If the Stock Market is Going to Right Itself, the Time is Now

Did delta-hedge selling overpower bullish sentiment? We'll find out this week

Senior Vice President of Research
Oct 23, 2023 at 9:49 AM
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The short-term technical outlook is neutral, as potential resistance overhead and support below are almost equidistant …the risk of delta-hedge selling begins if the SPY moves below the 425-strike, which is coincident with SPX 4,250. Such selling could intensify further if the SPY approaches the 420-strike, which is the site of the peak put open interest in the graph below.”

              -Monday Morning Outlook, October 16, 2023

Last week, I mentioned the neutral short-term outlook from the perspective of key support and resistance levels residing equidistant above and below the S&P 500 Index’s (SPX--4,224.16) Oct. 13 close. 

Additionally, I pointed out the impact that standard expiration of October options might have on stocks, whether that be a slight tailwind from short covering related to expiring put open interest on major exchange-traded funds or index options, or those same put-heavy strikes acting as magnets if “delta-hedge” selling was in the cards (I discussed delta hedge selling in last week’s commentary, per above). The latter scenario, with respect to the options market, seemingly took hold, beginning late Thursday afternoon.

Per the two charts below, after the SPDR S&P 500 ETF Trust (SPY--421.19) broke below the put-heavy 430 strike, other put-heavy strikes below $430 acted as magnets. In fact, the SPY moved below the 425-strike Friday morning following the breach of the 430 strike the previous day. Selling intensified when these put strikes were violated, likely due to a rush to sell S&P 500 futures by market makers – who aim to be neutral and are forced to sell futures to balance out losses on the options the had previously sold to portfolio insurance buyers.

mmo oct23 1

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“... if the SPX moves back below the June low… a retest of this month’s lows is likely”

            -Monday Morning Outlook, October 16, 2023

So now what?

After the SPX closed below its June closing low on Wednesday, the index indeed retested the early-October lows at the potential support level I discussed last week. In other words, with the SPX just a tad below its 200-day moving average, and at the lows earlier this month that equates to the level that is the round 10% above the 2022 close, as depicted in the chart below, the expiration-week pullback moves the short-term needle in favor of the bulls.

mmo oct23 3

This technical-based bullish outlook is built on the premise that downside risk is at 4,225, with potential upside to 4,325 and 4,385, the former representing the June 2023 closing low and the latter the current site of the SPX’s 50-day moving average, which marked last week’s Tuesday morning peak. Admittedly, such a rally must occur now based on this premise, with the SPX closing right on its support level.

A break of 4,225 support, however, would quickly put risk-reward in the bears’ favor from a technical perspective, as 4,225 would become potential resistance, with immediate downside to the 4,130 (resistance earlier this year) to 4,175, site of the important 36-month (three-year) moving average. Admittedly, there is little to almost no room for error if you are a bull, as longer-term moving averages are in sight.

While monetary and geopolitical risks remain on the forefront of market participants, the market has every reason to rally from a technical and options-based perspective if indeed the bulk of the action late week was dictated by delta-hedge selling. That bearish factor disappeared on Friday. In other words, if the market is going to right itself, now is the time.

My concern, however, is that equities have not responded to the unwinding of a recent extreme in pessimism that I have observed in recent weeks. For example, weekly surveys from the National Association of Active Investment Managers (NAAIM) indicated that activity investment managers increased equity exposure from Oct. 4 to Oct. 18th. But there has been nothing to show for their efforts. And stocks normally rally coincident with roll-overs from extreme highs in our equity-only, buy (to open), put/call volume ratio measures. But the market has made little net progress since the peak in these ratios.

mmo oct23 4


This begs the question, “Did delta-hedge selling trump the bullish sentiment measures we are seeing?” We should get the answer this week.

On the fundamental and macro front, one market focus will be the sharp pickup in earnings releases and outlooks this week, with behemoths such as Microsoft (MSFT), Alphabet (GOOGL), Amazon.com (AMZN), Meta Platforms (META) and Intel (INTC) set to report. Plus, there is a wide range of other high-profile companies such as Boeing (BA) and General Motors (GM) scheduled to report this week.

As investors weigh individual company earnings reports, there is no shortage of economic data due to be released this week: new home sales, jobless claims, advance third-quarter gross domestic product (GDP). And finally, on Friday, we’ll get data on personal income and spending, plus key inflation data ahead of the Fed policy meeting the following week.

In fact, perhaps due to the combination of expiration-week selling, uncertainties with respect to the Middle East, and the list of “known, unknowns” coming this week on the earnings and the economic front, the Cboe Market Volatility Index (VIX-22.10) pushed above key levels I have previously mentioned as important. Consider 18.23, or half the ’22 closing high, and 19.23, which is 50% above the September closing low. On Friday, the VIX closed at its 2022 year-end close of 21.67. A clear move above this level could result in this year’s highs in the 26-30 zone being tested, which would accompany an equity selloff. The 26 area, by the way, is double September’s lowest reading on the close.

We are at a critical juncture, especially for bulls, who have seasonal winds in their favor, but facing a rising volatility environment as longer-term support resides just below current levels.

mmo oct23 6

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

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