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Is Wall Street's New-Found Wariness Warranted?

The 10-day average of the equity-only, buy (to open) put/call volume ratio on SPX components is at an extreme too

Senior Vice President of Research
Jan 24, 2022 at 9:47 AM
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If the SPX closes below the trendline connecting higher lows since September (4,650-4,665 in the shortened holiday week) and its 80-day moving average -- currently situated at the round 4,600 century mark –- bears may grow even bolder. With the SPX below its 2021 close already, the technical backdrop would become a significantly weaker argument for bulls.

            -Monday Morning Outlook, Jan. 18, 2020

Just hours after my remarks excerpted above were posted on our web site, the S&P 500 Index (SPX — 4,397.94) closed below a key trendline connecting higher lows since September. Additionally, the index closed below its 80-day moving average. I had cautioned that a close below these levels would significantly weaken the technical backdrop of the SPX. Sure enough, the bears grew bolder, and/or the bulls went into retreat, as the SPX closed lower each day thereafter, trading 3.4% below Tuesday’s “sell signal” close at Friday’s low point.

Jeremy Grantham, the famed investor who for decades has been calling market bubbles, said the historic collapse in stocks he predicted a year ago is underway and even intervention by the Federal Reserve can’t prevent an eventual plunge of almost 50%...In a note posted Thursday, Grantham, the co-founder of Boston asset manager GMO, describes U.S. stocks as being in a ‘super bubble’Grantham is a dyed-in-the-wool value manager who’s been investing for 50 years and calling bubbles for almost as long.’”

            -Bloomberg, Jan. 20, 2022

During times of sharp selling and high volatility, it is natural for market participants to search for where a bottom could emerge, especially when there are some signs of extremes in fear. Or, you will see what appears to be extreme calls that get the media’s or anyone else’s attention, such as Jeremy Grantham’s note last week projecting that the SPX could drop to 2,500. As a side note to this, there were front-page articles in The Wall Street Journal in 2003 and 2009 with extreme analyst predictions on where the SPX would eventually trough. These articles were published within weeks of the eventual SPX lows, which were far above the dire predictions projected by those quoted in the respective articles.

Additionally, one of our analysts pointed out an “urgent” email he received on Friday afternoon from a newsletter that he is not subscribed to recommending the purchase of June SPDR S&P 500 ETF Trust (SPY – 437.98) puts. His comment was along the line of marketers pushing unicorns and rainbows no more, but appealing to the emotions of fear by recommending index put options.

He received the email when the SPY was trading at potential long-term support from its 200-day moving average and oversold, according to its 14-day Relative Strength Index (RSI). Additionally, this urgent email was pushed out when portfolio insurance, as measured by the CBOE Market Volatility Index (VIX -- 28.85), was 65% above this year’s low, which I found potentially questionable in regards the timing of an “urgent” put purchase.


Turning away from anecdotal evidence of potential extreme fears among traders and investors, which are fundamental to a market-bottoming process, let’s turn to a few quantified indicators, starting with those in the options market.

Per my observation on TweetDeck on Thursday, and courtesy of data from TradeAlert, the total dollars traded on equity put options on Thursday were more than those traded on call options. This is a rare event, and I incorrectly stated it occurred only twice last year. It was actually three times, with Sept. 30 added, the date of another market bottom. Unlike March and December, the SPX had broken below important support levels, such as a trendline connecting higher lows and its 80-day moving average, so this gives bulls some hope going forward. That said, the SPX was above its 200-day moving average on September 30, which is not the case as of Friday’s close.

The worsening technical backdrop potentially downgrades the implications of the sentiment extreme that I noted on Thursday afternoon. If market momentum continues lower, less investors feel “left out” and those making fresh bets against equities and the market are less prone to be squeezed. At the same time, such extremes in fear are welcome, but there has to be evidence that such fear has climaxed, which is a major uncertainty at present.

mmo jan 23 chart 1

The 10-day average of the equity-only, buy (to open) put/call volume ratio on SPX components is at an extreme too, but the direction of this ratio continues to be the biggest risk for bulls. In other words, the pessimism is building amid a technical breakdown last week, giving little reason for bears to give up on their positions as we enter the last full week of trading in January.

mmo jan 23 chart 2

Time will tell if last week’s sharp decline was helped along by expiration-week mechanics, specifically unwinding of long positions related to heavy call open interest strikes, followed by delta-hedge selling related to put-heavy strikes.

For example, it is a possibility that move back below the call-heavy 470 strike (equivalent to SPX 4,700) on Jan. 13 created unwind selling, as those long S&P futures to hedge sold calls liquidated their long positions as the SPX moved further below the 470 strike and other call-heavy strikes immediately below. Moreover, the break of the 450 put strike on Friday morning could have led to the next major put magnet at the SPY 440 strike, which is about where the SPY closed. I should note that put open interest at these strikes was about half of what I normally see during delta-hedge selloffs. But if there are very few willing buyers during this process, it could have the same negative effect, but on less volume.

If last week’s ceiling was in part to expiration mechanics, I would expect a recovery fairly quickly with the standard January expiration event now passed. It would not be the first time that I have seen a expiration-related technical breakdown that is quickly resolved to the upside.

mmo jan 23 chart 3



If selling momentum continues this week, I’ll take a stab at identifying where an area of support could emerge. The SPX’s 12-month moving average, which represents a one-year average, has sometimes been supportive on pullbacks, most notably in 2012, 2016, 2018 and 2019. During the past 10 years, when the SPX moves below this long-term moving average, it is usually a hint that trouble is looming for at least the next two months. This moving average is currently at 4,335.73. 

But I am watching two other levels of interest, one of which is obvious, the other of which is not. First, the September lows occurred at 4,300 (as seen in the chart below) and could be an area where buyers step in to halt the slide. Just below 4,300 is the 4,289 level, which is the level that coincides with a round 10% below 2021’s close. Long-time readers of this commentary know the historical importance of round year-to-date levels as hesitation or pivot points. But like other troughs, I think a bull would like to see a day or two of heavy selling in the morning, followed by a rally and close near or at the high.


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

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