“…the NDX did not experience a technical breakdown… amid the unwinding of this negative sentiment, bullish conditions persist. Pullbacks like Friday’s should be viewed as buying opportunities over the coming weeks, even if there is potential technical resistance overhead that could create speed bumps along the way. Specifically, the all-time closing high of 15,675 could be greeted by sellers…the NDX is currently flirting with a level that is 20% above last year’s close, which resides at 15,465 and was the vicinity of last week’s high.”
- Monday Morning Outlook, October 25, 2021
The heart of earnings season kicked off last week, and big-cap technology stocks took center stage. On Friday, Amazon.com (AMZN) and Apple (AAPL) missed estimates, and sold off in reaction to their respective earnings reports. Earlier in the week, Facebook (FB), Advanced Micro Devices (AMD), Texas Instruments (TXN), Twitter (TWTR), and eBay (EBAY) met similar fates. But some of these negative reactions were offset by positive reactions in regards to Microsoft (MSFT), Teradyne (TER), Alphabet (GOOGL), and Overstock.com (OSTK). Positive enough, in fact, to drive the Nasdaq-100 Index (NDX–15,850.47) higher.
While the NDX encountered resistance from its early September all-time closing high early last week, this level proved to be nothing more than a speed bump. In other words, the index achieved an all-time closing high on Thursday, as the unwinding of the recent climax in fear continued to favor bulls amid mixed earnings reactions from some of the most well-known, large-cap technology names.
So far this year, the NDX has had mixed results after marking new all-time highs following a notable pullback – it went roughly one month without reaching new highs after a September peak.
Following a pullback that stretched from February through March, the NDX made a new all-time high in mid-April around the 14,000 millennium level, but there wasn’t much immediate upside to follow. The index danced around the 14,000 mark for two weeks, before a slide down to 13,000 in early May marked its trough.
In mid-June, however, a breakout above the April highs led to an impressive rally that lasted into mid-July. Unlike the mid to late-April period, the NDX is currently not trying to overcome a major round millennium number.
Option buyers’ behavior at present is in contrast to the mid-April period, but similar to mid-June, when a breakout was more sustaining in the short term. In mid-April, option buyers were becoming more and more pessimistic on NDX components, after reaching an optimistic extreme weeks prior.
In mid-June, much like now, option buyers were getting more optimistic after hitting a pessimistic extreme. Such precedents suggest that there is staying power with last week’s NDX breakout, since there may be more unwinding among option buyers in the near term that is supportive of NDX components.
“With traders still unwinding bearish bets from earlier in the month, there is a good chance that the SPX could take out previous highs and make a run at the lower rail of that channel that was in place from mid-November 2020 into mid-September. The lower rail of that channel comes into the week at 4,590, and on the last trading day of October will be at 4,607.”
- Monday Morning Outlook, October 25, 2021
How options buyers acted towards S&P 500 Index (SPX - 4,605.38) components looks like how they acted towards NDX components, when analyzing the buy-to-open put/call volume ratio. Plus, like the NDX, the SPX also achieved new closing highs last week.
Moreover, as I discussed last week, various highs throughout the week were at the bottom rail of the channel that the SPX traded within on most days from November 2020 through September. Since the break below the channel in mid-September, the SPX has not traded back within it. And while this bottom rail used to represent an area in which buyers might emerge after a pullback, it is now acting as resistance during rallies. Fortunately for bulls, with that lower rail rising, resistance levels are rising in price with each passing day. For example, the bottom rail starts at 4,612 and ends the week at 4,630 this coming week.
If a short-term decline occurs from the bottom rail of the November 2020 through the September channel, there is a multitude of potential support levels that could see buyers emerge. The first is the September closing high at 4,537, which did not deter buyers during last week’s rally. The 4,475 area is another support level and double the 2020 closing low, as well as an area in which the breakdown below channel support occurred in mid-September. Finally, if these levels were to break, a retest of the early October closing low at 4,300 could be in order.
The fact that major indexes such as the SPX and NDX reached all-time highs last week suggests bulls are in control, and long positions should not be disturbed, as fighting the tape is not the road to riches.
There is one thing that I am seeing in the option market that warrants caution. Specifically, I am talking about the actions of CBOE Volatility Index (VIX – 16.26) futures option buyers, who are buying calls at an unusually higher pace than puts, as I observed on Twitter last week.
As you can see on the chart below, note that the 20-day buy-to-open call/put volume ratio on VIX futures is above 2.0, and at its highest level of the year. High readings like this have had a strong tendency to precede pops in volatility that coincide with equity market pullbacks. This comes as the SPX’s 14-day Relative Strength Index (RSI) is at a level that has coincided with recent peaks in the SPX.
Such caution might mean hedging long positions, or at least having a plan in place to hedge, should a support level break. Even though seasonality favors the bulls, there is an indication among VIX option buyers that a decline much like we have become accustomed to could be in the works before favorable seasonality factors fully take root. And while a pullback may not be in the immediate term – or may not occur at all – it could be in the cards if there is an instant in which option buyers on NDX and SPX components move back to an optimistic extreme, which could be just day or a couple of weeks away.
Todd Salamone is Schaeffer's Senior V.P. of Research
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