SPY Level for Bulls to Watch This Month

Bulls should be wary of a breakdown below the SPY's put open interest strikes at 275 and 280

Senior Vice President of Research
May 4, 2020 at 8:28 AM
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With the SPX 23% above its March closing low but still 16% below its February all-time closing high, the bears are pinning their hopes that an area between 2,900 and the 3,000-millennium level prove to be harder to overcome than the levels I mentioned last week as potentially dangerous..a wide area between 2,630 and 2,800 represents potential support.”

 Monday Morning Outlook, April 20, 2020

While sentiment measures suggest bullish action in the months ahead, the technical outlook suggests many hurdles ahead in the short term. This might contribute to a slow grind higher, with a lot of sector rotation, as big inflows into defensive names by some fund managers have supported the market, in addition to massive short covering in the second half of March that accounted for a strong finish to last month.”

Monday Morning Outlook, April 27, 2020

After the S&P 500 Index (SPX - 2,830.71) broke out above 2,800, I mentioned in my April 20 commentary that layers of resistance remained overhead as the market clawed higher, following its historic pandemic-related selloff in March, and subsequent stimulus efforts by the Fed and Congress in April. 

Indeed, several levels between 2,900 and 3,000 proved noteworthy, as three of the five levels that I listed two weeks ago came into play last week, before the SPX turned south. These levels were:

  1. 2,907 - This is coincidental with the round -10% year-to-date (YTD) return and in the vicinity of the 2,900-century mark. (In 2019, the +10% YTD return marked brief resistance in February, and support in early March, and early June).
  2. 2,940 - home to the 320-day moving average, which acted as support in early and mid-2019. 
  3. 2,948 - This is a 61.8% Fibonacci retracement of its 2020 closing high and low, and the area of the half-century mark.

While the first level, 2,907, was taken out early last week, the second and third area discussed above proved to be a brick wall, as you can see on the chart immediately below. The SPX peaked at 2,954 intraday last week, before closing back below the 2,900 century mark.  

May 3 MMO Chart 1

Last week’s SPX peak around the 2,950 half century mark was interesting from an options-related perspective too. When analyzing the SPDR S&P 500 ETF Trust (SPY - 282.79) open interest graph -- which is one-tenth the SPX -- note that the SPY 295 strike corresponds with the SPX 2,950 area. The SPY hit a “call wall,” where call open interest is relatively high, and easily exceeds put open interest at that strike. It is circled on the open interest configuration graph immediately below.

May 3 MMO Chart 2

Looking ahead to the next two weeks, which is when standard May options expire and options open interest potentially becomes more influential, bulls are hoping that potential support levels discussed two weeks ago, will act as support if more selling is on the immediate horizon. 

For example, the 280 strike is home to peak put open interest in the immediate vicinity of the SPY, and therefore a potential option-related support area. The put-heavy strike corresponds to the SPX 2,800 century mark, which marked a peak ahead of the December 2018 correction, prior to the Fed raising rates amid U.S.-China trade tensions. Just below 2,800 is the SPX’s 36-month moving average, which resides at 2,789.

May 3 MMO Chart 3

If the market stabilizes, it could benefit from a plethora of out-of-the-money put open interest that is getting set to expire in the next two weeks. If the heavy put open interest strikes stay out-of-the-money during the upcoming two-week period, short positions associated with the puts will slowly be covered, lending support to the market. 

However, and we have seen this before, if heavy put open interest strikes at 275 and 280 are broken to the downside, other heavy put strikes below could act as magnets, as sellers of those puts are forced into selling an increasing number of S&P futures in order to be appropriately hedged (called delta hedging). Such a scenario is one to prepare for if support levels discussed above are broken amid the higher volatility environment in which we are currently operating.   

On that note, per the SPY open interest configuration graph referenced above, the last heavy SPY put strike is at 250, which equates to SPX 2,500 -- close to the index's low on the first day of April, and around a trendline connecting lows from 2009, 2011 and 2020.

Here are a couple of other things that may be worth monitoring this week with respect to volatility expectations and sentiment:

Watch the CBOE Market Volatility Index (VIX - 37.19), as it continues to trade south of the 41.34 level, which is half its 2020 closing high, and coincidentally, is three times its 2019 close. If the VIX trades back above this level, we are at heightened risk of the market behaving like it did in late 2008 and early 2009 after the VIX pulled back to its half-high (also in the 40 area).   

I remarked in the April 13 commentary:

As it languished around 40, the S&P 500 Index (SPX -- 2,789.82) traded sideways before its final descent into its March low... if the VIX behaves like late 2008-2009, it could be indicative of choppy waters ahead and one more scary decline.” 

However, the VIX did hit a low of 30.54 last week, so the descent from its March high has been much greater than in 2008 and 2009. It goes without saying then that bulls want the VIX to remain below 41.34, and should grow more cautious if it moves above this level.

May 3 MMO Chart 4

I would find it highly unusual if we see another VIX spike like we saw in March, although the SPY open interest configuration could lend a hand in that happening if major put strikes are broken to the downside. It would be unusual since large speculators on VIX futures covered more positions last week, and the extremely light net short position is back to its March-end level, which occurred just ahead of volatility expectations plummeting. 

As I have said before, large speculators on VIX futures have been horrible timers of volatility. As you can see on the chart below, they were extremely short on VIX futures just ahead of a volcano-like explosion in volatility earlier this year. However, I would feel better about volatility continuing its descent if this group moved into an extremely rare net long position on volatility futures, which last occurred in December 2018.

May 3 MMO Chart 5

On the sentiment front, I find it interesting that the SPX failed at its 320-day moving average last week, just after a big increase in active manager’s equity exposure, per the latest National Association of Active Investment Manager’s (NAAIM) survey. 

Moreover, option speculators continue to unwind the multi-year peak in bearishness, with 10-day, equity-only, buy-to-open put/call volume ratio at 0.57, which is down from its recent peak around 0.80. The ratio has cratered around 0.45 and 0.50 in recent years, so this is a short-term risk to bulls as the ratio approaches this level and short-term trader optimism creeps into the market. This ratio has room to move lower, but short-term bulls should proceed with caution after the SPX failed to take out resistance last week and hovers just above potential short-term support.

May 3 MMO Chart 6

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

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