SPY Options Traders Target Fed-Day Resistance

Traders should stay tuned to the Russell 2000 as small caps look to find their footing

Senior Vice President of Research
Aug 7, 2017 at 8:53 AM
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"... dare I say it, the 1,500 half-millennium area marked the beginning of the last two bear markets, which began in 2000 and 2007. The peaks in 2000 and 2007 took months to form, so as the SPX probes 2,500 we are not suggesting a bear market is necessarily imminent. But this is a risk to put on your radar as other technical and sentiment indicators are evaluated in the days and months ahead."
    -- Monday Morning Outlook, July 31, 2017

Last week, I discussed the potential longer-term implications of the S&P 500 Index (SPX - 2,476.83) approaching the 2,500 mark -- namely, that two bear markets this century began around the 1,550 area, another half-millennium mark. In the course of the past week, the SPX traded in a sideways pattern around 2,470-2,475 (more on this later).

However, another popular benchmark -- the Dow Jones Industrial Average (DJIA - 22,092.81) -- received all of the media attention last week, as it conquered the 22,000 millennium mark the first time ever. For what it's worth, as the SPX was in its topping process around the 1,500 level back in 2000, the Dow had been struggling for months to sustain a move through the 11,000 mark -- which is half the round level that was taken out last week. There were a few "head fakes" above 11,000 from 1999 through 2001, but the monthly chart immediately below clearly shows that 11,000 proved to be a significant resistance area until late 2006.  

djia monthly chart 0804

"Dow pole vaults 22,000, but beware the landing"
    -- Reuters, August 2, 2017

"... given the market's sharp rise, Ramsey thinks 'it is too late for most investors' to get into U.S. stocks. ... 'Stocks are likely to be considerably cheaper in 2018, 2019 and 2020,' says Ramsey. 'While the market is in good shape for now due to strong earnings, a pullback of 10% or more for the first time since early 2016 is likely,' adds Kate Warne, investment strategist at Edward Jones. 'The road ahead is likely to be bumpy,' she says. 'So we think the Dow is likely to pull back to 20,000 before it hits 25,000.'''
    -- USA Today, August 2, 2017

"Dow 22,000 means the worst is yet to come"
    -- MarketWatch, August 3, 2017

"Dow 22,000? Most Americans don't benefit from record stock market gains"
    -- Chicago Tribune, August 3, 2017

"The longer the stock market goes up, the more clients of Alliance Bernstein ask when it will go down: That's according to Dianne Lob, senior managing director for equities, who says questions about the timing of the next 8 percent or 10 percent decline in the S&P 500 outnumber other inquiries... "
    -- Bloomberg, August 3, 2017

As loyal readers know, from a contrarian perspective, it is important to closely monitor prevailing sentiment within the context of the trend. And, as you can see from above, the reception to the Dow 22K record high wasn't exactly one of euphoria in mainstream financial television, newspapers, and websites. This aligns with the observations that I made last week, in which I contrasted the sentiment backdrop at present with those of 2000 and 2007. The takeaway, especially as it relates to the 2000 top, is that there is comparatively more skepticism in the current environment -- a stark contrast to the dangerous "the sky is the limit" mentality present in 2000.

Again, with the Dow at a key millennium level representing double the resistance that was in place for years during the 2000 topping process, coincident with the SPX lodging just below a half-millennium mark, this is something to put -- and keep -- on your radar for now. The sentiment backdrop suggests that there is a lower probability of this ending badly, as it did in 2000 when the DJIA was fighting a millennium mark coincident with the SPX trading below a key half-millennium level. This could change in the months ahead, but for now, longer-term investors should stay the bullish course.

"Another level to watch overhead is 2,477, which is where the SPX was trading at the time of last week's Federal Open Market Committee (FOMC) meeting. In recent months, the market has rallied when the Fed left rates unchanged, as they did last week. Bulls hope this pattern continues, but 2,477 could be another overhead level to key on in the days ahead."
 -- Monday Morning Outlook, July 31, 2017

Turning to the short term, it is noticeable that the SPX and SPDR S&P 500 ETF Trust (SPY - 247.41) have been turned back at their respective July 26 closes of 2,477 and $247.43. July 26 is the day that the Federal Open Market Committee (FOMC) met and did not raise rates. The pattern during the past several months is that "Fed day" closes usually mark resistance in the weeks after a rate hike. These resistance levels were then broken after meetings in which the Fed held pat. It took a couple of weeks for stocks to find their way after the early May meeting when the Fed stood pat, so perhaps that's a clue as to what is on tap in the weeks immediately ahead.

Nonetheless, if you are one to err on the safe side, you should await a close or two above the levels mentioned above as further indication that the bullish pattern that has developed after no-action Fed meetings will continue.

spy 30 minute chart 0804

While on the topic of the Fed, small-cap stocks, as measured by the Russell 2000 Index (RUT - 1,412.32) peaked last month on July 25, the day before the FOMC meeting. They have fallen steadily since the meeting, with the RUT's intraday and closing low occurring on Thursday at 1,402.39 and 1,405.23, respectively.

The RUT 1,400 level has been supportive since mid-June -- and not only is it a round century level that was first approached in December of last year, it is four times the 2009 low and site of its 80-day moving average. Will this be the week that small caps find their footing for the first time since late July?  Technically, I like their chances. Stay tuned.

Finally, we enter the period in which we are only two weeks away from the standard expiration of options, which occurs on the third Friday of each month. Big open interest strikes can impact the behavior of stocks and/or exchange-traded funds (ETFs) as expiration nears. Therefore, I will discuss the open interest configuration on the SPY, taking into account the weekly Aug. 11 expiration this Friday, combined with the standard expiration Friday on Aug. 18.

The first thing that stands out is the big put and call open interest at the 247 strike, which is in the vicinity of the July 26 close that was just discussed, and could be a volatility dampener in the absence of a catalyst to move the SPY through this level. In other words, the $247 area is not only important to those keying on the Fed, but also to many options players.

The big call open interest at the 250 strike also stands out. About half of this open interest will expire Friday, and the other half on Aug. 18. If the SPY moves through $248, the chances that this call open interest acts as a magnet is heightened, as sellers of the calls are forced into buying S&P futures to hedge.

There is also decent-sized put and call open interest at the 244-246 strikes, which could be a support area if stocks drift lower. The $245.88 level is nearest the 246 strike and represents a round 10% year-to-date gain on the SPY. Moreover, $244.24 is the closing level of mid-June, when the Fed last raised the fed funds rate, plus the site of the SPY's 40-day moving average.
The SPY 243 strike is put heavy, with much of the volume representing buy-to-open activity. Therefore, this strike is a potential magnet during a decline. But the good news, purely from an options perspective, is that strikes immediately below the 243 strike are not as put heavy, and thus they are less apt to act as magnets. Therefore, the SPY $243-$244 area can be viewed as support from multiple perspectives. These are levels to keep on your radar as we move through the next couple of weeks in these dog days of summer.

spy open interest august by strike 0804

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