How likely will there be a melt up till the end of the year?
Cem Karsan of Kai Volatility joins Schwab Network to explain why the out-of-the-money calls are too cheap and we are likely to go higher.
This can be seen as a continuation of my coverage after talking about a potential correction just before the election (which is the period we are currently in.
Much of this topic is related to the massive forces due to options positioning that I talked about occasionally in the past such as this post: How the Options Market ends up Controlling the S&P 500 in 2021.
Whether the election is traditionally a close fight or more confirm, people are worried about the outcome of the results of the US Presidential election and so they will buy puts to hedge their portfolio positions.
The demand for the puts pushes the prices and the Delta of those puts up. This is what we call high skew, where the out-of-the-money puts has a higher implied volatility compared to the at-the-money or in-the-money puts.
This inevitably increases the magnitude of the moves required in order for those puts to be in the money (which means the market has to REALLY move down for the puts to be able to monetize). This can be trigger by events that the market has not been priced in (you can assume that both parties winning is kind of known at this point so it has to be some external events).
If the risk probability reduces after the event, the market dealers that supply those puts bought to hedge will have to buy their hedge back. If you bought a put to hedge your portfolio, the dealer sold you
