What to Watch for Ahead of the Fed, September Options Expiration

Open interest on the QQQ, SPY, and IWM could play a key role this week

by 9/13/2014 8:39:43 AM
Stocks quoted in this article:

Major market indexes snapped their five-week winning streak, pressured lower by a slump in energy names. Additionally, a mixed bag of economic data stoked caution ahead of this week's Federal Open Market Committee (FOMC) policy-setting meeting. With a highly anticipated central bank statement overlapping with September options expiration, Schaeffer's Senior VP of Research Todd Salamone examines what we should be watching in a week that contains two potentially market-moving events.

  • Why patience is a virtue for technology bulls
  • 3 exchange-traded funds (ETFs) we'll be closely monitoring this week
  • Rocky White makes some surprising discoveries on SPY put volume

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: The Wait-and-See Game Continues
By Todd Salamone, Senior VP of Research

"... the PowerShares QQQ Trust (QQQ - 99.78) has gone flat during the past week, just below the round $100 century mark ... In the coming days, there may be a wait-and-see game for short-term players to deploy more cash to the market, or for the shorts to throw in the towel. The 'wait' might be related to how multiple benchmarks, such as the QQQ and SPX behave around their respective round-number levels, especially as we enter a historically weak month.
-Monday Morning Outlook, Aug. 30, 2014

"For the S&P 500 Index (SPX - 2,007.71) and SPDR S&P 500 ETF Trust (SPY - 201.11), 2,000 and 200, respectively, have presented quite the challenge, as they represent millennium/century marks and significant returns from a key point in time. Specifically, we pointed out during the past two weeks that 2,000.37 is triple the SPX's March 2009 low, and we find it of interest that last week's high on the SPY (at $201.58) was just 28 cents above $201.30, which is triple the March 2009 low of $67.10.

... our focus is once again on the SPY 200 level, where heavy call open interest is situated -- another reason why round numbers are more than just psychologically important. A move below this level could generate selling, as call writers liquidate long positions related to call open interest at this strike. However, we would expect 198 or 199 to be supportive, which is where put and call open interest are more balanced."

-Monday Morning Outlook, Sept. 6, 2014

"A debate is brewing over how the Federal Reserve will craft its language in next week's policy statement, with all eyes on two key words ... The Fed since March has said it will keep interest rates steady for a 'considerable time' ... some market watchers think it's time for the Fed to drop that language ... an eventual shift in language could cause turbulence in markets."
-The Wall Street Journal "Morning MoneyBeat", Sept. 12, 2014

Unfortunately, not a whole lot has changed since late August, when the equity market rallied off its August lows right into key round-number levels on multiple benchmarks. As you can see from the excerpts above, we have spent quite a bit of time discussing the potential of these levels to act as short-term resistance, and indeed, this has been the case.

In fact, even with Apple Inc. (AAPL - 101.66) rallying more than 3% -- and above the $100 century mark -- on the heels of its special "product pipeline" event on Tuesday, the popular PowerShares QQQ Trust (QQQ - 99.48) continues to trade in a narrow range. It has failed to sustain a move above the $100 level, despite multiple intraday moves above this area since the beginning of the month.

QQQ -- Buyers disappear at $100, but selling pressure is not significant

30-Minute Chart of QQQ Since Monday, Aug. 25

The technology group -- as represented by the QQQ -- is one of this year's best-performing areas, with the QQQ up 13%. Patience should reward technology bulls, even as the $100 mark has proven significant from a resistance perspective. For example, short covering has been supportive of this group since July, per the chart below, and short interest declined in the latest reporting period (data as of the end of August). But also note, total short interest on QQQ components is more than 25% above the levels of 2012, implying there is plenty of short-covering potential among those still betting against this group.

If a pullback occurs, look for the $96.50 area to act as support, which represents a 10% year-to-date (YTD) gain, and acted as resistance in July ahead of a modest pullback. This area is also the site of the QQQ's 60-day moving average, which has had some significance during the past year, both as support and resistance (see second chart immediately below).

Total Short Interest on QQQ Stocks Since January 2011

QQQ -- Horizontal line at 10% YTD gain

Daily Chart of QQQ Since September 2013 With 60-Day Moving Average

Looking ahead, expiration week is imminent, with September equity options, single-stock futures, index futures, and index options set to expire at the end of the week. Moreover, the last day to trade September options on CBOE Volatility Index (VIX - 13.31) futures is on Tuesday, ahead of Wednesday morning's settlement.

As of Thursday's close, 42% of the outstanding VIX calls will expire ahead of Wednesday afternoon's Federal Open Market Committee (FOMC) policy statement, an event many investors are keying on before making their next move. It will be of interest to see if VIX call volume is active on Monday and Tuesday, following relatively high volume on Friday, as hedgers are possibly rolling out September calls into the October and November series to hedge against Fed risk.

Expectations are for further reductions in bond buying, but most will be focused on the Fed's statement, and any clues as to when rates will be raised. At present, investors are expecting a spring or summer hike, so anything that suggests otherwise with respect to timing might be considered a surprise. It is likely, even if the words "considerable time" are removed, the Fed will continue to suggest that they will remain reliant on incoming data, thus allowing for maximum flexibility in the timing of the rate cut -- even though they are apparently attempting to be transparent with investors. The good news is that the market is bracing for rate hikes, and this is factored in, although the exact timing is uncertain.

If the VIX settlement on Wednesday morning is anything like the past few months, look for the VIX to settle below 14, as this would mean a major bulk of the September call open interest would expire worthless.

VIX Open Interest Configuration for the September Series of Options

Not a lot has changed with respect to the SPDR S&P 500 ETF Trust (SPY - 199.13) September open interest configuration chart, which we discussed last week, and will once again be important to pay attention to this week, with standard September options getting set to expire.

True to form, the "call wall" at SPY 200 remains firmly in place, with sellers coming in this past week each time the SPY attempted to sustain a move above the 200 strike. However, the 198 and 199 strikes continue to be potentially supportive on pullbacks. If these levels break, and the put-heavy 197 strike is broken, there is the risk of a call unwind and delta-hedge selling that pushes the SPY to 195 by Friday. There is heavy put open interest at this strike, and this area represents mid-June resistance and mid-July support.

SPY Open Interest Configuration for the September Series of Options

SPY -- Instability above 200, support at 199

30-Minute Chart of SPY Since Monday, Sept. 8

Another exchange-traded fund (ETF) that we will be closely monitoring next week is the iShares Russell 2000 ETF (IWM - 115.37), which found support at the put-heavy 115 strike last week. This level also marks the ETF's year-to-date breakeven point, and its 80-day moving average, which has had significance in the past as a support level.

If 115 breaks, the IWM will be vulnerable to call-unwind selling, but support could come in at the 113 and 114 strikes, where the put open interest magnet is small in comparison to the 115 and 112 put strikes. So, if 113 is broken early in the week, a quick move to 112 would be possible, with continued downside potential to the 108-110 area. In the event of an IWM rally, short covering related to expiring put open interest could push the IWM to the call-heavy 118 strike, which is the site of this month's high.

IWM Open Interest Configuration for the September Series of Options

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