Why SPX Pullbacks Could Be Buying Opportunities

Equity options buyers continue to show their pessimistic hand

Senior Vice President of Research
Nov 27, 2023 at 9:24 AM
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“…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. …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.”

          - Monday Morning Outlook, November 20, 2023 

One of last week’s takeaways was that recent option activity on short-term SPDR S&P 500 ETF Trust (SPY — 455.30) options consisted mostly of speculative puts, as traders adopted a mentality of “what goes up, must come down.” As such, bearish short-term bets on the SPY were more predominant than bullish bets, as the S&P 500 Index (SPX — 4,559.34) was closing in on a 10% rally from its October closing low.

On one hand, you can understand such behavior, as the SPX’s last all-time closing high came in January 2022 and the SPX was fresh off a 10% correction from its July 2023 closing high, into the October closing low. But on the other hand, amid strong momentum from its October low, the bearish option activity on the SPY did nothing to stop the momentum higher.

The sentiment takeaway is that if bearish bets were being made, there was likely a mentality among most market participants that equities had rallied “too far, too fast,” leaving a healthy number of potential buyers since there many pessimists at the October bottom.

Last week’s action proved that this sentiment takeaway had merit, as follow-through action materialized, with the SPX moving above potential resistance at 4,530, the site of its late August/early September high and the level that is 10% above its October closing low, which would suggest a profit-taking level. But since many have missed or bet against this rally, there was little profit-taking risk at 4,530 among market participants looking to take profits 10% above the recent low.

With the SPY around $450 going into last week’s trading, I again reviewed open interest changes on the SPY to get a feel for how short-term traders were viewing the rally. This time, I focused on all strikes in the Nov. 24 expiration series that were in the immediate vicinity of the SPY to gauge sentiment during the holiday-shortened week.

What I found was not much different than the prior week, which was a mentality among SPY option speculators that current upside momentum will end with an immediate downside move. In fact, the continued skepticism that I found in the SPY option activity was matched by a few Wall Street strategist comments last week, such as, “risk of disappointment in the near term,” or “priced for perfection” and finally, “vulnerable to profit taking or consolidation.” Some of you may recall strategist pessimism from early-April into early June, as the market defied this negativity for weeks before finally peaking in late July.

Therefore, for those with a contrarian mind, a bet would be continued upside and/or a consolidation with minimal downside during this period of favorable seasonality for bulls.

SPY Thanksgiving Week

In the equity world, option buyers on SPX component stocks are getting more bullish after this group of market participants was at a bearish extreme in September and October.

As you can see in the chart displayed below, the 10-day, buy (to open) put/call volume ratio on SPX components stocks is moving lower, but still not at an optimistic extreme that occurs when the ratio is at a relatively low reading. As such, the direction of this ratio as it moves lower from a high reading is bullish.

SPX PC Ratio November

While the SPX moved above a technical resistance level at 4,530 last week, the second potential level that I pointed out last week came into play on Wednesday and again in Friday’s shortened trading session.

That is, a potential trendline connecting the January 2022 peak with the peak in late-July that preceded the 10% correction into the recent October trough. I refer to it as a potential trendline because as of now it is connecting only two major highs, and I would prefer when drawing a trendline to connect three data points or more.

If the SPX fails to move above this potential trendline for a period of days, weeks or more, it will remain on my charts. For now, it is worth it being on your radar, and it comes into this week’s trading at 4,563 and ends the week at 4,561. Moreover, the Cboe Market Volatility Index (VIX—12.46) is at its 2023 low point and, as such, professional traders may look at this development to use SPX options to hedge long portfolios into year end, which could in turn be a coincidental headwind in the near term, as other potential resistance levels come into play.   

For example, just above potential trendline resistance is 4,589, or the July closing high. This could be the start of a headwind for bulls if chart followers use this area as a profit-taking zone or a level to bet against the market by initiating hedges or a short position.

Finally, SPX 4,607 should be on your radar, which is 20% above the index’s 2022 close. Long-time readers of this commentary have seen how round percentage year-to-date return levels can act as hesitation or pivot points. This year alone, for example, the March 2023 low was at the 2022 close (0% YTD), with a hesitation in April and May in the 4,220 area, or 10% above the 2022 close, and this year’s intraday high in late July occurring at 4,607.

“…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…”

          - Monday Morning Outlook, November 27, 2023

If sellers finally take control this week after four consecutive weeks of gains, the 10-day moving average could be a potential support level, as it was on multiple occasions during the March-July advance. It enters this week’s trading at 4,505 and continues to ascend sharply. The 4,530 area is another source of support, which marks the high after a mini rally in August and is 10% above the October 2023 closing low.

Do not disturb long positions but beware of technical resistance overhead before increasing exposure. View pullbacks as buying opportunities.

SPX 10day MA

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

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