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Could This Be a September to Forget For Bulls?

$390 is home to a considerable amount of SPY put open interest

Senior Vice President of Research
Sep 6, 2022 at 8:37 AM
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The technical environment deteriorated last week, after the SPX fell below 4,230 and the 4,160-4,170 area… To add insult to injury, Friday’s action can be classified as a bearish outside day, with the SPX’s intraday high above the previous day’s peak and the low and close below the prior day’s low... I see the next level of potential support coming from the SPX’s 50-day moving average at the round 4,000-millenium mark…Although this is an area of potential support, bulls should not ignore the fact that risk has increased amid breaks below higher levels of support amid the ‘bearish island reversal’ pattern last Monday and the bearish outside day candlestick on Friday.”

            - Monday Morning Outlook, Aug. 28, 2022

Per the excerpt above, I spent time discussing the equity market’s deteriorating technical backdrop, specifically as it related to the price action of the S&P 500 Index (SPX – 3,924.26) post Jackson Hole, Wyoming. This was when the message was, “expect interest rates to remain high for longer than some of you expect.”

In reviewing last week’s commentary, “risk has increased” was certainly true as it related to last week’s action. In fact, the SPX broke beneath its “next” level of potential support at the round 4,000-millenium level, which is also in the vicinity of both the popular 50-day moving average, and the less-popular but sometimes significant 80-day moving average.



… if you did not hedge long positions as advised last week, you should lighten up on your long positions, with the potential of lightening up further if other support levels break…”

            - Monday Morning Outlook, Aug. 28, 2022

For bulls, if there was any consolation with respect to last week, the round 3,900 level held the SPX’s lows on Thursday and Friday. This level is extremely important, as it is the site of the mid-July breakout level above a trendline connecting lower highs since March and its close on the eve of the Fed’s last rate hike.  

Moreover, 3,904 is a 61.8% Fibonacci retracement of the June low and August high. There is also potential support sitting at 3,900 using the lows from June, July, and last week as the basis for the trendline. 

Thursday’s bounce from this level was encouraging, but the close above it on Friday came in the context of sellers dominating the action after a strong opening on the heels of the August employment number. It was the second consecutive Friday that an “ugly” candle was formed, with the close far below the opening action and the high of the day.  If a close below the 3,875-3,900 area occurs  (3,875 is 10% below last month’s closing high), I think at least a retest of this year’s lows becomes an increasing probability -- thus reason to further decrease long exposure.

Looking ahead, in two weeks we have a standard expiration that occurs in the final month of the quarter and the regular quarterly expiration on September 30. These end of quarter expiration months (March, June, September and December), from my experience, tend to have the biggest open interest builds relative to months where it isn’t an end of the quarter. The implication is that with more put open interest on equity index and exchange-traded fund options, in periods of market weakness, there could be more selling related to big put open interest strikes. This could happen whether those puts were bought as a hedge or to speculate.

Outside of the February 2020 Covid selloff, the two biggest declines I remember that could have been exacerbated by the options market was December 2018 and June 2022 (there may be others, but those two remain freshest on my mind).

As such, I asked Rocky White, our Senior Quantitative Analyst, to do a study analyzing SPX price action in the 10 days prior to each standard expiration (third Friday of the month) and compare the price action with end-of-quarter months to those months that are not quarter end. He went back to the beginning of 2010 and found what has been summarized in the table below.


Note how the average return in the 10 days prior to standard third Friday expirations at the end of each quarter is negative, even though the returns are positive 64% of the time. The implication is that when option-related selloffs occur, they are larger than normal, as a higher number of S&P futures need to be shorted when big put open interest strikes are close to being violated or are breached. Note how the average negative return in the 10 days preceding standard expiration in quarter-end months is about 60% worse than the average 10-day negative returns during months that are not end of quarter.

I bring this up because we are in one of the end-of-quarter months with standard expiration less than 10 trading days when the bell rings Tuesday morning. As such, in such situations, you can sometimes throw your chart work out the window, as delta-hedge selling knows no chart boundaries.  

With the SPDR S&P 500 ETF Trust’s (SPY – 392.24) break below the 400-strike last week and the subsequent failure to sustain a move back above it early Friday, the odds increase that another June ’22 occurs, which was an extremely painful and dangerous few days for bulls.  

You should be on high alert for the potential of a severe, sharp decline these next two weeks as long as the SPY remains below the 400-strike. This is especially if it dips below the 390-strike between now and Sept. 16 expiration. 

If you are an option buyer, ensure you have puts in your portfolio to either hedge long portfolios against a massive pullback before end of month, or as a speculation tool for leveraged gains.

If there is any potential upside to the massive put open interest on the SPY, the longer the SPY manages to hold above key huge put open interest strikes in the next 10 days, the more potential for buying to occur as those that sold the puts unwind short positions as we move closer to expiration.

Per below, the $390 level is not only important on a chart, as discussed above, but it is home to a considerable amount of put open interest that could generate heavy selling if breached. Other heavy put strikes below 390 could act as magnets. But if technical support on a chart ($390) holds nearer to and into expiration day, there could be short covering related to put open interest at the 390 strike and other heavy put open interest strikes immediately below.  



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

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