Beware This Sector Ahead of Fed Meeting

Shorts are building positions on the tech-heavy QQQ

Senior Vice President of Research
Jun 17, 2019 at 8:08 AM
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"So now what? A full-fledged V-rally would push the SPX back to highs in the 2,950 area, but during the next two weeks -- up until June standard options expiration -- the SPY must first overcome peak call open interest at the 290 strike, which is equivalent to SPX 2,900. Many of the SPY 290-strike calls were bought to open, which means this strike could be a magnet like the put-heavy strikes, and a move through the 290 strike could generate additional futures buying as the call sellers look to hedge."
-- Monday Morning Outlook, June 10, 2019

The Federal Open Market Committee (FOMC) meeting on Wednesday will be on everyone's radar. According to the CME Group's website, fed funds futures traders are giving a roughly 26% probability of the Fed lowering the fed funds rate by 25 basis points. There is a little less certainty than usual, as the odds ahead of past meetings were much more extreme in terms of expecting either a rate hike or standing pat on rates. 

Therefore, the conclusion of this meeting might surprise more traders than usual, as there is not really a clear consensus as to the meeting's outcome. This is true whether the Fed holds rates steady or lowers them, and the implications would be increased odds of the equity market moving more than expected.

Our Senior Quantitative Analyst, Rocky White, did an in-depth study of Fed weeks since December 2015, when the Fed began the current tightening cycle. It will be interesting to see if S&P 500 Index (SPX - 2,886.98) is more volatile than usual after the outcome of this week's meeting, since there is not as clear of a consensus as usual about the Fed's anticipated action (or no action). 

MMO 1 spx fed weeks

Additionally, the expiration of standard June options will be among other highlights that traders will have to deal with in the upcoming week. In the past couple of weeks, I have written about key levels on the SPDR S&P 500 ETF (SPY - 289.26) and the SPX pertaining to heavy open interest levels at certain strike prices. 

In fact, last week, I specifically mentioned the call-heavy 290 strike on the SPY -- equivalent to the 2,900 century mark on the SPX -- as a big level to overcome if the April highs in the 2,950 area are to be retested in the short term.   

The SPY $290 level did prove fleeting for bulls last week, as intraday moves above this level were met with selling, and this call-heavy strike capped Thursday's high in the opening hour of trading, and subsequently later in the day. A late-day surge toward this strike on Friday was met with heavy selling too.   

While the SPY closed last week above the previous Friday's close, the week's gains can be attributed to the Monday morning gap higher after President Donald Trump announced he would not slap 5% tariffs on Mexican imports, after threatening to do so in late May. 

MMO 2 SPY hourly chart


Following Monday's gap higher and brief move through the SPY 290 strike, the SPY moved sideways the rest of the week, closing the week below the 290 strike and the round 2,900 century mark on the SPX. The obvious macro event on this week's calendar that could push the SPY through the 290 strike is the Fed. 

But then again, if the SPY pulls back, SPY option-premium sellers would love to see a Friday close around the 285 strike, which would maximize the number of June-expiration SPY calls and puts that expire worthless. A move down to the SPY 285 strike would be around a 1.5% drop, which is in line with its typical move when negative for the week, but slightly better than its average when negative during an FOMC meeting week.

A bullish sentiment driver that we uncovered this week is the action in the SPY's 10-day, equity-only, buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), which began to roll over from a high level. As you can see on the chart below, when this ratio begins to roll over, stocks typically rally strongly in the subsequent weeks and months. An exception was December 2018, when the Fed raised rates and heavy put open interest on SPY strikes acted as magnets, with the SPY plunging to the lowest of these heavy put strikes before finally stabilizing just one week after December expiration. 

However, as I said last week, the SPY is not susceptible to a sell-off driven in part by the open interest in the options market like December 2018, if it remains above the 280 strike. And as we enter this week, there is more room to "play with" relative to December 2018, if a decline occurs in reaction to the Fed. And while there are no guarantees, it doesn't appear as if the Fed is going to raise rates amid growing uncertainty on macro factors like trade, which the market clearly frowned upon back in December.

Above said, tread carefully with technology stocks. Per the second chart below, shorts are building positions on components of the technology-laden PowerShares QQQ Trust (QQQ - 182.64). Admittedly, tech covers many sectors and individual stocks. One of our lower-ranking groups is technology hardware and equipment. As of last week, only 38% of stocks in that group were trading above their 80-day moving average, putting this group on questionable ground, from a technical perspective. 

MMO 4 SPY pc ratio

MMO 5 QQQ short interest

Todd Salamone is Schaeffer's Senior V.P. of Research.

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