Critical SPX Level to Watch Ahead of Expiration Week

Some tips on how bulls should approach the market during options expiration week

Senior Vice President of Research
May 17, 2021 at 8:46 AM
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“…. potential support resides at 4,050 – or roughly six times the 2009 closing low- and the round 4,000-millennium point. For what it is worth, the SPX’s 50-day moving average, popular with many technicians and retail investors that use technical analysis, is quickly closing in on that 4,000-round level. Note that this moving average contained two of the past three pullbacks in the in index.”

          -Monday Morning Outlook, April 26, 2021

I have noted increasing vulnerability to a market pullback for weeks now, whether sentiment-based or, in the case of last week, daily candlestick patterns that emerged in late April -- the tri-star doji pattern…With the VIX back below 18.60…the worst of a volatility increase hinted at last month may have passedWith the SPX closing Friday at an all-time high and more than a week surpassing since the emergence of the bearish ‘tri-star doji’ reversal pattern, one must wonder if the bulls dodged yet another bullet?”

          -Monday Morning Outlook, May 10, 2021

In a matter of days, the answer to the question that I pondered last week was answered. Stocks sold off and bulls were tested. Specifically, at Wednesday’s close, the S&P 500 Index (SPX – 4,173.85) found itself 4% below the previous Friday’s close and back below the lower boundary of a channel in place since mid-November, wiping out more than a month of gains in only three days. 

However, like other instances in which the SPX moved below its lower channel boundary, it was for only a brief period. In fact, per the chart below, there was a “trifecta” of support in the vicinity of last week’s closing low of 4,063, with the lower boundary channel at 4,072, its 50-day moving average at 4,050 and finally 4,056, which is six times its 2009 bear market closing low, and a level that I have discussed multiple times since the beginning of the year.  

May 16 MMO Chart 1

The rally from these support levels was sharp, pushing the SPX back above other key area of support that emerged the week prior at 4,131, which is 10% above the 2020 close and 4,100 -- the level at which the SPX broke out above the upper boundary of its channel since positive news on Covid-19 vaccines began to emerge.

As we look ahead to expiration week, I see the round 4,100-century mark as a critical level. Not only is this level the site of the breakout above its channel in mid-April, but with the SPX’s 50-day moving average rising about 30 points a week, it is projected to be around 4,100 by week’s end, and that lower boundary of the channel will be at 4,104 on expiration Friday. With the SPX trading most of last week within that channel, it is possible that its upper boundary acts as resistance, which begins the week at 4,220 and ends the week at 4,240.

During last week’s pullback, the Nasdaq-100 Index (NDX – 13,393.12) found support at the round 13,000 millennium level, with Wednesday’s intraday low of 12,967 just 80 points above its 2020 close at 12,888. As I pointed out on Twitter, put buyers on components of this index emerged in a big way during the past two weeks, driving the buy (to open) put/call volume ratio on its components to a one-year high on Wednesday. 

The index peaked in mid-April, and option buyers finally reacted to this weakness. While pessimism as measured by this ratio has not reached the levels of 2018-2020 during pullbacks, the current sentiment backdrop is more supportive of higher prices in the weeks ahead, relative to last month’s reading or the extreme low ratio that preceded its weakness in September. 

The pullback in equities as of Wednesday’s low is far from what would be labeled a correction because the SPX did not breach intermediate term moving averages, nor did it move lower by 10% or more, which is typically viewed as a corrective move in the media. 

But the reaction to the weakness in equities since the beginning of May has been enough to cause market participants to move to a more cautious view, implying there was an unwinding of the excessive optimism present one month ago. In fact, as the SPX was trading at support last week, there was clear evidence of pessimism emerging among some market participants, implying many have missed the move off last week’s low.

“… according to the weekly National Association of Active Investment Managers (NAAIM) survey, the average portfolio exposure was 103.72, with 100.0 considered fully invested and 200.0 being leveraged long. The last time a reading came in above 100.0 was mid-February. The current reading implies that this group is not a huge potential source of buying power like they were coming into April, when the reading was 52.02, or only about half invested.”

          -Monday Morning Outlook, May 3, 2021

Not only is this evident in the action of NDX component equity option buyers that I discussed above, but also in surveys, such as the National Association of Active Investment Managers (NAAIM). Just two weeks ago, I pointed out the high NAAIM reading as a sentiment-based risk to the market. Now, just two weeks later, this reading is at 46.86, or less than half invested. It was the biggest weekly decline in exposure since September 9, 2020 and the lowest reading in more than a year. The implication is that the very group that was not a huge source of buying power just two weeks ago is now a source of buying power that bulls can look to.

The 75% surge in the CBOE Market Volatility Index (VIX – 18.81) from the prior week’s close to Thursday’s intraday high may have signaled panic among market participants scrambling for portfolio protection.

In fact, this is exactly why I was advising hedging long positions around the VIX’s recent lows two weeks ago, as: 1) buying index put protection proved very costly in the middle of the week, and 2) to the extent your hedge is working for you, you are less prone to panic sell long positions at the exact wrong moment.

On Thursday morning, I pointed out internally that the VIX’s high on Wednesday and Thursday morning occurred at its 320-day moving average -- a long-term moving average on our radar, but not on the radar most long-term moving average followers. The peaks were also around the late-February VIX closing highs. 

The subsequent VIX retreat off last week’s high is encouraging because it is: 1) below its 2020 close at 22.75, which marked peaks in mid-February and mid-March, and 2) back below a trendline connecting lower highs since the beginning of 2021 (see the graph below).

However, bulls would like to see the VIX back below half its 2021 closing high, or 18.60. If the VIX moves back above the trendline connecting lower highs and its 2020 close, another volatility pop would likely be imminent. 

May 16 MMO chart 2

Finally, with it being expiration week, it makes sense to evaluate the SPDR S&P 500 ETF (SPY -- 416.49) May open interest configuration to assess how heavy call and put open interest strikes could influence the market.

In the chart below, big put open interest is evident at the 390, 400 and 405 strikes. Digging deeper into this open interest, it was bought (to open), implying the floor is short these puts. If the SPY would approach the 405 strike, which equates to 4,050 on the SPX, there is risk of a delta-hedge selloff in which the floor sells more and more S&P futures to offset the losses on the puts that they sold.  Such activity could push the SPY lower, forcing them to hedge the heavy exposure at the 400 and 390 strikes. Note that 4,050 is in the vicinity of six times the 2009 closing low.

In a nutshell, if the SPY moves back below last week’s closing low of $405.41, we could see a move to SPY $390, or SPX 3,900 (the March low), by the end of the week. Not only would a move below $405.41 potentially cause technical selling, but those that are short the 405-strike puts would be forced to sell more and more S&P futures to offset losing put sell positions. In fact, and in hindsight, the 405-strike may have acted as a magnet last week as put sellers sold futures to offset growing losses, and these hedges may have been immediately lifted after the ETF finally found support, helping generate a sharp rally at the end of the week.

Absent a spark of some kind to get the ball rolling back to the 405-strike, it is setting up to be quiet expiration week from an options perspective, with the SPY more than 11 points above the $405 level. But with $405 being touched just three trading days ago, the delta-hedge selling scenario is a worthwhile mention.

May 16 MMO Chart 3

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

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