SPY 260 Steps Up as Stocks Remain Stuck in a Vicious Circle

Major equity indexes are pinned below stubborn resistance levels as macro uncertainty lingers

Senior Vice President of Research
May 7, 2018 at 8:48 AM
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It was déjà vu last week, as the day-to-day market action felt just like prior weeks. In other words, a lot of movement that amounted to nothing but noise from the perspective of weekly closing levels. My Friday mid-afternoon tweet below, listing the SPDR S&P 500 ETF Trust's (SPY - 266.02) weekly closes going back to mid-April, gives you a nice numerical perspective. For what it's worth, the SPY's 2017 close of $266.86 seems to be a major point of resistance, when focusing on weekly closes.

And with the latest close this past Friday, May 4, arriving at $266.02, phrases that pop into my head to describe the SPY's price action since mid-April are: "going nowhere fast"; "directionally challenged"; "stuck in neutral"; "spinning its wheels"; "a vicious circle"; and "an endless loop."

Fortunately, with the last couple of weeks marking the heart of earnings season, individual equities have given traders the opportunity to profit, powered by big earnings reactions that echo a theme I have discussed for several weeks: shortening your time frame to counter the daily volatility that has yielded nothing over a period of weeks.

There were a few macro factors last week that could have pushed stocks decidedly one way or the other, such as the Federal Open Market Committee (FOMC) meeting and the beginning of trade talks with China. However, there were no major surprises on either front, as the Fed did not raise rates and the U.S. delegation in China did not come to an agreement with Chinese leaders on demands from both countries, although they agreed to continue talking. The two events ultimately left investors with lingering questions, such as, "Will there be three or four rate increases in 2018?" and "Will China and the U.S. eventually find a middle ground and avoid a trade war?"

It was Friday's employment report that lifted stocks from recent support levels, as the unemployment rate slipped below 4.0% amid no visible signs of wage inflation, assuaging recent fears -- at least temporarily -- of rising inflation and slower growth.

If you're paying attention to the daily action, U.S. equity benchmarks again traded lower during the week, but found support at key levels that I have discussed in the past as having significance. For example, the SPY rebounded from $260, which is equivalent to the round 2,600 century mark on the S&P 500 Index (SPX - 2,663.42). The exchange-traded fund (ETF) dipped intraday below its popular 200-day moving average, only to close back above it ahead of Friday's rebound day. It was the fifth touch or near-touch of this moving average since early February, as the $260 level continues to assert its importance as a support area.

From an options-related perspective, as you will see later in this discussion, it was important that $260 held. However, the March "Fed day" close just above $270 continues to be an important resistance level, as does the area just below $273, which is where a line connecting the January and March highs lives currently.

spy daily ytd with 200-day moving average

As the SPX and SPY were testing support, so too was the Russell 2000 Index (RUT - 1,565.60), a small-cap stock benchmark. The RUT's low last week occurred around its 2017 close. In other words, whereas the SPY's year-to-date (YTD) breakeven mark has been a source of resistance from a weekly closing perspective, the RUT's YTD breakeven mark -- just above the important 160-day moving average -- became a source of support in last week's trading. The price action in these two benchmarks has taken slightly different paths. For example, both are marking lower highs on rally attempts, but the RUT has also made a series of higher lows, whereas the SPY lows have occurred around the same level.

Bulls would like to see the RUT take out 1,585, which is where a trendline connecting lower highs since the January peak is currently sitting. But the round 1,600 level is yet another potentially powerful source of resistance, as there have been two failures at this century mark already this year.

rut daily ytd with 160-day moving average

The Nasdaq Composite (IXIC - 7,209.62) found support at a key round number last week -- specifically, the 7,000 millennium mark -- and its own 160-day moving average, which acted as support in February and early April. From a short-term perspective, the IXIC comes into the week roughly equidistant from important support and resistance areas.

The IXIC 6,900-7,000 zone, as you can see in the chart below, is home to a round number, a key moving average, its YTD breakeven (6,903), and a trendline connecting the February and March lows. The 7,500-7,600 area represents a round number that marked the January high, in addition to an area from which a major gap lower occurred in March. Plus, 7,600 is the site of the March peak, which corresponds with a round 10% move above the 2017 close.

ixic daily chart with 160-day moving average

As noted above, the SPY's hold at the 260 strike last week was significant. I mention this because we are in that window within two weeks of a standard options expiration. Standard options contain larger amounts of open interest, and thus they can be more influential on equities, particularly as expiration nears -- sometimes exaggerating movements, or building an additional layer of support or resistance.

With that said, note on the graph below the huge put open interest at the SPY 260 strike. Our data sources indicate these options were bought to open, implying those who sold the put options and typically hedge will have to sell more and more S&P futures if the SPY moves significantly below this strike, in a process called delta hedging. The bigger the open interest, the more S&P futures that are likely to be sold, which could create a sharp downside move below the strike. Moreover, if momentum and technical sellers jumped on a break of $260, the put-heavy 250 strike could be the next magnet, as the open interest here was buyer-driven, too.

At the same time, as expiration nears and the SPY remains above both $250 and $260, one might expect a slow, gradual unwinding of short S&P futures positions related to these big put strikes. Time is on the side of the bulls as long as the SPY remains above $260 in the weeks ahead.

spy may open interest by strike

"There is a glimmer of hope for bulls... during the current tightening cycle that began in December 2015, the SPY has behaved much better in the short term in the immediate aftermath of the Fed holding rates steady relative to hiking rates.

"...the sentiment backdrop supports higher stock prices. However, if this year's lows are taken out, it becomes a matter of price action supporting the sentiment backdrop, therefore downgrading the significance of negative sentiment being a supportive factor for equities."

-- Monday Morning Outlook, April 20, 2018

The sentiment backdrop continues to favor the bulls, as we have seen pessimism build in this trading-range environment in which the highs for the SPX were last seen in January. And as I noted last week, equities have performed better in the short term when the Fed holds rates steady versus hiking rates during this tightening cycle. Therefore, with support continuing to hold on pullbacks and negative sentiment representing future buying power, the current environment favors the bulls. However, all bets are off if the support levels discussed earlier finally break down.

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