2 Encouraging Signs for Stock Market Bulls

Pin risk for the SPY resides at 475, 480 this expiration week

Senior Vice President of Research
Jan 16, 2024 at 8:53 AM
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“…. sellers came in on Thursday, with the SPX only four points below its Jan. 23, 2022 record closing high of 4,797…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.”

          - Monday Morning Outlook, January 2, 2024

The good news: After the S&P 500 Index (SPX — 4,783.83) crossed below its 20-day moving average in the first week of 2024, it took only two trading days for the index to rally back above it. In a previous commentary, I had noted how moves below this moving average in the second half of 2023 proved to be bearish short-term omens.

The not so good news: the SPX’s inability to slice through the January 2022 all-time closing high. This level acted as resistance in the final week of 2023 and continued to act as a lid last week.

And with the turn of the calendar year, the SPX’s 2023 close at 4,770 is one to pay attention to also. Fortunately for bulls, the index closed above this level on Friday, after December inflation data was released and voting Federal Open Market Committee (FOMC) members warned market participants that rate cuts may not begin in March 2024, as many had begun to suspect.

The SPX’s pause just below the 4,800-century mark is not a major surprise, as the 2022 all-time closing high is on the radar of most – if not all- technicians, who may view this level as an opportunity to lighten up on long positions and/or “wait and see" if a breakout occurs before accumulating equities.

Moreover, those that bought the SPX’s mid-November trendline breakout above a trendline connecting lower highs from July through early November are sitting on a nearly 10% gain since that breakout, which may inspire profit-taking too. The 4,835 level is exactly 10% above the trendline at the time of the breakout.

SPX 20 50 Day Jan 2024

A potential challenge for the bulls in the weeks ahead is a shifting sentiment backdrop. Since late-December, however, the yield on the 10-year Treasury bond has ticked higher… this occurred when short-term equity option buyers on SPX component stocks near a bullish extremeThe latest data from the National Associations of Active Investment Managers (NAAIM) showed a massive reduction in equity exposure last week, but their net long exposure is still more than double that of early November.”

          - Monday Morning Outlook, January 8, 2024

A risk I presented to bulls last week, ahead of inflation data and the uncertainty of the interest rate environment, was the unwinding of short-term optimism that had come into the marketplace as equities rallied from their late-October lows into year end.

With the SPX unable to push through its January 2022 all-time closing high, and index options, as measured by the Cboe Market Volatility Index (VIX — 13.25) relatively cheap, my thinking was (and continues to be) that a hedge to long positions is worthwhile.

There are encouraging signs for bulls, in addition to the SPX’s immediate recovery after the decline below its 20-day moving average.

First, after the release of inflation data last week, the bond market did not experience meaningful selling. In fact, the yield on the 10-year Treasury bond remains below its 200-day moving average at 4.05%. Plus, the 4.10% level has had importance, as it represented former highs in March 2023 and early-July 2023. When the yield moved above 4.10% in July, it marked the beginning of the correction in the stock market that persisted into late-October. As such, as long as the yield on the 10-year Treasury remains below these levels, the equity market may remain stable.

The second encouraging sign is that since equity option buyers on SPX component names began placing more downside bets (put purchases) relative to upside bets (call purchases) in comparison to previous weeks, it has not had a coincidental negative impact on the market. However, the risk of this occurring remains as long as the ratio keeps moving higher.

As shown below, the 10-day, equity-only, buy (to open) put/call volume ratio on SPX components troughed on Dec. 22 with the SPX at 4,754. But amid an increasing number of put purchases relative to call purchases, the SPX has rallied amid the headwind from equity option buyers.

SPX PC Ratio Jan 2024

An offset to the increasing put purchases relative to call purchases since might be short covering. Data released last week on short interest numbers on individual stocks as of the end of December indicated that there was short covering on SPX component names, per the chart below. A continuation of short-covering activity, after short interest on SPX component stocks reached a multi-year high in mid-December, could limit the downside in the market or even push the SPX through resistance at its January 2022 closing high.

SPX SI Jan 2024

Finally, standard January options are set to expire on Friday. Per usual, after a rally, there is not a lot of delta-hedge selling risk when looking at options on the SPDR S&P 500 ETF Trust (SPY — 476.68). If the SPY moved closer to the 465-strike during the week, delta-hedge selling risk would increase.

Based on analysis of the SPY option open interest and volume only, I would not be surprised if the 475 strike acts as a floor and the 480 strike acts as a peak.

At the 480-strike, where call open interest is predominant, a deeper dive indicates that the open interest is made up of a balance of buy (to open) and sell (to open) volume. As such, pin risk at 480 (SPX 4,800) is a possibility if option mechanics are the predominant theme as expiration nears. Looking at SPX open interest figures, put and call open interest at the SPX 4,800-strike are equal, which could accentuate the century mark pin risk. 

Pin risk at the SPY 475 strike is also a possibility if a retest of the 20-day moving average is in order.

In the absence of an upside breakout on short-covering activity in the equity world, if volatility rears its ugly head in a violent downside expiration week move, the SPX 4,600 level is the biggest source of support, site of the July peak and current site of the upsloping 50-day moving average.

SPX PC Ratio Jan 2024

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

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