Why SPY 220 Is the Strike to Watch This Options Expiration Week

Huge call open interest at the SPY 220 strike could hold the key for the stock market this week

Senior Vice President of Research
Aug 15, 2016 at 9:49 AM
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"Dow, S&P, Nasdaq Close at Records on Same Day for First Time Since 1999"

-- The Wall Street Journal, August 11, 2016

Last week, we mentioned the buzz created when the Dow Jones Industrial Average (DJIA - 18,576.47) declined for seven consecutive days. Our observations were: 1) the decline was significantly mild compared to past losing streaks; and 2) the Nasdaq Composite (COMP - 5,232.90) declined only once during that losing streak, as it inched up against past all-time highs.

A mild decline in the DJIA from all-time highs as the COMP inched higher toward all-time highs set up the contrast with what occurred last week, when the DJIA, Nasdaq Composite and S&P 500 Index (SPX - 2,184.05) achieved new all-time highs on the same day -- a first since 1999. The buzz about this feat was similar to that of the losing streak endured by the DJIA.

As usual, we were curious about the historical implications of this occurrence. Specifically, our Senior Quantitative Analyst Rocky White researched the occasions since 1980 when these three indexes achieved new all-time highs on the same day. He took the research a step further by adding a parameter that such a signal could not occur over the previous six months, implying these indexes went through a period of relative weakness before the new highs occurred simultaneously.

We found this bullish event actually preceded short-term declines on the SPX and DJIA two weeks later in most instances, but there was also a tendency for these benchmarks to achieve new highs three months later (although not necessarily on the same day).

The Nasdaq, for what it is worth, had the best one-month performance, managing to beat the at-any-time expected performance.




"Note that in the expiring weekly August 12 and standard monthly August series that quite a bit of call open interest has built up at the SPY 218.50 strike. This strike boasts over 220,000 contracts in open interest, and is the second-largest strike in the vicinity of Friday's SPY close. The point is that the 218.50 level could be significant in the immediate days ahead as traders locking in 10% profits from the late-June low -- plus an attempt to keep the SPY below a major call open interest strike by those selling the calls at this strike -- represent a potential short-term headwind."

-- Monday Morning Outlook, August 8, 2016



Per the SPDR S&P 500 ETF Trust (SPY - 218.46) hourly chart below, note how the $218.50 area acted as resistance last week, which we suspected could happen, due to a combination of option-related call resistance at this strike going into last week's trading and the fact that $218.50 is 10% above the late-June low, which we theorized could lead to profit-taking among short-term traders.

SPY Hourly2

As we head into standard August expiration week, note below that the 218.50 strike is much less significant from an options-related perspective, due to the massive call liquidation that occurred. Whereas there were more than 220,000 outstanding call contracts at this strike in the combined 8/12 and 8/19 expiration series (most of which was contained in the 8/19 series), now a total of 60,000 call contracts are outstanding at this strike in the 8/19 and 8/26 expiration series, rendering this strike price much less significant.

What stands out is the massive call open interest at the overhead 220 strike, which boasts more than 600,000 open call contracts in the 8/19 and 8/26 series (394k in the 8/19 series and 231k in the 8/26 series). Note that volume of more than 200,000 contracts occurred in the 8/26 220-strike options, so there may have been liquidations. Additionally, call open interest is heavy at the 218 strike too, which also presents a headwind in the immediate days ahead.

In the absence of a catalyst that generates a big SPY move, as the deltas on the 218- and 220-strike calls decrease with the passage of time (implying the options becomes less sensitive to changes in the SPY as time passes), long S&P futures positions associated with this call open interest will be closed, creating a headwind for the market. The good news for bulls is the delta on the 220-strike call options is small, which suggests the headwind isn't as great. But a move below SPY 218 could induce some selling as the call delta at this strike decreases due to the strike being above the SPY price and expiration approaching.

If there is a catalyst to push stocks higher, the call-heavy 220 strike would likely act as a magnet, as S&P futures are purchased as the security approaches the strike, and the option becomes significantly more sensitive to changes in the SPY relative to its sensitivity this past Friday.

Finally, like recent months -- and unlike what we had to experience one year ago -- there is little threat of the options market helping inflict major short-term damage on stocks if a negative catalyst emerges. In other words, there are not large open interest put strikes immediately below Friday's close that could generate delta-hedge selling.

In fact, this week's SPY open interest configuration stands in huge contrast to the August 2015 expiration week open interest configuration. During August 2015 expiration week, the SPY plunged nearly 5%, assisted by delta-hedge selling when it broke below two put strikes that carried over 300,000 contracts in open interest. Those who sold those puts were forced to sell S&P futures to hedge their positions. Now, the largest August standard expiration put open interest strike is at 205, with just under 180,000 contracts. Moreover, this strike is currently far out of the money.

From purely an options perspective, the more likely scenario is the SPY being susceptible to a drift lower over the course of the week to about the 217 strike. This would occur in the context of long S&P futures positions associated with the big call open interest being unwound at a measured pace. This scenario is aligned with the historical statistics we presented about short-term weakness in the market in the days immediately following the three major U.S. equity benchmarks hitting new highs on the same day, after a lengthy period of not doing so.

The smaller possibility is the sharp rally up to and through the 220 strike. With Federal Open Market Committee (FOMC) minutes from the July meeting due to be released on Wednesday, this presents a potential catalyst. However, market participants are likely to place more value on the early August employment report that occurred after the July FOMC meeting, making it less likely that the minutes will generate a big reaction. But if you see the SPY push toward 220 for whatever reason, beware that you could see buying power on par with the selling that occurred in August 2015, as those who sold the 220-strike calls scramble to buy S&P futures to hedge positions.

MMO SPY Open Interest

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