Getting Familiar With These SPX Support Levels

The SPY avoided delta-hedge selling at the 450-strike

Senior Vice President of Research
Dec 13, 2021 at 8:44 AM
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“…one thing still weighing on my mind is the three-day pattern on Nov. 5 (a Friday), Nov. 8, and Nov. 9. These three days are not officially a bearish “tri-star doji” pattern (which has preceded bearish short-term moves this year). However, the two consecutive doji -- a daily candlestick in which the open and close are the same or nearly the same -- days followed by the SPX’s close at its low on Nov. 9, may still be a risk factor worth being cognizant of, as the SPX is below the Nov. 8 close that was part of the three-day pattern I am talking aboutOn the sentiment front, even amid the stronger-than-expected CPI report in mid-November that may have turned the tide against bulls, investors have not hit the panic button. In fact, the NAAIM reading came in above 100 for the fourth consecutive week.”

          - Monday Morning Outlook, November 22, 2021 

Delta-hedge selling is not a slam dunk, but bulls beware that the chances of such a scenario developing have increased considerably. Such market action would be a major hit to those that trade seasonality, with December’s historically bullish bias… For now, the SPX is clinging to potential support, as it closed above the September closing high and its 80-day moving average, which was support at the trough in early March. Moreover, the SPY closed above that key 450-strike. Dare I say it, the close above SPY 450 on Friday is the silver lining for bulls, since there is bullish unwind potential from short positions being covered related to the put open interest at the 450-strikes and below. This scenario is a possibility if the SPY remains above this strike into December expiration.”

          - Monday Morning Outlook, December 6, 2021

In reviewing certain comments and observations I have made during the past month (excerpted above), there are nuggets of information that may explain the market’s behavior the past few weeks, and what could lie ahead.

The first is the warning signs about a significant pullback that emerged in early November, with one being the three consecutive day candlestick pattern, similar to those that preceded short-term pullbacks throughout 2021. Not long after this warning sign, the weekly National Association of Active Investment Manager (NAAIM) survey indicated that long exposure among this group was at an extreme high for the fourth consecutive week, suggesting an optimistic extreme that heightens the risk of a pullback.

The pullback eventually came on that Nov. 22. Moreover, in last week’s commentary, I suggested more selling could be on the horizon if the SPDR S&P 500 ETF Trust (SPY — 470.74) experienced a noticeable close below the 450-strike that could set in motion delta-hedge selling. I noted that like December 2018 — a previous instance in which delta-hedge selling occurred — the Federal Reserve is in hawkish mode at a time that investors are preoccupied with the potential for slowing economic growth.

Last week’s action was critical in that the SPY never moved below the 450-strike that I pointed out as the potentially decisive point at which we could either see delta-hedge selling, or bullish unwinding of short positions related to the huge put open interest at out-of-the-money put strikes. Moreover, the S&P 500 Index (SPX — 4,712.02) never broke below support from its September highs and its 80-day moving average. Coincidentally, this support was around the 4,507 level, which is a round 20% above last year’s close.

News flow was the catalyst for last week’s rally, which was likely supported by short covering on Tuesday morning’s gap higher. Admittedly, the gap gave bulls little chance, as the SPX was trading right below a trendline connecting lower highs ahead of the gap. The Cboe Volatility Index (VIX — 18.69) close back below previous 2021 highs in the 28-29 area Monday evening was an indication of a potential move higher in equities.

The next morning, a sense of relief among investors surfaced, as medical experts hailed early data that suggested complications from the omicron variant are not as serious as those from the delta variant, and current vaccines and their boosters may neutralize the new variant. Such headlines reassured investors that had sold equities on risk of renewed economic fallout from the omicron variant.

SPX channel 80day

The SPX enters the week around the levels from which the selloff began, which is where the three-day bearish candle pattern appeared in early November. This area happens to be around the SPX’s 25% year-to-date return, where sellers have been predominant. There is potential resistance here, but with sentiment not as optimistic now relative to when the SPX was trading at this level last month, the outlook is more positive for bulls.

For example, the past week’s National Association of Active Investment Managers (NAAIM) reading was 69, its lowest level since mid-October. In the options market, equity options buyers have ramped up put buying relative to call buying considerably on SPX and Nasdaq-100 Index (NDX — 16,331.98) components. Finally, the American Association of Individual Investors (AAII) survey came in with 31% bears and only 30% bulls, whereas the bullish percentage doubled the bearish percentage in early November.

The next lines in the sand for a potential VIX peak are 34.17, which is 50% above last year’s close, and this year’s closing high at 37.21a VIX reading below previous highs in the 28-29 area should be considered before going long or unwinding any of your hedges to long positions.”

          - Monday Morning Outlook, December 6, 2021

As referenced above, the VIX gave us an early indication of Tuesday’s rally, based on Monday’s move below the 28-29 area, although this was not confirmed by the SPX, which had closed below a short-term trendline.

Based on Friday’s VIX close, the outlook continues to look bullish for equities, as the volatility expectation measure closed back below a trendline connecting higher lows from June into September. Note in the chart below how the move above this trendline in mid-November was an early indication of higher volatility ahead. The jury is out, however, as to whether Friday’s low simply marks a higher low, per the dashed line segment in the chart immediately below.

VIX Daily 2021

As we enter standard December expiration week, the second half of December, and approach the Federal Open Market Committee's (FOMC) decision day on Wednesday, the outlook is much brighter for equities relative to one week ago, thanks to early indications that the omicron variant is not as threatening to economic growth as first feared. With the SPX rallying strongly after holding critical support ahead of that news, delta-hedge selling risk has diminished.

With respect to the FOMC, it is expected that Chairman Jerome Powell will announce that the tapering of bond purchases will end sooner than originally planned, stemming from comments he made a couple of weeks ago. An announcement that deviates from that expectation would be considered a surprise. If you are interested in the SPX’s bullish tendencies historically in the second half of December in years the SPX is up 20% or more year-to-date, see our Indicator of the Week below, written by Schaeffer's Senior Quantitative Analyst Rocky White.

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

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