Hedging Long Positions Could Be This Week's Move

The SPX has potential support areas that bears should pay attention to

Senior Vice President of Research
Aug 21, 2022 at 7:43 PM
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“…when an index or equity rallies after a prolonged selloff, there are multiple potential resistance levels overhead … The level that corresponds with the SPX’s round 10% below the 2021 close is at 4,289. In February-March, the index chopped around this area, and it acted as short-term resistance in early May prior to a steep selloffIt is standard expiration week for August. In reviewing the SPDR S&P 500 ETF Trust (SPY - 427.10) open interest configuration, the 430-strike, which is equivalent to SPX 4,300, stands out. It is the first strike where call open interest is far above put open interest and could pose as a ‘call wall’ this week.”

          -Monday Morning Outlook, August 14, 2022

Per the excerpt above from last week’s commentary entitled, “Hesitation Points Loom Ahead of Expiration Week,” it was obvious that the S&P 500 Index (SPX—4,228.48) was going to be challenged again with another set of technical resistance levels to overcome.

Not only did I mention the “call wall” just overhead with respect to SPDR S&P 500 ETF Trust (SPY—422.14) options that equated with SPX 4,300, but the level that corresponded to the round 10% below last year’s close was just overhead, a level that has presented challenges already in 2022.

Those were just two perspectives. And I didn’t even get into the popular 200-day moving average overhead, situated at 4,320, which marked the intraday high on Tuesday. Nor did I mention potential trendline resistance residing just above the 200-day moving average connecting the January and March highs, which comes into this week sitting at 4,329 and ends the week at 4,316.

SPX 200-Day 

At minimum, I think the trendline connecting the January and March highs discussed above and a move above the January-February trendline breakout level at 4,375 must occur to put more pressure in the “this is a bear market rally” camp. 

With the SPX in the early innings of potentially moving out of an overbought condition, the combination of technical resistance from the perspective of trendlines, moving averages, and former short-term highs may be among the most challenging yet since the June lows.

 

With resistance overhead, the SPX has a multitude of potential support areas that bears should pay attention to before getting too excited about last week’s decline. I say, “too excited” because anecdotally, when watching television last week, it was noticeable how many guests were saying, “Don’t buy the rally” and “we are the cusp of big downturn” with the usual warnings of “don’t fight the Fed” and earnings estimates will come down and stocks will follow.

As a trader, I am open to all possibilities and agree it isn’t a good time to chase stocks right here, given the potential resistance overhead and central bankers meeting in Jackson Hole, Wyoming this week. I would not be unloading long positions yet and instead consider hedging long positions, as the Cboe Market Volatility Index (VIX—20.60) is around a four-month low heading into this potentially pivotal event at Jackson Hole.

The anecdotal stuff I heard last week suggested there is still a lot of skepticism and that buying the dips could be the strategy in the weeks ahead. What I heard among many television guests and commentators suggests to me that many have missed the rally from the June low, suggesting plentiful sideline money that is necessary to push stocks through the challenging technical areas discussed above.    

Unfortunately for bulls, the first line of potential support was broken in Friday’s trading, when the index fell back below the 4,262 area. This area was also its close the eve of the first Fed rate hike in March and proved supportive in the middle of expiration week.

Additional support is at 4,230, which is a 50% retracement of this year’s high and low and below that is the 4,160-4,170 area, site of the June highs and its upward-sloping 20-day moving average. If the SPX declines back below the June highs, I think this would be the time to begin de-risking.

The Nasdaq-100 Index (NDX—13,565.87) experienced another breakout above potential trendline resistance last week, just as the SPX did last month. As I said last week, I find this price action encouraging from a contrarian perspective on the heels of a Bloomberg BusinessWeek cover story in late May entitled, ‘The Great Tech Rout’…. If you are aggressively long this sector, you could define your “first level of risk” as last week’s breakout level above the trendline connecting lower highs since December at 13,280.”

          -Monday Morning Outlook, August 14, 2022

Another option for you is to consider buying put options on sector exchange-traded funds (ETFs) if you are weighted heavily in a particular group. For example, with the Nasdaq 100 Index (NDX—13,242.90) falling back below its trendline breakout level at 13,280, one might hedge further technical breakdowns with Invesco QQQ Trust (QQQ—322.86) puts. The downward trendline connecting the December, March and early-August short-term peak begins the week at 13,142 and will be at 13,056 on Friday. At 13,056, coincidentally, is round 20% below the 2021 close. The good news is the NDX remains above these levels, but the bad news is these levels become lower as time passes.

NDX December Peak

Finally, and very much worth mentioning, is that the buy (to open) put/call volume ratio on both SPX and NDX component stocks is turning higher once again. In bear markets, this ratio will trough at unusually high levels, and note that troughs have been at higher and higher levels. This is a risk to bulls and could become a greater risk if support levels discussed above are breached in the days or weeks ahead. The recent action in this ratio is another reason to hedge long positions, as hedging activity should occur before more evidence of technical deterioration in the market, if indeed that is what lies ahead.

SPX pc ratio

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

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