The Surge in Options Buying That Just Tipped off Volatility Spikes

From a technical perspective the bulls remain in full control

Senior Vice President of Research
Nov 8, 2021 at 8:48 AM
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“…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.”

                - Monday Morning Outlook, Nov. 1, 2021

Fortunately for bulls, the S&P 500 Index (SPX -- 4,697.53) finds itself in familiar territory. After about a six-week hiatus trading below a long-term channel that it traded within on most days, it impressively moved back into this channel last week. In response, the index carved out new all-time highs in the process.

A couple of positive catalysts surfaced last week, with the first being the Federal Reserve removing uncertainty with respect to when tapering of their purchases of treasury and agency-backed mortgage bonds would begin. A second was, coincidentally, a positive headline with respect to Pfizer (PFE) sharing that its Covid-19 pill reduced hospitalizations and deaths by 89%. I said coincidentally because it was positive headlines regarding potential Covid-19 vaccines on the immediate horizon that snapped equities out of a funk in mid-November 2020.

For the time being, traders can again use the rails of that channel to define potential support and resistance levels in the immediate term, unless and until these boundaries are no longer effectively defining short-term support and resistance areas. The top rail of this channel comes into the week at 4,766 and ends the week at 4,785. The bottom rail is at 4,634 today and will be just above 4,650 on Friday.

For the "too far, too fast" crowd and those anchoring to the early-October closing low at the round 4,300 century mark, a 10% move above this level is at 4,730. In addition to short-term channel resistance, the area between 4,700 and 4,730 could be a potential profit-taking and/or hesitation zone from a round-number vantage point. In fact, the last time the SPX was this overbought, using the 14-day Relative Strength Index (RSI), was mid-April. It was trading above the top rail of its channel too. The index went on to grind higher for a couple of weeks before experiencing a notable pullback in early May to the bottom rail of its channel.


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 namesIn 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.”

                - Monday Morning Outlook, Nov. 1, 2021

While the SPX finally (and impressively) made its way back into a channel that it had broken below in September, the Nasdaq-100 Index (NDX -- 16,359.37) moved out of its own channel in place since August 2020. Unlike the SPX, the NDX never moved below the bottom rail of its channel, despite a significant pullback like the SPX experienced in September. For what it is worth, when the SPX broke out above top rail of its channel in early April, it rallied for about a month before experiencing a significant pullback. If a pullback occurs, a first line of defense for bulls is the September highs in the 15,675 area.


After the NDX’s technical breakouts above the September closing high two weeks ago and the top rail of its channel last week, there appears to be room for a continued unwinding of the climactic fear that occurred at the recent trough.  

Per the chart below, note how the 10-day, buy (to open) put/call volume ratio on NDX components was at 0.44 at the end of last week. Low points in this ratio during the past year have occurred in the 0.33-0.35 range. I’ll be monitoring this ratio closely, as a ratio in this range is indicative of heightened risk of a pullback at which point hedging with Invesco QQQ Trust Series (QQQ -- 398.60) puts may be an action worth considering if you are long this exchange-traded fund and/or multiple components of the NDX itself.


There is one thing that I am seeing in the option market that warrants caution… 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….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.”

                - Monday Morning Outlook, Nov. 1, 2021

Whether it is seasonality, or a continued unwinding of the pessimism that emerged in September – or a combination of both – from a technical perspective the bulls remain in full control. But as I mentioned last week, the one thing in the options market that I’m monitoring closely is the action of CBOE Market Volatility Index (VIX -- 16.48) futures options buyers, who ahead of last week’s Fed meeting, were buying calls on VIX futures at a rate higher than usual. Since last week, the rate has dropped off a bit. Such a high rate of call buying relative to put buying has tipped off volatility spikes.

The current unwinding from relatively high negativity in September, combined with all-time highs in a positive seasonal period suggests remaining the bullish course. With the VIX bouncing from the 15 area, which appears to be a floor, a hedge might be worthwhile since index options are cheap – at least when compared to the past year.


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

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