Sideline Cash Ready to Extend Stock Rally

SPY open interest activity suggests plenty of sideline cash ready to fuel more gains

Senior Vice President of Research
Nov 20, 2023 at 9:14 AM
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“…the SPX closed above its 80-day moving average that was supportive in August, as well as trendline resistance since the July peak, giving bulls momentum heading into standard November expiration week... Upcoming economic reports include data on the consumer and inflation, with the release of the consumer price index (CPI) this Tuesday, and retail sales and inflation data at the producer level coming on Wednesday. These upcoming “known, unknowns” will have a significant impact on interest rates and equities…”

          -Monday Morning Outlook, November 13, 2023

The momentum higher that equities experienced heading into last week’s standard November expiration continued, with most of the gains attributed to softer-than-expected October consumer price index (CPI) data released Tuesday morning.

Per the S&P 500 Index (SPX — 4514.02) chart below, equities gapped higher on Tuesday’s open due to the CPI news. There was follow-through buying on Wednesday through Friday, as other economic reports continued to suggest the Federal Reserve is not only done hiking rates, but could begin cutting rates sooner than officials anticipated. 

For example, despite many Fed officials warning last week that rate hikes may not be over, bond and Fed funds futures traders paid more attention to the latest data on inflation and retail sales. Yields on the 10-year Treasury bond dipped about 20 basis points as Fed funds futures traders raised the probability of rate cuts by May 2024 to 60%, nearly double the probability heading into the release of the inflation and retail sales data.

SPX 80-Day Fed Pause

This week’s inflation figures marked the denouement of yet another shift in the market narrative, and what on the face of it was a wild overreaction to some good inflation figures. On one level the market did exactly as it should: Inflation was lower than expected, so bond yields fell and stock prices rose, with rate-sensitive stocks rising the most. But the scale of the moves was out of whack with what happenedShort-covering accentuated the move.”

          -The Wall Street Journal, November 17, 2023

Regarding the above excerpt from an article in The Wall Street Journal on Friday, I admit the rally I envisioned could occur was more than I expected, a testament the market can and will do anything – usually what is not expected.

I discussed in last week’s commentary the prospect of delta-hedge buying related to heavy call open interest at the SPDR S&P 500 ETF Trust (SPY — 450.79) 440-strike, which is equivalent to SPX 4,400, but by week’s end the SPY was trading above the 450-strike.

The Tuesday morning gap, driven in part by short covering on some stocks that had been weak in months prior, was so big that the call-heavy SPY 450-strike came into play in the blink of an eye. The 450-strike was not on my radar going into expiration week, given its delta -- or expected movement in the option price for each one-point move in the SPY -- was so low.

However, with four full trading days left in the week at the time of the Tuesday morning gap, and with the help of Wednesday’s produce price index (PPI) data, the SPY drifted up to and through the 450-strike, as the call delta of this option increased, forcing those that sold those calls to buy more and more SPX futures as a hedge.

In other words, just as we have seen big put open interest strikes act as magnets fueled by negative reactions to headlines, last week may have been a rare instance in which heavy call open interest acted as a magnet in reaction to positive headlines, in addition to short covering.

It has been nearly two years since the SPX peaked, and we recently observed a 10% correction from the July 2023 closing high. As such, despite the sharp V rally from the October lows, there are still multiple potential resistance levels that could come into play.

The first is the 4,530 level, which marked a peak after a mini-rally from its 80-day moving average in the second half of August. Coincidentally, the 4,530 level is exactly 10% above the late-October closing low. Just above that level is 4,565, the site of potential trendline resistance connecting the early 2022 all-time SPX high with its late-July 2023 peak.

Momentum is clearly on the side of the bulls. The two-month decline from the early-September peak has been nearly wiped out in only 15 trading days. Usually, it is the other way around, as weeks or months of gains are wiped out in a matter of days.

Nonetheless, if a post-expiration pullback materializes, the 10-day moving average could be the first point of support. It is currently rising at a rate of 15-20 points per day and comes into the week at 4,430, which is the level at which the SPX broke below the bottom rail of a bull channel in mid-August.

As such, 4,430 is now a static support level. And if it were to give way to sellers, the next big support area is between 4,390, its 80-day moving average, and 4,415, which is the breakout level two weeks ago above a trendline connecting lower highs since July.

On the sentiment front, activity in the options market suggests many have been caught on the wrong side of the move, and/or are assuming a mean-reverting “what goes up quickly and sharply must then come down quickly and sharply” mentality. 

The chart below shows total open interest changes over a five-day period on the standard November SPY options, with the 430-strike on the far left, and the 455-strike on the far right. The red bars indicate changes in put open interest, while the blue bars are changes in call open interest.

Given I focused on open interest changes over only a one-week period on options that just expired, my gut is these are speculative plays. Note the overwhelming put speculation, as traders positioned themselves for an immediate pullback that never materialized.

My takeaway from this activity on the SPY is that there are plenty of doubters, and thus plenty of fuel on the sidelines that represents would-be buyers.

SPY Novembe OI

A graph that you are more familiar with is the 10-day, buy-to-open put/call volume ratio on SPX components. Note that this ratio is rolling over, but from relatively high levels, suggesting equity option buyers were near a pessimistic extreme at the bottom, but still far from shifting to an optimistic extreme that makes stocks vulnerable.

SPX pc ratio Nov MMO

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

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