The Big Question Looming Over the S&P 500 Index

While a number of short-term headwinds exist, the long-term backdrop looks favorable for bulls

Senior Vice President of Research
Jun 22, 2015 at 9:10 AM
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"… the Fed is back in the spotlight this week, with a policy statement on Wednesday followed by a press briefing from Fed Chair Janet Yellen … SPDR S&P 500 ETF (SPY - 210.01) finds itself in precarious position, trading around the put-heavy 210 strike. It is one of those situations in which a macro event (Europe, Fed) can drastically push the SPY in one direction or the other, which calls for exposure to both sides of the market amid the uncertainty this week ... Sharper moves than usual can occur because those that sold portfolio insurance via SPY put options hedge themselves by shorting SPX futures ... In situations wherein the SPY moves further above heavy put strikes, such as 210, those options become decreasingly sensitive to SPY moves, and the hedges are unwound via short covering, producing potentially powerful short-term rallies."
-- Monday Morning Outlook, June 15, 2015

After a sharp sell-off last Monday morning due to a breakdown in negotiations between Greece and its creditors, equities rallied sharply from Monday’s low. The advance was in part due to the Federal Reserve plotting a projected slower course for rate hikes this year and in 2016-2017.

As expected, macro events that occurred during expiration week last week generated dramatic moves in the market. This time, the move was in the bulls' favor, with the SPDR S&P 500 ETF Trust (SPY - 210.81) rallying strongly from heavy put open interest at the 208 strike -- Monday morning's magnet -- to the call-heavy 213 and 213.50 strikes, which emerged as a "call wall" after the "hurry up and get there" short covering related to expiring out-of-the-money put open interest dissipated. 

SPY June Open Interest Configuration -- SPY lows and highs last week clearly defined by "lopsided" call versus put open interest in the just-expired June series, marked by horizontal lines in 30-min SPY graph from last week ​



"If you are looking to reduce equity risk … avoid Europe -- where there is a lot of uncertainty, despite being a popular destination among many investors. And even though the DJIA and SPX are trading around support, you can reduce exposure in these underperforming areas of the market ... Maintain your current allocation to outperforming areas, such as small-cap and mid-cap stocks. These areas have been relative-strength leaders in recent weeks and have rewarded investors this year, more so than their larger-cap counterparts."
-- Monday Morning Outlook, June 8,  2015

Looking ahead to this week, we expect that the special European summit -- called in an attempt to carve out a deal with Greece -- and a robust U.S. economic data calendar will dominate headlines. Whether Greece strikes a deal with its creditors or not, whether or not a "no deal" results in Greece eventually leaving the European Union, and the impact (if any) of a "Grexit" are still unknowns. But judging by what the markets are saying at this juncture, headlines related to Greece seem to be generating a lot of noise in the short term, while bigger picture, the markets seem to be saying that Greece is not as big of an issue to the U.S. as the headlines might suggest. Put another way, Greece's stock market is deep in the red this year, whereas the S&P 500 Index (SPX - 2,109.99) has been trading above its 2014 close since early April.  Moreover, the Russell 2000 Index (RUT - 1,284.66), S&P MidCap 400 Index (MID - 1,540.83) and Nasdaq Composite (COMP - 5,117.00) have posted respectable gains between 6% and 8% in 2015.

"Since 1990, the Dow Jones Industrial Average has averaged a 1.1% decline the week after June’s witching day, falling 22 of the last 25 years, according to Jeff Hirsch of Stock Trader’s Almanac. The S&P 500 and Nasdaq slid 0.7% and 0.2%, respectively, during the same time frame."
-- The Wall Street Journal, June 19, 2015

In addition to the drama surrounding Greece, the charts present a few interesting situations. With the exception of the RUT, many equity benchmarks are trading just below previous resistance levels as we move into this week, which historically has been weak, per the Wall Street Journal excerpt immediately above (this past Friday was a "witching" day -- expiration of index, futures, and stock options).

The COMP, which achieved a new intraday all-time high in Thursday's trading and then closed right at 5,132 -- its previous all-time high in 2000 -- before retreating slightly on Friday. Despite the COMP trading just below its 2000 intraday high, it remains above its 2015 closing high at 5,106. As you can see on the below graph, the COMP broke out above an ascending triangle last week, and if this breakout holds, a minimum target of 5,340 is on the horizon.


But the big question for those following the S&P 500 Index -- which remains locked in a range -- is whether or not the round SPX 2,100 level continues to act as a magnet, which has been the case since mid-February. Other equity benchmarks continue to do battle with round numbers, such as the Dow Jones Industrial Average (DJIA - 18,015.95), as sellers predominate on moves above 18,000, but buyers continue to emerge when this average pulls back to its 2014 close in the 17,800 area. Since the DJIA first touched 18,000 on Feb. 13, this level has been touched on 36 days, or 41% of the trading days.

DJIA 2015 -- As simple as it sounds, pullbacks to the area of its 2014 close (horizontal line) have produced short-term buying opportunities since mid-April  


"… on Friday morning, the VIX peaked at 15.65, which is in the area that marks half its 52-week high at 31.06, and 50% above its 52-week low at 10.28. We have observed on numerous occasions that the VIX has had a peculiar tendency to peak or trough at 50% or 100% above or below major inflection points. With that being said, there is an increased chance that the mean-reverting VIX put in a short-term top last week. If, however, the VIX takes out last week's highs over the course of this upcoming week, bulls should take caution."
-- Monday Morning Outlook, June 8, 2015

We continue to keep a close eye on the CBOE Volatility Index (VIX - 13.96), which again ran up to the 15.50 area this past week before turning sharply lower. With 15.50 roughly half its 2014 high of 31.06, and also 50% above the VIX's 2014 closing low of 10.32, we have keyed on 15.50 as a potential marker for a pivot or continuation move during multiple VIX pops this year.

VIX -- Multiple reversals from 15.50 in recent months


With the VIX still relatively "tame" amid volatile macro headlines, the historical implications of a strong market immediately following pessimistic extremes in retail investor sentiment (discussed last week), key areas of the market such as small-caps and financials hitting new highs (as some technicians obsess about weakness in transport stocks), the market is positioned for healthy upside. Such doubt and caution represent potential buying power that can weaken the shackles that define the persistent range.

That said, with nearly 7 million SPY puts expiring on Friday, or 30% of those outstanding, and VIX call activity likely to be robust following the expiration of June VIX futures options last Wednesday, increased hedging activity could cap rally attempts into the end of the month. Nonetheless, risk-reward continues to look favorable for bulls.   

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