What This Period of Bullish Seasonality Could Mean for Stocks

One trendline could be hinting at a shallow pullback for the VIX

Senior Vice President of Research
Dec 14, 2020 at 8:48 AM
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… many sentiment indicators we track are displaying levels of optimism that have historically made stocks vulnerable to pullbacks. Or, at best, vulnerable to a period of underperformance.…if you are looking for an area that the SPX might have to move below before risk grows of an unwind of the growing enthusiasm we are seeing at present, I think the 3,550-3,580 area is a good starting point…Do not disturb long positions, as the trend is your friend and market enthusiasts have been given no reason to panic. But with the CBOE Market Volatility Index (VIX -- 20.79) at four-month lows, you could hedge long positions in recognition of the sentiment-based risk.”

 Monday Morning Outlook, Dec. 7, 2020   

The CBOE Market Volatility Index’s (VIX -- 23.31) pullback to multi-month lows proved to be an opportune time to hedge long positions. That is, if the decline in equity’s last week continues in both duration and/or magnitude. 

In fact, as you can see on the chart immediately below, after the VIX peaked at 40.28 in October (a level 200% above its 2019 close), it has found support at the 20.14 area, which is not only half of its October closing high, but also an area that is roughly 50% above its 2019 close of 13.78.  


As a side note, I have been monitoring the VIX’s 30-day moving average for the past several months, as I find it intriguing. Most interesting of late is the “fear gauge’s” Friday failure at this declining moving average -- which could be hinting that the VIX’s pullback will be shallow.

Last week’s pullback may not have been a huge surprise, given the sentiment-based risk, and especially, if you have been in touch with the weakness stocks typically experience in the first half of December.  

Plus, multiple equity benchmarks are simultaneously flirting with round-number psychological resistance levels such as the 3,700 level on the S&P 500 Index (SPX -- 3,663.46), the 30,000 area on the Dow Jones Industrial Average (DJI -- 30,046.37), and the $300 level on the technology-heavy Invesco QQQ Trust Series (QQQ -- 301.85) exchange-traded fund (ETF).

Last week’s decline was hardly enough to get the bulls’ attention, as the SPX did not break below its 20-day moving average and remains above November’s close of 3,621.63 (implying it remains positive during a normally weak, two-week period). Even if these levels were to break, there is potential support in the 3,550-3,580 area as I discussed in detail last week.


In fact, after tomorrow’s trading, we enter a historically bullish seasonal period for the SPX, as the second half of December historically produces bullish price action. Per the table below, if the SPX closes the first half of the month positive, but by less than 2%, the expectation would be a lower-than-average return in the second half. As of Friday’s close, the SPX was up 1.1% for December. 

A weaker-than-average second half of December would not be a huge surprise, given the optimism that continues to prevail among short-term traders. This suggests positive news is being factored in, leaving the market more vulnerable-than-usual to negative headlines.


This week brings us standard December expiration. One interesting thing to watch involves the huge call open interest at the SPDR S&P 500 ETF Trust (SPY -- 366.30) December 363 and 364 strikes, with Friday’s SPY close at $366.30. 

Most of the open interest came on at this time last year, when a 160,000 contract debit spread was put on for about 13 cents, with the SPY around $317. The maximum value of this spread that occurs is $1.00 (difference between strike prices), and this happens if the SPY trades at $164 or higher on expiration Friday. This trade is likely fully hedged, but an early unwinding of the position or a move below 163-strike could be a headwind.  

Other than that, I would not expect anything like December 2018 from purely an option-related and monetary perspective. When an already weak stock market
(due to a Fed rate hike amid China-U.S. trade uncertainty) contributed to a massive sell-off (driven in part by delta-hedge selling during expiration week), the SPY moved below heavy put open interest strikes and the put sellers were forced to hedge their positions by shorting S&P futures.


We are entering a period of bullish seasonality and the technical backdrop continues to confirm the optimism that we are seeing among short-term traders. But this optimism presents a risk to the bullish case, so keep those hedges on that you put on last week or the week prior. 

Small caps may be the biggest area of opportunity, as measured by the iShares Russell 2000 ETF (IWM -- 190.30) and Russell 2000 Index (RUT -- 1,911,69).  With the IWM and SPY experiencing about the same performance in 2020, there is much more short-covering potential in the small-cap area relative to large-cap stocks. 

Note in the graphs below that SPX component short interest is at a multi-year low after significant short covering since the middle of the year. There has been short covering in the small-cap space since July too, but note how total short interest on components of the RUT is still nearer to multi-year highs, suggesting the shorts could be in the early innings of covering.



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

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