As options become cheaper, put exposure in your portfolio could be prudent
“….Chairman Jerome Powell -- offering up cautionary comments about the economy,…investors were given little to get excited about in reviewing the headlines during May expiration week.”
-Monday Morning Outlook,
May 18, 2020
It was a mirror image of the prior week with respect to last week’s S&P 500 Index (SPX--2,955.45) price action. Investors were receptive to several headlines inferring potential progress on vaccines for COVID-19, including one as early
as September. Moreover, Fed Chairman Jerome Powell told viewers on a Sunday night television program that “You wouldn’t want to bet against the American economy,” in contrast to remarks he made one week earlier. His comments
included an assurance that the Fed was not out of bullets “by a long shot” to support the economy.
“… 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.”
-Monday Morning Outlook,
April 20, 2020
“…In February, investors quickly bought the [SPX's] 10% pullback from the January 2019 close. But after sharp selling occurred after the break of the -10% YTD level they are now quick to sell here, content with taking a year-to-date loss of 10% versus the 2020 paper losses of a much larger magnitude just weeks ago.”
-Monday Morning Outlook, May 18, 2020
The headlines were enough to push the range-bound SPX to the top of its range in the 2,950 half-century mark, which is a 61.8% retracement of the closing high and low this year, and a level that I’ve been highlighting since April 20 as
potential resistance. And as you can see on the chart below, previous moves to this resistance level have not been received well, as sellers emerged quickly and noticeably.
But in a change from what has occurred during the past month, the SPX lingered around 2,950 throughout the rest of the week, perhaps a win relative to a noticeable selloff. Moreover, for the first time since the February and March selloff, investors
headed into a weekend with the SPX less than 10% below its 2019 close.
Improved price action around 2,950 last week could be a cue that the SPX is on the verge of finally taking out this resistance that has been in place since late April. However, the 3,000-millennium level is 45 points, or just 1.5%, above Friday’s
close. With the lower boundary of the range at 2,800, the risk-reward favors the bears from a short-term technical perspective, even though there could be slightly more upside to the round 3,000 level in the coming days or weeks, which is also
the site of the SPX's widely followed 200-day moving average.
“It is interesting that last week’s VIX closing low occurred on Monday at 27.57, with 27.56 representing exactly double the 2019 close. This will be a level to watch if the VIX declines in the immediate future.”
-Monday Morning Outlook, May 18, 2020
On the heels of last week’s rally and the SPX confronting resistance again in the 2,950 area and just overhead at 3,000, there are a couple of indicators flashing potential short-term vulnerability. First, the CBOE Market Volatility Index
(VIX—28.16) declined coincident with the stock market rally last week. It is now trading just above 27.56, which is double its 2019 close and a level from which it popped two weeks ago. If the SPX approaches 3,000, there is a chance
that the VIX moves to the 24 area, which is double its 2020 closing low and another level from which a short-term pop could occur.
Additionally, short-term traders are becoming increasingly optimistic, evident by the 10-day moving average of our customer-only, equity-only buy (to open) put/call volume ratio, as seen in the chart below. As the market troughed in March, these
market participants were at a pessimistic extreme not seen in years. Now, just two months later, this group is showing levels of optimism seen at short-term tops in 2019.
For short-term options traders, this would imply having put exposure in your portfolio, even if this means by way of pair trades or straddles -- especially now that options have become cheaper, as broader market volatility expectations have declined
and individual equity implied volatility has decreased -- as we move out of earnings season.
