With the Major 'V' Rally in the Rearview, What's Next?

Taking a historical look at how the S&P performs in the final two weeks of the year

Senior Vice President of Research
Dec 20, 2014 at 9:30 AM
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It was a volatile week of trading, but Wednesday's "patient" positioning by the Fed in regard to interest rates brought buyers to the table en masse -- and the Dow Jones Industrial (DJIA) within striking distance of record-high territory. With the major market indexes fresh off a major "V" rally, Schaeffer's Senior VP of Research Todd Salamone takes a good, hard look at what we can expect heading into the final two weeks of 2014.

  • 5 critical technical levels that showed their might in the "V" bottom, and 3 to watch going forward
  • The key role VIX open interest played in last week's price action
  • Despite a rough start to the month, Rocky White offers up some encouraging words for end-of-year bulls

Finally, we close with a preview of the major economic and earnings events for the week ahead, plus our featured sector.

Notes from the Trading Desk: Round-Number Resistance Levels are Back In Play
By Todd Salamone, Senior VP of Research

"... the IWM's close below the put-heavy 115 and 116 strikes enhances the possibility of delta-hedge selling. That said, a strong rally off the bottom of its short-term trading range could inspire short covering related to the expiring put open interest.

"Strong price action, positive December seasonality, and recent evidence of short covering and buyback activity that is usually robust at this time of year, are reasons not to disturb long positions ... we still have not lost sight of the fact that the 'higher volatility ahead' trade -- via the purchase of CBOE Volatility Index (VIX - 11.82) calls -- has deteriorated significantly in recent weeks ... Therefore, with VIX futures relatively low -- plus major equity benchmarks around the world trading near potential millennium resistance levels -- it might be prudent to add VIX calls as a portfolio hedge before something emerges that sparks renewed interest in the once-popular volatility trade."

- Monday Morning Outlook, Dec. 6, 2014

"After consecutive months in which 90% to 99% of VIX call options expired worthless, could this be the month that the few who stuck with the higher-volatility trade are rewarded with call options that expire with significant value? ... [S]ellers of VIX call options run the risk of a continued advance in volatility, so they may be looking to hedge this risk by buying VIX futures, which could drive volatility higher and stocks lower. December VIX futures closed on Friday at 19.58, just below December's peak call open interest. If the VIX surges above 23.64 -- double its recent low and December VIX futures move above 20, we could see another sharp increase in the VIX, especially if VIX call buyers suddenly surface again.

"With an FOMC meeting this week ... [s]tay tuned -- it should be an eventful expiration week."

- Monday Morning Outlook, Dec. 13, 2014

"$VIX settlement ($VRO) is 24.09... 67% Dec call options expire in the money after several months of 90-99% expiring out of money"

"Many $VIX peaks occur 50% above, or double/triple a key low. 12/5 closing low was 11.82- 12/16 closing high was 23.57 (23.64 double low)"

"After the $DJIA beat down from 18K, 17K supportive post #Fed - $MID held round 1,400 and $QQQ held $100 - round #'s still important"

-@ToddSalamone on Twitter, Dec. 17-18, 2014

The excerpts from our past two weekly communications -- along with the various real-time tweets from last week -- should give you an excellent summary of the volatility surge that we discussed as a possibility earlier this month, and the roller-coaster ride stocks have taken.

It was indeed an eventful expiration week, with the Federal Open Market Committee (FOMC) policy statement acting as the main catalyst for back-to-back 2% S&P 500 Index (SPX - 2,070.65) advances on Wednesday and Thursday.

The catalyst was the Fed's statement that interest rates would remain low for a considerable period, which inspired an unusual amount of short covering. Some of this was related to equity index puts that were due to expire at the end of the trading week, and a relative "boat load" of in-the-money CBOE Volatility Index (VIX - 16.49) calls that expired on Wednesday morning.

Those that sold VIX calls to portfolio-protection buyers were likely short an unusual amount of S&P futures and/or had an unusual amount of volatility futures in their inventory at expiration to guard against a continued rise in pre-Fed volatility, as delta-hedge selling gripped the market in the days leading up to the meeting. When the VIX calls expired Wednesday morning -- and there was little demand from VIX buyers to quickly replace the calls -- the long volatility/short S&P futures hedge, among sellers of portfolio protection, was unwound, leading to historical equity advances in a two-day period.

The timing for last week's catalyst -- the FOMC meeting -- was impeccable. Not only was the meeting scheduled on a VIX futures options expiration day, and during expiration week of equity and index options, but key indexes and equity benchmarks that we closely monitor were situated at important, potentially pivotal, levels. Consider:

  • The Dow Jones Industrial Average (DJI - 17,804.80), after getting rejected just shy of the 18,000 millennium mark earlier in the month, was trading less than 100 points above the 17,000 millennium level pre-Fed.

  • The S&P 400 MidCap (MID - 1,449.73) was trading around the round 1,400 level and its 200-day moving average ahead of the Fed meeting.

  • The PowerShares QQQ Trust (QQQ - 104.32) had pulled back to the 100-century mark the day before the Fed's statement.

  • Not to be forgotten, the SPX was in the vicinity of the round 2,000 level.

  • Finally, the VIX closed at 23.57 the evening prior to the Fed's announcement, just below 23.64, which marked a doubling of the Dec. 5 closing low of 11.82. We discussed the importance of 23.64 last week, and have on numerous occasions observed how the VIX will tend to peak at levels that are 50%, or double and triple important lows.
Daily Chart of VIX Since September 2014 With Line at Double the Early December Closing Low

The graph below displays the December open interest configuration of the SPDR S&P 500 ETF (SPY - 206.52) options, which just expired. The higher the put open interest (red bars) at the respective strikes, and the closer the underlying is to that strike during an advance in the market -- not to mention the closer to expiration of the options -- the greater the short covering. With the SPY trading in the 200 area ahead of the Fed's announcement, there was major short-covering potential on a well-received announcement.

By Friday, the SPY was far above most of the put strikes, with major call open interest strikes (green bars) coming into play at 207 and above. It appears that by late Friday afternoon, the 207 strike acted as a call wall. In fact, it may have been a big pay day for SPY premium, as the $206.52 close appears to be the maximum payoff for those selling put and call options, with the goal being for these options to expire worthless, as a huge majority did.

SPY Open Interest Configuration for December Series of Options

So, now that we have an explanation to what might have been behind the massive "V" rally, where do we go from here?

First, the second half of December has historically been bullish, so while the market may not benefit from expiration-related short covering like last week, momentum players or those short individual equities may be supportive, as they throw in the white towel to get a fresh start next year.

That said, just as many key equity benchmarks were trading around round-number century and millennium levels the day ahead of the Fed meeting, we are -- in the blink of an eye -- back in a situation like that of early December from a technical perspective, when round-number resistance areas were in play. For example:

  • The DJI comes into the holiday-shortened week just 200 points below the 18,000 mark, following an 800-point rally in just two days.

  • The Russell 2000 Index (RUT - 1,195.94) is trading just below the 1,200 century mark, which has acted as resistance on multiple occasions since March. The good news for small-cap bulls is that the RUT gapped above the 1,180 level on Thursday, site of short-term peaks in January and September.

  • The MID is just below the 1,450 half-century area, which has acted as resistance three separate times since it was first touched in early July. That said, the neckline of an inverse "head-and-shoulder" formation is at 1,450-1,460, and a breakout would be bullish, targeting a 12% move to 1,640 in the five months after such a breakout.
Daily Chart of MID Since January 2014 With Line at 1,450
Chart courtesy of StockCharts.com

A few weeks ago, we observed the turn in the 10-day, buy (to open) put/call volume ratio as a risk to the bullish case. In hindsight, this was a risk well worth acknowledging. While this ratio is not near the July or September extremes, it is near extremes in 2013 and early this year that marked key turning points.

If you are a risk taker, you might forego a portfolio hedge with the VIX still considerably above its 2014 lows, suggesting portfolio insurance is relatively expensive. A roll-over in this ratio from the current high level would likely have bullish implications. Our gut is a roll-over is in the cards with the "V-bottom" the market just experienced, and with seasonality now bullish for the next few weeks, a breakout above resistance could be imminent.

That said, if you tend to be cautious, respect that round-number resistance lingers overhead and the buy (to open) put/call volume ratio (first chart below) is still rising. Moreover, an added risk to bulls is the extremely low call open interest on the VIX (see second chart below) and the fact that almost 25% of outstanding SPY puts just expired. This would imply that hedging activity remains low, which was also the case earlier this month preceding a 5% pullback. The one difference between now and early December, however, is that portfolio insurance was cheap and should have been bought, whereas now it is relatively expensive. But the bottom line is unhedged longs are more prone to panic on negative news, which is perhaps a risk worth noting.

Equity Option Speculators -- Pessimistic Extreme?

ISE, CBOE, PHLX 10-day, equity-only, buy-to-open put/call volume ratio with SPX since 2013

Extremely low level of VIX call open interest -- VIX doubled last time open interest was this low

VIX Daily Open Interest since January 2014
Chart courtesy of Trade-Alert

Indicator of the Week: Holiday Weeks
By Rocky White, Senior Quantitative Analyst

Foreword: A couple of weeks ago, I showed a chart of the average S&P 500 Index (SPX) December over the past 50 years. It revealed the SPX averages a flat return through the first half of the month, but then spikes higher in the last two weeks. Below is that chart juxtaposed against this December so far.

We had a rough start to the month, but the rally last week happened right when expected. The next two weeks are holiday weeks, and as you can see in the chart, they are typically pretty strong. I'll break down these holiday weeks a little further and look into how stocks typically behave around Christmas and New Year's.

SPX Average December 2014 vs Last 50 Years

Holiday Weeks: The tables below show the SPX returns during Christmas week and New Year's week since 1950, and then over the last 20 years. As we saw in the chart above, these have typically been good weeks for the market. Since 1950, the SPX 500 has averaged a gain of 0.63% for each holiday week, with 68% of them positive. The typical week since 1950 averaged a gain of 0.14%, and was positive 56% of the time.

I also included the average positive and negative returns. Going back to 1950, Christmas week has tended to have very low volatility. The average gain and loss are smaller in magnitude when compared to other weeks, especially to the downside, with an average negative return of just 0.76%. Looking at the more recent time frame of just the past 20 years shows New Year's week was less volatile than the week of Christmas.

SPX Last 20 Years and since 1950 During Holiday Weeks

Surrounding Days: These next two tables show how the SPX has performed in the days immediately before and after the holidays.

The first table shows the days surrounding Christmas; the last column shows the typical return for a day. It's notable that over the past 20 years, every single day from two days before Christmas to two days after has averaged a stronger-than-usual return, and has been positive a higher percentage of the time than typical days. As you might expect, the days around the holidays show less volatility than normal, as measured by the standard deviation of returns.

SPX Last 20 Days Surrounding Christmas

Finally, below are the days surrounding New Year's Day, which aren't quite as bullish. New Year's Eve (or the last trading day of the year) has averaged a loss of 0.17%, and has been positive just 35% of the time over the past 20 years. The first trading day of the year boasts a very good average return, but has been positive just half the time. Also, it's interesting that the first two days of the new year have been more volatile than the typical day for the market, according to the standard deviation of returns.

SPX Last 20 Days Surrounding New Years

This Week's Key Events: GDP in Focus During Holiday-Shortened Week
Schaeffer's Editorial Staff

Here is a brief list of some key market events scheduled for the upcoming week. All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.


  • The holiday week kicks off with existing home sales. There are no notable earnings on tap.


  • On Tuesday, durable goods, the final reading on third-quarter gross domestic product (GDP), personal income and spending outlays, the Thomson Reuters/University of Michigan consumer sentiment index, and new home sales are all scheduled for release. Cal-Maine (CALM), CalAmp (CAMP), Walgreen (WAG), Piedmont Natural Gas (PNY), and China Finance Online (JRJC) will step into the earnings confessional.


  • With markets shuttered Thursday for the holiday, weekly jobless claims will come out on Wednesday. Also set for release is the regularly scheduled crude inventories update. Markets will close at 1 p.m. ET for Christmas Eve. There are no major earnings reports on the docket.


  • Markets will be closed on Thursday for Christmas Day.


  • Friday's economic and earnings calendars are empty.

And now a sector of note...


The retail sector has been in the headlines recently, with holiday shopping season getting into full swing. In fact, November retail sales figures topped expectations, and the SPDR S&P Retail exchange-traded fund (ETF) (XRT) touched a record peak of $95.64 on Thursday. The shares are currently sitting atop several layers of previous resistance, including their year-to-date breakeven mark of $88.10, and $90.12 -- a 10% premium to XRT's mid-October closing low of $81.93. What's more, the round-number $90 level is significant, as it's roughly double the ETF's 2007 and 2010 resistance level at $45, and could now reverse roles to act as support.

Digging deeper, nearly two-thirds of the 72 retail stocks we follow are trading above their 80-day moving average. Nevertheless, the typical short interest-to-float ratio among these equities exceeds 12%, which would take more than a week to cover, given average daily trading volumes. Also, fewer than half of the brokerage firms covering these names have handed out "buy" ratings. All things considered, retail stocks could be poised to run higher on potential short-covering activity and/or a round of analyst upgrades. In the short term, keep an eye on November personal income and spending data -- set for release on Tuesday -- which could impact the retail sector.

Weekly Chart of XRT since January 2007

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