SPY Strikes to Watch as 2019 Comes to a Close

Enthusiasm among options buyers remains one risk to bulls

Senior Vice President of Research
Dec 23, 2019 at 8:37 AM
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 “In two operations in the form of repurchase agreements, or repos, the Fed injected $26.25 billion in overnight liquidity and about $31.27 billion in 14-day liquidity…Since the large interventions started, money-market rates have calmed.

            -- The Wall Street Journal, December 19, 2019

“Senate passes spending bills to avoid a government shutdown, sending them to Trump”

            -- CNBC December 19, 2019

“House approves Trump’s USMCA trade deal amid shadow of impeachment”

            -- The Hill, December 19, 2019

… household spending rose a seasonally adjusted 0.4% in November from October, the Commerce Department reported Friday. The increase in spending came alongside a rise in personal income, which was up 0.5%. Economists surveyed by The Wall Street Journal expected a 0.4% rise in household spending and 0.3% increase in personal income.”

            -- The Wall Street Journal, December 20, 2019


Just one week removed from a week in which positive macro headlines helped push stocks higher -- alleviating a few of several uncertainties overhanging the market -- a series of related positive macro headlines followed last week, sending stocks higher in the last standard options expiration of the year.

 “As we look to expiration Friday, I find it interesting that the SPDR S&P 500 ETF Trust (SPY - 317.32) rallied above the 315 strike, home to more than 100,000 calls outstanding. The big open interest at this strike may have played a part in the Thursday rally, as those shorting those calls were likely pressed into buying S&P futures to remain neutral It will likely take another positive catalyst for the big 320-strike calls to become influential.”

            -- Monday Morning Outlook, December 16, 2019

As I alluded to in the excerpt above from last week’s report, my thought was that any buying related to December options open interest would not occur unless a positive catalyst pushed the SPDR S&P 500 ETF Trust (SPY -- 320.73) above the call-heavy 320 strike, at which point this would likely cause sellers of the calls with an aim to be neutral to buy more S&P 500 futures to hedge further upside above the 320 strike.  

Without a catalyst, or catalysts, the risk to short-term bulls was a mild pullback related to the unwinding of long positions related to the 320 strike call open interest. And as you can clearly see on the 30-minute SPY graph last week, the 320 strike acted as resistance in listless trading, until traders and investors were treated to another series of positive macro news beginning on Thursday. Yes, uncertainty prevails with respect to the political theater of the House impeaching President Trump. It is largely expected that the Republican-majority Senate will not uphold the impeachment, resulting in a non-event among the other events that surfaced late last week.

SPY Dec 20 OI Config

SPY 30 Min Last Week

While SPY call open interest was notable at the 320 strike and above, it was only about half to three-quarters of what we typically see when prominent put strikes come into play during market declines. The implication is that while S&P futures buying related to SPY call open interest likely emerged last week, it wasn’t as significant as what might occur during a sell-off around expiration when a series of big put strikes are violated, like what occurred in December 2018.

To the degree option open interest played a part in some of the buying that occurred during the past two weeks, I would not be surprised to see the market give up some ground as S&P futures are sold that were related to the now-expired, in-the-money December calls. In fact, the last hour of trading on Friday could be hinting at this, when it was evident the expiring 322 and 323 strikes were not going to be taken out, thus long futures tied to these strikes were likely unwound.  

Additionally, the SPY is overbought according to its 14-day Relative Strength Index (RSI), and the S&P 500 Index (SPX -- 3,221.22) is toying with the round 3,200 century mark. But I would expect if stocks do give up ground, it will not be as sharp as the ground that was gained in the week after December 2018 expiration, when options open interest played a part in the sell-off into expiration before stocks came roaring back beginning the following week. Again, this is because any selling related to S&P futures bought the last two weeks related to call open interest pales in comparison to the number of S&P futures that were sold last year related to the huge put open interest strikes that were in play.

But if momentum continues, keep in mind that there is the 12/27 and the quarterly expiration of SPY options that expire this week and on the last trading day of the year. The call open interest in near-term strikes is similar to the number of contracts outstanding going into December’s standard expiration. Without a catalyst, the SPY 323 strike could act as resistance and the longer the SPY is below these strikes, the more it can be seen as a headwind. However, if the year closes with a predominance of momentum players even without a catalyst in play, the SPY could easily test the 325 strike by year end, which is the site of the last heavy call strike that could act as a magnet if the SPY takes out the 323 strike.

SPY Open Interest

Looking further ahead, I still think this is a market that could be supported by short sellers in the weeks ahead, as data through the end of November suggested little covering activity amid the November rally and major equity benchmarks are still in bullish technical patterns that emerged weeks ago, and I observed in this report.

But one risk is that equity option buyers are as enthusiastic as they were in January 2018 -- prior to a 10% correction -- and June 2018, which preceded a mild 3% pullback. If a pullback occurs, the shorts are likely to view it as an opportunity to exit losing positions, suggesting risk in the short term is closer to June 2018.

pc ratio since 2018

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

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