Expiring SPY Options Could Dampen Volatility This Week

With sellers in control, September expiration week could play out differently than usual

Senior Vice President of Research
Sep 17, 2018 at 6:30 AM
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"Not only is the excitement of the early August Fed pause over, but the height of earnings season is behind us, and market participants are now more likely to trade off macro headlines -- most notably, headlines regarding trade negotiations.

"... I am seeing cross-currents that might suggest range-bound trading into the end of the month. For example, the SPX rallied above the 2,900-century mark in late August, but the breakout was short- lived and a pullback has since pushed the index back below this level. But as I said earlier, the SPX appeared to be finding support around its January 2018 high in the immediate aftermath of Friday's trade headlines, suggesting a bounce could be imminent following the weakness that occurred in the first week of September."

-- Monday Morning Outlook, September 10, 2018

After a steady decline throughout the first week of September, the S&P 500 Index (SPX - 2,904.98) reversed gear last week. The equity benchmark advanced throughout most of the week, and finished Friday just above its month-end August close at 2,901.52.

As I anticipated last week, macro headlines on trade issues influenced stocks, with the SPX jumping early in the week on reports from The Wall Street Journal that the U.S. was set for a new round of trade talks with China. But as you can see on the chart below, about halfway through Friday's trading session, Bloomberg reported that President Donald Trump still wants to pursue $200 billion in tariffs on Chinese goods, even as a fresh round of talks could be coming. The SPX sold off as traders quickly pushed it down to its August closing level. In assessing the first two weeks of September, weekly moves that have added up to a total of roughly 96 absolute points have netted nearly zero in directional movement.

spx month to date sept 2018

As we await the outcome of the Sept. 26 Federal Open Market Committee (FOMC) meeting, when another interest rate hike is expected to occur, I would not be surprised to see equity benchmarks dance around key psychological round-number century and millennium marks that have been highlighted in this report the past few weeks -- such as SPX 2,900, Nasdaq Composite (IXIC - 8,010.04) 8,000, and Russell 2000 Index (RUT - 1,721.72) 1,700.

The RUT, for what it's worth, first touched 1,700 in June and finally broke above it in mid-August, but retested this area last Wednesday. Its September high is 1,740, with the 1,740-1,750 area potentially marking resistance in the weeks ahead.

With the SPX entering the week trading around last month's close, the late-August high around 2,915 serves as a potential short-term resistance point and the January 2018 closing high at 2,873 should continue to act as support, as it did on Sept. 7. This level is just above the index's 30-day moving average, which was supportive last month and in May.

If the resistance and support levels discussed above are broken, I could see the SPX 2,850 half-century mark as another area of support. SPX 2,940 would likely act as short-term resistance, which is a round 10% above the 2017 close and the site of a trendline connecting higher highs since mid-May.

spx daily with 30-day ma

It's standard September options expiration week, so I checked into the SPDR S&P 500 ETF Trust (SPY - 290.88) open interest configuration to see how the options market might influence the SPY in the coming days. Immediately standing out is the call open interest immediately overhead. In fact, data from the Chicago Board Options Exchange (CBOE) indicates that most of the 291-strike calls were sold to open. The implication is that selling may occur as the SPY approaches this strike, as buyers of those calls (market makers) who want to stay neutral on their position will short more and more SPY or S&P futures to remain delta-neutral as the SPY moves up to and above the strike. The 295-strike call open interest is also heavily seller-driven, implying an options-related lid at the SPY 291 and 295 strikes.

As far as open interest below the SPY, the 285 strike stands out, where there is big put and call open interest. This coincides with the SPX 2,850 half-century mark that I mentioned as a potential support level on a pullback.

Unlike most other expirations, and due to many of the options being sold to open, the current open interest configuration suggests a dull expiration week. At the very least, it is not a week in which options are likely to magnify major moves, as options that are sold to open typically dampen, rather than enhance, volatility. That said, if there is a catalyst that pushes the SPY through the call-heavy 291 and 295 strikes, the prospect of the call sellers closing their positions to manage losses would have bullish implications as floor traders unwind short positions associated with those calls.

spy september oi by strike

U.S. stock bulls should stay the course. If you are concerned about trade war risk in the coming days, consider the purchase of put options on emerging market exchange-traded funds (ETFs), such as the iShares MSCI Emerging Markets ETF (EEM). With implied volatility readings in the 18-20 range on the EEM, compared to 63-day historical volatility running at 19%, options on the ETF are reasonably priced.

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