The Odds Are Stacked Against SPY This Expiration Week

However, a technical breakout by SPY could trigger a rally up to the call-heavy 250 strike

Senior Vice President of Research
Sep 11, 2017 at 8:25 AM
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"There was a little bit of improvement in the short-term technical backdrop, even though most equity benchmarks enter the week trading at, or just below, resistance. The SPY, for example, finally closed above $247.43, its close when the Federal Open Market Committee (FOMC) last met and decided to hold rates steady. For weeks, this level acted as resistance on a closing basis... the S&P 500 Index (SPX - 2,476.55) comes into this week's trading slightly below its July 26 close of 2,477.83.

"...Was last week's action a prelude to a breakout, or just a move to the top of the range as we head into September, a historically weak month for equities?"

    -- Monday Morning Outlook, September 5, 2017

The question I posed last week, about whether we were witnessing a breakout or simply a move to the top of the range in the equity market, is still open. Equities declined last week, but the pullback was hardly noticeable.

For a market that is hyper-sensitive to headlines between Fed meetings, bulls might be encouraged by the fact that sellers had a few reasons to predominate -- especially with technical resistance overhead as tensions between North Korea and the U.S. continue to linger, and a second major hurricane in as many weeks was bearing down on the U.S. mainland. Plus, investors learned that the debt ceiling uncertainty will linger for another three months, after a deal was struck between President Trump and Democrats that moved the deadline from this month until mid-December.    

"'My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target,' [Fed Governor Lael] Brainard said in a speech at The Economic Club of New York on Tuesday. If inflation continues to fall short of the central bank's 2 percent target, 'it would be prudent to raise the federal funds rate more gradually.'"
    -- Bloomberg, September 5, 2017

"'I actually believe we should be patient here,' said Robert Kaplan, who runs the Dallas Federal Reserve Bank and who is one of nine current voters on Fed policy this year."
    -- Reuters, September 5, 2017

The behavior of stocks in recent weeks hints strongly that how the Fed navigates the current environment seems to be of most significance to investors. For example, the two recent successive closes by the SPDR S&P 500 ETF Trust (SPY - 246.58) above its July 26 Federal Open Market Committee (FOMC) close were quickly reversed last week. In other words, the July 26 close of $247.43 continues to be a thorn in the side for bulls seeking a breakout. Moreover, the S&P 500 Index (SPX - 2,461.43) still has not closed above its July 26 finish at 2,477.83 since that FOMC meeting.

The failure of stocks to break out to new highs reversed a recent pattern in which the market rallies soon after the Fed stands pat on interest rates. Perhaps market participants are looking for the best of both worlds -- an accommodative Fed, and signs of economic growth -- before pushing stocks above resistance. So far, though, they've been getting one, but not the other. There is the headwind with respect to the yield curve flattening, which could be sparking growth concerns -- but accompanying this is a tailwind with respect to an accommodative Fed, as the odds of another rate hike by year-end have dropped from 50% one month ago to a one-in-three chance on the heels of recent dovish comments by Fed officials.

The result is trading range behavior, not only since the last Fed meeting on July 26, but since June 19, when the SPX experienced its first close above the 2,450 half-century mark (which we cautioned months ago could be a hesitation area in this bull market). Since July 26, there have been 21 closes above 2,450 and 10 closes below this level. And, since June 19, there have been 37 closes above 2,450 and 27 closes below it, proving once again the historical significance of half-century marks on the SPX over the years.

spy 80 day moving average 0908
Chart courtesy of

"....the all-equity, buy-to-open put/call volume ratio is rolling over from a multi-month high, implying fear is giving way to optimism. Typically, when this happens, equities drive higher... but note how the recent peak in the ratio wasn't nearly as high as in the past. This might suggest that follow-through buying from last week will be limited."
    -- Monday Morning Outlook, September 5, 2017

Meanwhile, the all-equity, buy-to-open put/call volume ratio has declined further, and is now back below the 0.60 level, just above multiple low points in the ratio since 2016. The direction that this ratio was heading gave bulls some hope that a breakout was imminent, but since it peaked at a relatively low level, the "pessimism unwind" potential isn't as strong as those that precede significant rallies. There is room for this ratio to fall to the June lows, and bulls would welcome that. But the risk-reward for bulls is deteriorating, as the unwinding of last month's peak in pessimism has not been enough to generate a noticeable equity breakout.

With the first of the month occurring on a Friday, September standard options expiration occurs at its earliest possible -- in the middle of the month, this Friday. With Friday's SPY close at $246.54, the upside this week looks limited from both a chart and options-related perspective.

In fact, as of now, a Friday close at or near the 245 strike would make SPY put and call sellers happiest, as this is the point at which the largest number of options would expire worthless. Additionally, the longer the SPY remains below the 247, 248, and 250 strikes as we move through expiration week, the stronger the headwinds are from the unwinding of long positions associated with the call open interest.

The 242-243 put strikes are the biggest magnets in the immediate vicinity, if there is a catalyst that sparks significant selling this week and puts these strikes into play. Therefore, this area would be considered a first line of support from an options-related perspective, but this is only if the key 80-day moving average at $244.17 is breached. Much larger put magnets are at the 230, 235, and 240 strikes, which I left off the chart below to make it easier to read. There is a remote possibility that these strikes come into play, but it's worth mentioning in the event of an unexpected event that unleashes expiration-week selling.

If the SPY moves above both the 247 and 248 strikes, not only is the chart resistance discussed above taken out, but the 250 strike becomes a potential magnet. In other words, a technical breakout on the SPY price chart during this expiration week would likely continue with a quick, sharp move to the $250 level, as both technical buyers step in and sellers of SPY 250-strike calls are forced to partake in the buying as a hedging strategy. Such a scenario would produce short-term call buying opportunities.

spy september open interest by strike

Finally, on this 16th anniversary of 9/11, my thoughts and prayers remain with all the victims and their families, and many thanks to the first responders and those who continue to defend our country.

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