MMR

Options, Sentiment Backdrop Hinting at Trend Reversal

The market remains in its bull trend, but temper expectations this week

CMT, Senior Market Strategist
Nov 18, 2024 at 8:58 AM
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We saw profit-taking and volatility towards the end of last week. The S&P 500 Index (SPX – 5,870.62) retraced 61.8% -- a Fibonacci retracement level -- of its 4.1% move from the election night close to the Monday high. 

“…The SPX 6,000 level may hinder short-term advances from a psychologically-important vantage point. For reference, the SPX chopped above and below 5,000 for two weeks in February 2024 before finally distancing itself from that millennium mark. A repeat of such action would be a challenge for those seeking direction in a short time frame.”

- Monday Morning Outlook, Nov. 11, 2024

As we highlighted last week, the spot where equities peaked in the near term perfectly aligned with the round $600 level in the S&P 500 ETF Trust (SPY –  585.75). This also happens to be the 1.618% Fibonacci extension level from the July peak to the August low. Moreover, the SPX was trading near the top rail of the current channel. So, many factors were in confluence to produce a quick market yank, as bulls were a bit too excited post-election.

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In addition to the above, the SPY has experienced a second “island reversal” in the past two weeks. First a bullish reversal, and now a bearish reversal. In the shorter term, this signals the potential for bearish follow-through price action in the coming days.

Plus, Friday’s closing candle held the 20-day moving average, which aligns with October highs. This is the first level I expected bulls to try to defend, which we saw on Friday later in the day. So, price action could chop around for a couple more days while it attempts to carve out a bottom right here, too.

If bulls give up this level, two more support areas below should interest those with a longer-term bullish outlook. First, there is the $582.50-$579.50 range that we gapped down from before the election. This range is more pronounced in an hourly timeframe, with little significance in the daily chart, but it’s prudent to be aware of it since markets are moving fast and that would be a perfect bear trap.

The second and more substantial support level is where the lower rail of the price channel resides, the 50-day moving average, which completes the “gap fill” from the election reaction around $577. I'd expect bulls to fiercely defend this area to hold the trend into the new year.

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The most bullish of all election moves other than crypto was in small caps. The pre-election to post-election high was 8.1%, but they have given back nearly three-fourths of those gains. To put it into context, this was a massive breakout in the iShares Russell 2000 ETF (IWM – 228.48), and price is now pulling into the former resistance zone of $227-$225, now potentially support.

We see this kind of reaction all the time during earnings for individual companies, but these moves are rarer in the indices. In my view, election night was their earnings night, so these reactions are not worrisome. Nonetheless, we need to watch how prices react at these levels, because that could ultimately determine the direction of markets for the next few weeks.

My expectations are that we’ll hold this breakout level in the coming days or weeks, which will set us up for a rally into the end of the year. On the flip side, if I’m wrong and we break down, it could be an early signal that the overall trend in equities is reversing.

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Quickly looking at the SPY open interest configuration for the next five days, we sit in the middle of the put/call walls on the open interest configuration. The 595-strike call level is a large call wall to open the week, and will likely hinder price action should there be any rebound attempts.

The 575-strike put will initially act as your put wall, but is not as significant. However, the weekly 11/29 expiration peak put also resides at the 575-strike. This aligns with the more substantial support region highlighted above and could be a spot for options bulls to add exposure.

We’re also starting to see a build of put exposure at the 580-, 585-, and 590 -strikes over the last five days, so any subsequent moves lower into the support area could be met with a potential tailwind that unwinds if price rallies sharply from support.

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From a sentiment perspective, a couple of data points have me a little concerned. First, the buy-to-open put/call volume ratio is near its year-to-date low range. While overall it’s bullish directionally, we are in a ripe spot for a reversal, and the last few times we reversed from this range low, it produced a pullback or choppy price action. 

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The second point of concern is the SPX advance-decline line that has yet to break out and remains in a consolidation phase. Over the past few years, we have almost become conditioned that breadth doesn’t matter. It’s become a common theme for the majority of stocks to go through corrections while the large-cap market leaders prop up the indexes for the past two years. However, I think it is prudent to be more cautious when we see breadth fail to break out on such a significant move.

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While the market firmly remains in its bull trend, those expecting significant moves this week might want to temper expectations. The market could enter a choppy period until we see a resolution, with the overall data pointing to the market being set up for price discovery these next few days.

 Matthew Timpane is a Senior Market Analyst at Schaeffer's Investment Research 

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