Key SPX Level to Watch After Last Week's Rally

There is no immediate danger of delta-hedge selling this expiration week

Senior Vice President of Research
Apr 17, 2023 at 8:54 AM
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Short-term momentum continues to favor the bulls, with the SPX up about 6% from its mid-March low. However, the index remains stuck in the middle of potential support and resistance, whether looking at daily or longer-term monthly charts…The 3,950 region could also be important if a selloff emerges, as this is the site of the SPX’s 200-day moving average... Just 55 points above Friday’s close is 4,160, which marked the February high, implying the SPX has room for a little more upside.

            - Monday Morning Outlook, April 10, 2023 

The S&P 500 Index (SPX – 4,137.64) made headway last week, settling 32 points above the previous week’s close. Technical selling may have prevented the SPX from gaining more than it did, as the 4,160 level marked Friday’s high.

This level is one to watch closely, as it marked the February high before the benchmark lost more than 7% during a six-week period. Prior to February, the 4,160 level acted as resistance in late May and early June, ahead of a two-week, 12% selloff. In other words, bulls and the 4,160 level have not mixed well in recent history. 

The May through June period was essentially the beginning of a volatile trading range that has persisted, implying we are trading near the top of it. The last time the SPX sustained a move above 4,160 for more than one week was in August, but it took the index another week to push through this level. This move above it only lasted eight days before a bearish “island reversal” pattern pushed the SPX back below it on Aug. 22.

The 4,160 level is also important because it is 10% above the December closing low. It should continue to be on your radar since sellers have emerged here multiple times since May 2022.

Those anchoring to the December 2022 low may be tempted to take profits in the 4,160 area, with Federal Reserve and economic uncertainty looming, and the index still in the red year-over-year. As such, some may view the rally as simply a bounce in a bearish trend, since J.P. Morgan Chase (JPM) and Wells Fargo (WFC) strategists have warned investors about the possibility of a 10% correction in the coming months.

If past is prologue and we see significant selling from the 4,160 zone, I would expect the 3,950 (which was supportive in November, and is the site of the 200-day moving average and an extended trendline connecting lower highs since a February peak) to 3,970 (the site of a January breakout above a 2022 trendline of resistance, and its close prior to the February through March trendline breakout) zone to act as support. This area is about 5% below the 4,160 level, and 4% below Friday’s close. 

If a breakout above 4,160 is not in store this week, we could also see a shallower pullback compared to those that we have experienced after a touch of 4,160. The 4,070-4,080 area is the first line of defense, which is the site of the December high and last week’s lows.

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The shorts are viewing the rally as an opportunity, but then again that sentiment has been in place since early February. Short interest on SPX component stocks hit its 2023 low in early February and has risen 7% since then.

In that period, the SPX was flat, though it had a downside bias. Anyone that put short positions on in early February is likely not feeling pain, but since mid-February newly added short positions could be underwater. If the SPX can make a calendar-year high in the coming weeks, it may squeeze some shorts, which would likely lead to an upside bias into early summer. 

From a sentiment perspective, betting on a breakout above 4,160 would be the contrarian play. The index is trading above short-term moving averages amid shorts building positions since early February; at least two strategists calling for a correction; active investment managers reducing their long exposure the past two weeks; and only 26% of respondents bullish in the American Association of Individual Investors (AAII) weekly survey. 

If the SPX rallies through 4,160, the next potential resistance is between 4,200 and 4,225. The former is the site of the index’s 24-month, or two-year moving average that has marked peaks since July. And the 4,225 level is 10% above its 2022 close, which is ripe for profit-taking.

From a longer-term view, short interest continues to build from its early 2022 low. This could be a headwind down the road in the absence of a major rally, since shorts that got in early last year remain profitable and are not yet being forced into a covering situation.

In fact, rallies could be viewed as shorting opportunities among the stronger hands that made bets against stocks early last year. This would contribute to the range behavior that has been so prevalent the past several months.

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It is also standard expiration week. The good news is that from an options perspective, we are not in immediate danger of delta-hedge selling, as the SPDR S&P 500 ETF Trust (SPY –  412.46) is 6% above the 390-strike, which is the first put-heavy strike of significance.

The downside is that to the extent that the recent rally got help from short covering related to big put open interest strikes that are now situated far below the SPY’s current level. It may be near its end since the put deltas have imploded as the SPY moved further above the put-heavy strikes, and the time until expiration of these option has been reduced.

In fact, call-heavy strikes are now in play, and could act as a lid as we move into expiration Friday.

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

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