The SPX is back where it stood at the time of the last FOMC meeting
“Something that caught my eye with respect to the Aug. 5 gap lower is how delta-hedge selling may may have played out in the pre-market … The potential for the options mechanics of last week impacting stock prices this week are still in play…whereas in early 2020 the SPX crashed far below its 200-day moving average, the VIX high last week was concurrent with the SPX trading 100 points above this long-term moving average. In other words, it was a panic VIX reading -- even though it was pre-mature to panic from a longer-term technical perspective.”
- Monday Morning Outlook, August 12, 2024
Last week’s closing comments were extremely valuable to readers. After explaining what I believed caused the Aug. 5 gap lower (option mechanics known as delta-hedge selling) and stirred historic panic among traders, buying opportunities emerged that morning and on every subsequent day since. Additional panic set in with the S&P 500 Index (SPX – 5,554.25) still far above long-term moving averages, and not even in correction territory at its low point.
A risk I mentioned last week was delta-hedge selling occurring again if multiple economic releases during the week disappointed. But the big pop in the Cboe Volatility Index (VIX – 14.80) to levels last seen when the Covid-19 virus shut down the economy was a signal that expectations hit rock-bottom levels. An anecdotal example of the panic was the call for an emergency interest rate cut.
With expectations for the economy reset in a significant manner, the reports on inflation, retail sales, as well as employment were not enough to justify the panic that gripped the marketplace.
Instead of a delta-hedge selloff, a sense of relief was enough to support stocks. Ultimately, what materialized was a short-covering rally from the unwinding of short positions related to expiring put open interest (OI) during standard August expiration week.
The SPX is now back where it was at the time of the last Federal Open Market Committee (FOMC) meeting and disappointing July employment report, the latter of which marked the beginning of the massive selloff in the first three trading days of the month. To some, the price action is described as a “V-rally,” for obvious reasons.
The technical short-term risk is the SPX coming into the week around the 5,555-5,560 area. This is because potential sellers view the rally as a second-chance opportunity to exit, especially if the damage that occurred two weeks ago is still top of mind.
The 5,556 level is the SPX’s close ahead of a gap lower on July 24, and is the approximate site of intraday highs on the day of and after the last FOMC meeting.
The good news for bulls is that the SPX is also back above previous levels of potential support. For example, it is above 5,508, which is 20% above the July 2023 closing high, where it hesitated for about two weeks in June before moving to a new all-time high.
Plus, the SPX is above its key 30-day moving average at 5,470, which has flattened after sloping higher since early May. This moving average has had significance since October 2023 as both resistance and support, with crosses above and below marking buy and sell signals, respectively.
In fact, the gap below this moving average on July 24 was a sell signal, a retest, and a failure to move back above the 30-day moving average. This marked the start of three days of vicious selling in early August. With the gap above the 30-day trendline on Thursday morning, bulls are hoping this is a buy signal like that of early May.
The sentiment backdrop is certainly supportive of bullish price action in the weeks ahead.
Per the chart below, note that option buyers on SPX components have reached a level of pessimism that existed at the April trough. The ratio of put buying to call buying is in a zone that is typically bullish for stocks. A rollover of this ratio could be a sign that buyers are in the early stages of returning.
Something I referenced in the past as potential support is the multi-year high in short interest on SPX components, which can fuel rallies or support pullbacks as shorts look to cover losing positions. Per the second chart below, there is evidence of short covering in the latest reports, and thus a short-covering rally could be a risk to bears. Previously, the short interest build was a headwind for bulls. As such, the rally during that short interest build was impressive amid those headwinds.
Todd Salamone is the V.P. of Research at Schaeffer's Investment Research.
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