Why the Ugly Sideways Movement Could Persist

The SPY looks poised to repeat its price action from a year ago, trading sideways between $204 and $210

Senior Vice President of Research
May 16, 2016 at 9:36 AM
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"We will be paying close attention to the location of SPY put adds in the following week to assess downside risks from an option-related perspective as we move closer to May expiration. For now, Friday's low around the 204 strike could be a floor in the weeks ahead. And, if the SPY can find a base above the 205 strike, short covering related to the heavy put open interest at this strike could be a tailwind as we draw closer to standard May expiration."
-- Monday Morning Outlook, May 9, 2016

This week brings the expiration of standard May options, and not much has changed from last week with respect to SPDR S&P 500 ETF Trust (SPY - 204.76) strikes, with heavy put and call open interest that could continue to influence trading behavior. With the expiration of weekly May 13 options this past Friday, we will again look at the combined open interest of options expiring in the next two weeks, which includes standard May 20 options and weekly May 27 options.

Like last week, the 204 and 205 strikes are home to fairly heavy put open interest. Given the heavy call open interest at the 205 strike, it would not be a huge surprise if the SPY continues to waffle back and forth above and below this strike. And it is the 204 put strike that remains the site of the last heavy put open interest in the immediate vicinity of the SPY. This strike may continue to act as a magnet on significant breaks of the $205 level, as those that sold these puts hedge by shorting S&P 500 Index (SPX - 2,046.61) futures. But the magnets are much smaller below the 204 strike, thereby reducing delta-hedge selling below $204.

SPY combined open interest
Standard May 20 and weekly May 27 expiration series

spy open interest 1

Below is a 30-minute chart of the SPY, from Friday, May 6, through Friday, May 13.  Two things stand out:

  1. Last week's SPY peak in the $208 area is the first strike in which call open interest exceeds put open interest in the May 20 and May 27 series.
  2. Friday, May 6, and Friday, May 13, look similar in that sharp selling occurred down to or near the put-heavy 204 strike, at which point the SPY managed to stabilize and/or rally.

So, from an options-related perspective, it would not surprise us one bit if May expiration week behaves similarly to the first two weeks of the month, with $204 acting as a floor and $208 acting as a lid.

spy 30 minute chart 2

"… note that $203.87 represents the SPY's year-to-date (YTD) breakeven level, which is also in the vicinity of its 50-day moving average, a trendline heavily followed by market technicians."
-- Monday Morning Outlook, May 9, 2016

Last week's trading was a carbon copy of the previous week's trading, with SPY highs in the $208 area early in the week followed by Friday weekly lows in the vicinity of SPY's 2015 close of $203.87. However, unlike the previous Friday, the SPY closed below the popular 50-day moving average last week. For now, however, bulls can hang their hats on the fact that the SPY enters this week above its 2015 close, as the unpopular but significant 320-day moving average provides support, coincidentally situated just above the important 204 strike.

spy daily chart 3

Speaking of carbon copies, it is possible that the next few months are a lot like last year around this time, as circled in the graph above. In other words, ugly sideways movement between the $204 and $210 levels may be evident for the next several weeks. In fact, while the SPY has been using its YTD breakeven level as a support area, I would be remiss to point out that its rolling year-over-year (YoY) return has been acting as resistance, as displayed in the chart immediately below. As we move forward into the rest of May and June, this would imply resistance between $208 and $210, if the SPY continues to get turned away at its YoY breakeven level on rally attempts.

spy daily chart 4

"There were six consecutive intraday moves above 16.05, which is half the VIX's 2016 intraday high. But on all occasions, the VIX closed at or below this critical level, which also acted as resistance in the first half of April. So, risk of an additional volatility pop is still in play, especially with historically 'wrong-way' positioned large speculators in the Commitment of Trader's report still short volatility futures and the VIX above support from half its 2016 closing high. But bulls are hoping that the VIX's 2016 half-high continues to act as a cap in the immediate days ahead ...

"A potential scenario is the SPY entering a short-term choppy, directionless phase, in which the VIX finds itself swinging between the 14 and 16 levels. Such a scenario would make selling option premium, or concentrating on extremely short-term option-buying trades, attractive."
-- Monday Morning Outlook, May 9, 2016

Commitment of Trader's (CoT) -- VIX futures players extremely large short position; risk of VIX pop
commitment of traders 7

Meanwhile, the CBOE Volatility Index (VIX - 15.94) continues to bounce around two important levels that we have discussed in prior weeks, and noted in the tweet above. Last Tuesday's close below 14.07 didn't last long, as the VIX immediately popped back above this level and now comes into the week trading in the middle of a range that dates back to early April.

vix daily chart 5

Additionally, standard options on May VIX futures (15.89) expire on Wednesday morning. Based on the May open interest configuration, sellers of VIX calls will do everything in their power to keep May VIX futures below 17 or 18. If this occurs, a huge majority of VIX call options will again expire worthless, which is seemingly a theme from month to month.

VIX May Open Interest Configuration -- Wednesday morning settlement below 17 keeps VIX call sellers happy
vix may open interest 6

Total $SPX component short interest down 5.6% in report dated 4/30 - on way to 2015 lows? $SPY pic.twitter.com/uH1qk2enrC

It is a mixed picture from a sentiment perspective. On one hand, there was massive short covering in April, and short interest remains far above the levels of 2014. But will the shorts continue to cover, now that resistance in the SPY 210 area reared its ugly head again as election and Fed uncertainty loom?  

Certainly, the fact that short interest remains at multi-year highs is appealing for bulls, in addition to the fact that surveys we are seeing are indicating high levels of pessimism, even with the SPX in striking distance of all-time highs. But, as we mentioned in prior weeks, the risk is in the short term, with the VIX trading nearer to 52-week lows as large speculators on VIX futures have built up a net short position now equivalent in size to June 2015. The risk that we see is that this group has been wrongly positioned on volatility futures ahead of major moves. In fact, the net short extreme reached in June 2015 preceded a doubling in the VIX from June into early September. This risk warrants a healthy balance of call and put exposure in your options portfolio.

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