Momentum Favors Bulls, but Risk of Pullback Grows

Expiration week has the SPX facing off with a key trendline

Senior Vice President of Research
Apr 12, 2021 at 9:29 AM
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The horizontal lines mark levels that coincide with 2x, 3x, 4x, 5x and 6x the 2009 closing low. Note that in all instances, the SPX either hesitated for a lengthy period or experienced significant drawdowns immediately after touching these corresponding levels relative to the 2009 closing low. While I may be getting ahead of myself, the 4,056 area is the next big level to watch from this perspective, as it is six times the 2009 closing low. With the SPX 5.5% below this level, there is room to run before this next big hurdle comes into play.”

          -Monday Morning Outlook, January 25, 2021

The excerpt above can be used to reference an updated monthly graph of the S&P 500 Index (SPX—4,128.80) immediately below. It is the same graph that I included when I made those comments in late January. As you can see, the SPX is now above the 4,056 level, which is six times its 2009 closing low. 

This graph is something to keep in mind. In three instances – double the 2009 closing low and price points that coincided with three and five times the 2009 closing low – such levels marked immediate resistance ahead of notable short-term pullbacks. 

At present, the SPX is behaving more like the action around four times the 2009 closing low, when it immediately pushed through the 2,700 area in January 2018. But note, however, that the breakout was short-lived, as a 12% correction into the end of February soon followed the fake-out breakout.

There is not a rule suggesting that past patterns will persist. But it is worth noting that after long periods of market momentum like we are experiencing now, these levels have corresponded with either the beginning of corrective moves and/or lengthy periods of choppy price action around these key levels. In fact, the SPX began its pandemic-driven bearish price action at the level that corresponds with five times the 2009 closing low.  If past is prologue in the context of this discussion, the risk-reward scenario is not the healthiest for bulls at this particular juncture.

For what it is worth, as we have been bullish on small-cap stocks as measured by the Russell 2000 Index (RUT—2,243.47), the 2,289 to 2,380 area marks seven times its 2003 and 2009 troughs at 327 and 343, respectively. The RUT has been struggling to take out these levels since February.


SPX 2009 Closing Low

If we “zoom in” on the SPX by analyzing a daily chart since November 2020, there is also evidence of potential resistance. For example, since positive headlines on a vaccine surfaced in mid-November, I have discussed a channel that this index has been trading in on most days.

Per the chart below, note that the SPX has been hugging the upper channel on this trendline during the past week. In fact, the price action around the top of the channel looks similar to mid-January and mid-February, which I circled in the graph below. 

In both instances, a short-term pullback occurred, with the first pullback pushing the SPX to its 50-day moving average and the second decline finding support at its 80-day moving average. In the three instances in which the lower boundary of the channel was breached, it was short-lived. That said, Friday’s close was above this channel line, which leaves the bulls in control going into this week.

With standard April expiration week upon us, potential upside resistance is at 4,127, or the top of the channel at the Friday expiration close. There is additional resistance just five points above that level at 4,131, which corresponds to a round 10% above the SPX’s 2020 close. Per the second graph below, note that there is considerable call open interest at the SPDR S&P 500 ETF Trust (SPY—411.49) 410 strike, which corresponds to the SPX's 4,100. 

Much of the volume making up the open interest at the SPY 410 strike was bought (to open), so delta-hedge buying related to the calls may have helped push the SPY through the 410 strike late last week. As the delta on this option is now at 90%, buying related to these calls is mostly over, implying option-related buying related to April expiration will not be a supportive factor in the days ahead. 

In fact, a significant move below the SPY’s 410 strike, or SPX 4,100, by Friday could lead to the unwinding of long positions associated with that strike and tilt the odds in favor of the bears this week. If the SPX declines this week, support comes in at 3,990, or the lower boundary of the channel in place since November. Additional support is in the area between its 80-day and 50-day moving averages, or 3,855 and 3,915, respectively.


SPX 50 80 day





mmo final chart

Finally, per my observation on Twitter on Thursday, note that Cboe Market Volatility Index (VIX—17.35) futures options buyers have returned, with the 20-day buy (to open) call/put ratio at 2.21. The chart above depicts how this ratio usually heads higher ahead of VIX pops. The ratio is at its highest level since late-May 2020, which preceded a VIX pop. 

Long-term readers of Monday Morning Outlook have seen comments in the past along the lines of VIX option buyers historically being smart money. The good news is the VIX moved below support at 20 as Matt observed last week.  Moreover, the VIX moved below one half its 2021 closing high (37.21) at 18.60. Be on the lookout for a sharp move higher if the VIX closes back above 18.60 in the days and weeks ahead. 

That said, the VIX reading is at its lowest since February 2020, which preceded the pandemic-related selloff. With the ability to hedge a long portfolio now the cheapest in 14 months amid the risk factors I outlined, now might be the time to hedge long position, as the momentum higher is the biggest factor on the bulls’ side right now.  But this could change in the blink of an eye, so better to be proactive to address current risks versus reactionary.  

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

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