for companies like Nvidia to be up so much, and trade accordingly, the bullish run is nearing a peak. When a market rallies nearly 8% in 2 weeks you know the melt-up is in full force.
- More potential realized volatility: As the market goes higher and is increasingly dissociated from fundamentals, and volatility rises, danger increases.
- Vol supply is becoming unpinned: Vol in dealers hands is no longer being pinned. Big block orders are buying vol across the distribution creating a dangerous recipe.
How To Trade The Turning Point
Melt-ups can be very dangerous because buying late is accompanied with huge risk while shorting can be even more perilous. The solution, therefore, is to increasingly layer shorts, meaning add more bearish positioning to a portfolio as we go higher.
For those holding stocks, it could mean adding puts and selling calls against stocks, or indeed taking short positions outright, but doing as part of a hedged portfolio. What it doesn’t mean is flipping a portfolio entirely from long to short.