Why SPY Open Interest Won't Matter This Expiration Week

The SPY and RUT charts show stocks stalling out around December's pre-Fed closing prices

Todd Salamone
Jan 17, 2017 at 8:53 AM
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 "... we are seeing optimism come into the market, which usually occurs prior to a sell-off or trading range behavior... For example, newsletter advisor optimism, per a survey by Investors Intelligence (II), is at the highest level since July 2014... The data suggests that the optimism isn't necessarily an alarm bell for bulls to exit, but it does suggest that the expected returns over the next days and weeks are flat, and far below the 'normal' returns for various time frames."
    -- Monday Morning Outlook, December 19, 2016

"This week, Morgan Stanley published a report titled, 'Buy the Election and Sell the Inauguration?' It looks at the possibility that even if earnings growth continues to pick up after Trump takes office, the stock market's price-to-earnings ratio could contract due to higher uncertainty and rising interest rates."
    -- Barron's, January 6, 2017

"Technically, stocks continue to look healthy, as they digest post-election gains. But the sentiment backdrop suggests they are more vulnerable than usual to negative headlines, so ensure that you are prepared for a setback, with Dow 20,000 continuing to loom overhead amid a loss of leadership in the small- and mid-cap spaces."
    -- Monday Morning Outlook, January 9, 2017

The above excerpts from my weekly market commentaries and Barron's are intended to give you a flavor for where we have been from a sentiment and technical perspective (Dow 20,000 remains untouched) during the past few weeks, and what lies immediately ahead -- including the inauguration of President-elect Donald Trump at the end of the week.

As we cautioned in mid-December, increasing post-election optimism among traders, combined with round-number resistance overhead, suggested equities were vulnerable to trading range behavior at best, and, at worst, a short-term pullback. Fortunately for bulls, amid the increasing optimism, price action since mid-December can be characterized as a trading range environment.

Might resolution in one direction or the other be imminent, perhaps beginning Friday with the inauguration? Or, with the number of companies reporting quarterly earnings -- and, perhaps more importantly, outlooks for next year -- market participants may give an overall "thumbs up" or "thumbs down" based on what they see and hear, effectively releasing the S&P 500 Index (SPX - 2,274.64), S&P MidCap 400 Index (MID - 1,687.40), and Russell 2000 Index (RUT - 1,372.04) from their respective narrow ranges.

To be fair, some indexes are not range-bound -- notably, the Nasdaq-100 Index (NDX - 5,059.51), a benchmark for large-cap technology stocks that we discussed last week, continues to ascend above the 5,000 mark.



Another event in the not-so-distant future is the Federal Open Market Committee (FOMC) meeting, which occurs Jan. 31-Feb. 1. I mention this because there has been a lot of talk lately about the "Trump rally." This doesn't come as a major surprise, as the SPX is up about 8.5% since the election, he held his first press conference since being elected last week, and his inauguration is just days away. In fact, the area 10% above the SPX's pre-election close, at 2,293, is one to watch, as short-term traders who were long into the election may seek to lock in profits around this level.

However, the SPDR S&P 500 ETF Trust (SPY - 227.05), an exchange-traded fund (ETF) that is the second most active security among individual stocks and ETFs, made its closing high on Dec. 13 -- the last trading day before the FOMC raised rates and upped its forecast to three rate hikes this year, compared to the two hikes predicted in its previous forecast. It is interesting that in the two immediate days after the FOMC meeting, as well as last week, the SPY failed to close above the Dec. 13 closing level.

Coincidentally, the SPY's Dec. 13 close is also 10% above the 2015 year-end close (see top pane in chart below), and this round-number percentage gain area was something we were noting as potential resistance last month. The SPY continues to "dance" around this area.

spy daily 0113


As we noted last week, the MID and RUT have behaved similarly to the SPX and SPY. The below RUT chart displays a dance around the Dec. 13 close, with a few closes above this level that were not sustained. Like the SPY, the RUT's Dec. 13 finish coincides with an area that is a round-number percentage gain above the 2015 close; in this case, 20% (first pane in graph below). The RUT's 40-day moving average acted as support at last week's low.

rut daily 0113


"The (SPY) $225 level coincides with S&P 500 Index (SPX - 2,259.53) 2,250, a half-century mark -- and such half-century marks have historically acted as magnets during trading range behavior and/or key pivot areas after a big advance or pullback (see chart below). The importance of these half-century levels could be due to the heavy open interest that tends to build up on SPX and SPY options at these strike prices that represent half-century levels on the SPX. "
    -- Monday Morning Outlook, December 12, 2016

It is also of interest that the SPX continues to flirt with the half-century 2,250 level, which is equivalent to SPY $225. In fact, this was the area of last week's low. As we mentioned last month, SPX half-century marks have historically acted as magnets during trading ranges, or have served as major pivot points when reversals occur.

We hypothesized that one reason these levels could act as magnets and/or major pivot areas is due to the open interest that tends to build at half-century strikes on the SPX, or midpoints between round numbers on the SPY. That said, standard January options expire on Friday.

From a purely options-related perspective, this is not the kind of open interest configuration that has existed when we have experienced sharp, swift sell-offs in the week of or before expiration during the past few years. In other words, we do not see big put open interest strikes immediately below the market that dwarf call open interest, which are the kind that tend to act as magnets during sell-offs (especially when an enormous put open interest strike is broken and there are other fairly heavy open interest put strikes below).

spy oi config 0113


If we break below the narrow range we have been in, the SPY could visit $220, where there is large call and put open interest. A move to this area would not be helped along, however, by anything related to the current SPY open interest configuration. The same is true if a sharp advance occurs. The SPY 230 strike (equivalent to SPX 2,300) is home to big call open interest, which could act as a magnet if expiration week bulls come out in full force. However, keep in mind that the $229 area is 10% above the pre-election close, and thus a potential profit-taking area.

In the absence of a catalyst, however, the SPY is at risk of chopping around in its current range. From a sentiment perspective, risk remains to the downside -- but with equities trading near all-time highs, that risk is downgraded until there is a degradation in the technical backdrop.

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