Traders Beware of Potential Post-Options Expiration Swoon

An unwinding of excessive pessimism has slowed

CMT, Senior Market Strategist
Sep 11, 2023 at 9:23 AM
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News that China banned government employees from bringing iPhones into government buildings pressured markets during the holiday-shortened week. The following day, markets saw more pain after reports the iPhone ban could also extend to government-backed companies. This is important because when a market-cap behemoth like Apple (AAPL) sees a downside move of -6.5% in two days, it can’t help but damage the broader indices.

Apple’s current weightings are 7.04% in the SPDR S&P 500 ETF Trust (SPY – 445.52) and 10.85% in the Invesco QQQ Trust ETF (QQQ – 372.58), and that’s after the Nasdaq-100 Index (NDX) special rebalance in late July. Moreover, if China is willing to go after Apple, investors must consider the risks this could present to other companies. After all, CEO Tim Cook said just six months ago that Apple and China had a symbiotic relationship.

“While it's well known we're in a seasonally tumultuous period, there still are opportunities afoot for nimble traders, and one could be on the horizon for the bulls as the conditions are ripe for a rally into mid-September.”

Monday Morning Outlook, August 28, 2023

In my last commentary, reporters and strategists were racing to be the first to break down September monthly return data for the S&P 500 Index (SPX – 4,457.49). It’s also not surprising that we found resistance near the range I outlined as a target for the SPX back in July. The 4,536 level is the SPX’s September 2021 closing high and the low-end of the range that marked the 2022 bear market breakdown.

mmo1sept10

One concern for bulls now is we’ve officially put in a lower high. While this doesn’t necessarily kill the bounce, it warrants caution. Furthermore, the SPX is now sandwiched between its 20- and 50-day moving averages, and is below double the 2020 March closing low as we head into options expiration week (OPEX). In other words, the technical backdrop has the potential to produce choppy market action, shaking bears and bulls out of position as price searches for direction.

mmo2sept10

If that wasn’t enough, this week is jam-packed with economic data that could move markets. After another tame consumer price index (CPI) report in August and softening jobs data during the summer, market participants lowered expectations of a rate hike in September to 8%. However, a surprise to the upside for inflation data could see those tides turn quickly.

Federal Reserve Chairman Jerome Powell was steadfast in leaving the door open for a rate hike during the September Federal Open Market Committee (FOMC) decision. Two leading indicators present some concerns: Jobless claims have fallen in the past few weeks, so the softening everyone was betting on is strengthening; and while the oil weight in CPI data is only 7%, we’ve seen it rally 11% since the committee last met. So, at the very least, CPI won’t have the drop-off effects from oil it’s been benefiting from.     

mmo3sept10

Looking at the open interest configuration heading into OPEX, critical overhead strikes to watch on the SPY are the 450- and 460-strike call walls. These levels likely cap price action to keep the SPY within the range I discussed two weeks ago. Additionally, the first put wall support resides at the 440-strike, which coincides with the 80-day moving average -- where we found support in August.

If this level were to break, we are at risk of a swift move to the 430-strike, where we see the second largest concentration of put open interest for September expiration, concurring with the August 2022 peak. It also should be noted that we are seeing a concentration in put exposure through October expiration, indicating options traders are betting on the post-OPEX decline.

mmo4sept10

Seasonally, we see a downturn post-OPEX in the month of September, with OPEX typically marking the tipping point for seasonal drifts before finding a low in the first two weeks of October. The weeks following the large September quarterly expiration are why September is the poorest-performing month for equities.

However, this also presents opportunities for active traders as gyrations give way to potentially wild swings until we see the prototypical Q4 rally into year-end. If history rhymes, we’ll likely see sideways -- or even positive -- price action into Friday, followed by a downturn into early to mid-October. If it doesn’t, this would probably catch a lot of traders offside, as this is well-known data, and a directional move higher could break equities out of the summer range.

mmo5sept10

In the past few weeks, we’ve discussed the 10-year Treasury yield and its implications on equities. Yet, this week, I want to look at the U.S. Dollar Index (DXY – 105.09). Whereas rates and equities can move higher in conjunction for extended periods, it’s rare for the dollar and equities to be correlated for long periods. For instance, the dollar low in July coincided with the SPX peak. Since then, the DXY has been on a relentless rally and has blown past potential resistance at the downtrend of the March and May 2023 peaks that formed.

The DXY stuttered at those May highs, another possible spot for resistance, only to break above it last week. However, we are now at $105 on the basket, which was a considerable pivot point range in 2022 that marked multiple peaks and troughs. It’d be wise to watch the dollar over the next week or two, as it may be your best indicator for market direction.

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Looking at breadth measures, it’s really a tale of two stories. The SPX advanced/decline line has thus far held its breakout from late June. However, the NDX's advanced/decline line continues to deteriorate, breaking its lows and failing on a retest of them. When looking under the hood, many names in the NDX have yet to break out from the ranges they’ve been stuck in since last spring.

Only a handful of large-cap tech leaders went on to test their prior all-time highs. Furthermore, the leading sector in technology, semiconductors, is battling overhead supply at the $155-160 resistance zone. If semiconductors can’t break out and continue to lead, bulls need to see another sector take the reins, like software or cyclical sectors, for the rally to carry on.

mmo7sept10

 

“However, coincident with last week’s rally, the SPX component 10-day, buy (to open), put/call volume ratio finally rolled over. Together with the improving technical backdrop, a continued unwind of the extreme in pessimism could have bullish implications.”

Monday Morning Outlook, September 5, 2023

The unwind in excessive pessimistic sentiment in the SPX components' 10-day buy-to-open put/call ratio has slowed over the past week as market participants seemingly are positioning for a potential selloff. With the indicator not that far off the highs and hovering in the extreme pessimism territory that depicts bullish potential, it wouldn’t take much amidst the current market backdrop to present another contrarian opportunity.

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Risks are present for a swoon post-expiration, so it might be wise to remain more cautious this week with new longer-term positions or even lighten up on some positioning if history wants to repeat. Another option is to add some short-term hedges this week, to protect gains against any potential downside risk while holding on to your current positions. That is, at least until we see which way the market breaks post-September expiration.   

Matthew Timpane is a Senior Market Analyst at Schaeffer's Investment Research.

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