How Shorts are Supporting This Latest Rally

Plus, a VIX level to watch, and SPX resistance overhead

Senior Vice President of Research
Feb 20, 2024 at 9:05 AM
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“We received end-of-January short interest figures late Friday night and expect to ‘slice and dice’ the data…judging by the price action from the past two weeks, I still believe that we are in a major short-covering rally."

 -Monday Morning Outlook, February 12, 2024

As I mentioned last week, we were slicing and dicing short interest data released by the exchanges the Friday before. As I suspected, and this probably comes to little surprise to anyone that follows the market closely, short covering is indeed one of the drivers of this rally, as it continued its descent from the mid-December peak.

mmo 1 feb20

And as we learned after a violent reaction to the hotter-than-expected consumer price index (CPI) data on Tuesday morning, the shorts will not only drive rallies longer than many anticipate, but short covering can keep pullbacks in check. It is likely that some of those individual equities used the pullback to cover positions that were in the red. The level and the direction of short interest (December was near a four-year high) is bullish.

I found it interesting that the lows after the CPI data were at a level that I suspected a period of profit taking could occur. For example, the S&P 500 Index (SPX--5,005.57) 4,940 level is 20% above the October 2023 closing low. The idea is that those anchoring to that trough may be tempted to take some profits. There was hesitation here for three days before the SPX surged past it. As you can see on the chart immediately below, it was supportive last week.

In fact, the 30-day moving average, which marked the mid-January low after acting as resistance in mid-October just ahead of the plunge into the late-October low, did not even come into play.

This moving average is at 4,880 and is currently rising at a rate of eleven points per day. As such, in this holiday-shortened week, it is projected to be around 4,920-4,925 at this time next week. Potential short-term support is in the 4,920-4,940 zone, the latter of which was discussed earlier. 

mmo 2 feb20

The prior week’s high at 5,050 becomes the first level of potential resistance. This is something to watch, as the most recent survey from the National Association of Active Investment Managers (NAAIM) showed these active market participants are nearly fully invested again. In fact, the four-week moving average of allocations is nearing the July 2023 level that preceded the correction into late-October 2023. 

SPDR S&P 500 ETF Trust (SPY--499.51) puts for the next two months would be one way to hedge this risk immediately. Or consider hedging activity if the SPY moves below support levels discussed above. At present, these managers are not being forced to liquidate as the broader indices march higher.

mmo 3 feb20

If you have been reading this commentary the past several weeks, you are familiar with my weekly observations on open interest changes on the most recently expired Friday SPY options. In this case, I looked at the February 16 expiration. It doesn’t measure the daily outlook for the broad market like the more popular zero-days until expiration (0DTE) options, but it is a gauge for how short-term traders are playing the broad market over a period of two to five days. 

The chart below shows that put open interest changes were again predominant, as short-term SPY traders continue to bet that momentum will shift in favor of the bears, as is evident by the put adds (downside bets) outweighing calls adds (upside bets). Maybe they will be right eventually, but only after losing serious money on this rally. Or, perhaps a yellow or red flag goes up if we see a predisposition for calls among this group of market participants, which has yet to be the case since December.

mmo 4 feb20

mmo 5 feb20

Per my observation on X, formerly Twitter, last week, the Cboe Market Volatility Index (VIX--14.71) came close to hinting at trouble ahead when it threatened to sustain a move through the January highs at 15.40, which is one half the 52-week high of 30.80.

If the VIX moves through 15.40 again, I would view this as a caution signal for bulls, at least for the short term.

For now, stay long, as the shorts are seemingly keeping pullbacks in check and rallies alive. But take technical cues from the broader market and/or VIX on when trouble could be brewing, especially as active investment managers approach fully invested levels, implying this is a source of fire power that could erode in coming days.

mmo 6 feb20

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

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