Short-Term Traders: This Rally Has No Legs

Total short interest on SPX components now sits at a 3-year high

Senior Vice President of Research
Jan 2, 2024 at 9:02 AM
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Happy New Year, everyone! For investors who are heavily weighted in U.S. stocks, we hope that 2024 is as good as 2023, a year in which the S&P 500 Index (SPX - 4,769.83) rallied almost 25% and the Nasdaq-100 Index (NDX - 16,825.93) rallied more than 50%.

The rally defied Wall Street strategists, who expected the SPX to retreat, making it the first time since 1999 a decline was anticipated in the upcoming calendar year. The mood for this group as we enter 2024 is better, but only slightly. On average, they are looking for the SPX to end the year around 4,800, which is flat relative to 2023's close at 4,770. 

The flattish call could be incorrect again, whether we see a continued rally or the dreadful decline strategists were expecting in 2023.

The S&P 500 Index (SPX – 4,754.63) continued to climb last week, entering the last week of the year only 40 points below its January 2022 all-time closing high. Market participants will be focusing on this as a potential hesitation or pivot point, as those thinking ‘breakeven’ relative to the peak nearly two years ago could be sellers."

 - Monday Morning Outlook, December 26, 2023

The last week of 2023 ended higher, the ninth consecutive week of gains since the late-October bottom. But sellers came in on Thursday, with the SPX only four points below its Jan. 23, 2022 record closing high of 4,797. We enter 2024 only 27 points below this.

As you can see on the graph below, the selling wasn’t violent enough to cause any late-comers to the current rally to panic. In fact, the SPX is still 2% above its ascending 20-day moving average. Based on the current rate of change, this moving average will be sitting at 4,735 at this time next week.

Even if the current week ends nine consecutive weeks of gains, it is not necessarily a bearish omen, especially if the SPX does not move below support levels. The first of which is its 20-day moving average, while another is the 4,500-4,600 range -- site of the rising 50-day moving average at 4,502 and the July peak at 4,600.


“…total short interest is rolling over from the highest levels in more than a year. But the rollover is small, implying short covering was minimal in the month of November. As such, short covering could very much be supportive of the market into year end, even as short-term option speculators bet against the upside action the past several weeks.”

Monday Morning Outlook, December 18, 2023

Two weeks ago, I hypothesized that short covering could drive a rally into year end. While stocks advanced into year end as I anticipated, I was shocked to see that short interest on SPX components actually increased 4% in the first half of December, after mid-December short interest data came out last week.

In fact, total short interest on SPX components now sits at a three-year high, with the SPX just below its all-time high. For bulls, this is encouraging, as short covering remains a source of fuel that could push the SPX through its all-time high.


Moreover, the “what goes up, must come down” mentality that has been persistent since mid-November among strategists and exchange-traded fund (ETF) options players is still evident.

For example, piggy-backing on an observation that I made the past several weeks, put open interest (OI) over a five-day period has increased relative to call OI on SPDR S&P 500 ETF Trust (SPY - 475.31) options when using options with a five-day or less expiration time frame.

In fact, last week was the most pessimistic I have seen this group after reviewing open interest changes on 12/29 expiration SPY options with strikes between 458 and 485.

As you can see, short-term SPY traders are clearly exhibiting either the "rally has no legs” or “the next big move is lower” mentality. The "rally has no legs" mentality is evident by the call liquidations last week at multiple strikes, and the big put open interest adds on strikes below the market reflect bets on a big downside move being imminent.

Perhaps this group will eventually be correct, but for now, I am looking for evidence of a “the sky is the limit” mentality from this group that has been dead wrong for weeks.


“But active investment managers, per the weekly National Association of Active Investment Managers (NAAIM) are nearly fully invested, suggesting they have helped push stocks higher in prior weeks. But this is an area of the market that may not be as supportive in the weeks ahead… equity option buyers are a lot more optimistic relative to weeks ago.”

 - Monday Morning Outlook, December 26, 2023

Not everyone is pessimistic and, as such, in addition to the technical risks of the early-2022 high being in sight, there are a couple of sentiment-based risks that become more relevant if there is a short-term technical breakdown below support levels I discussed earlier.

For example, active investment managers are now slightly leveraged long on equities. This group has increased its allocation to equities since early November. I imagine this group may take some chips off the table around the SPX’s prior high, but I don’t see this group panic selling unless there is technical deterioration in the short term.

And as I mentioned last week, equity option buyers are more optimistic now relative to weeks ago and the level of optimism is at a level at which corrective moves have begun.

This is something to keep an eye on in the days and weeks ahead. I think the key there has to be something to panic active investment managers and equity option buyers before these sentiment-based risks become reality.

The extreme short position on SPX components along with momentum favoring the bulls is neutralizing these risks at present.


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

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