A Bullish Sign as COMP Revisits Tech-Bubble Highs

The COMP is closing in on 5,000 again, and we're keeping an eye on VIX call volume levels

Senior Vice President of Research
Feb 23, 2015 at 7:55 AM
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"After the SPX breakout above its 2014 close, many indexes -- including the SPX -- now face another potential short-term hurdle from round-number levels, including 18,000 on the Dow Jones Industrial Average (DJIA - 18,019.35) ... From a short-term perspective, however, note that the round 1,500 level is now in play for MID ... Small-cap investors would like to see the RUT finally make a noticeable break above the 1,200-1,220 area, which has turned back all rallies since March 2014.

"... Why is the fact that large speculators are net long, according to the Commitment of Traders (CoT) report, making a lot of noise? ... since the financial crisis, it has been a rare event for these investors to be net long, or looking for higher volatility. In fact, since 2011, it has happened on only three occasions...In the few instances that this has happened, volatility headed lower or rose modestly over the next two months, while stock prices (as measured by the SPX) soared."

-- Monday Morning Outlook, February 16, 2015

If you tend to view the glass as "half full" instead of "half empty," you should be encouraged by last week's holiday-shortened, expiration-week price action. The S&P 500 Index (SPX - 2,110.30), after breaking out above resistance around 2,060 earlier this month, took a breather around the round 2,100 level -- as we suggested in last week's report could occur, especially with other key benchmarks trading around respective round numbers, too. The optimist would note that an immediate sell-off did not occur, as the index went sideways, with Friday's lows of the week occurring at the uptrending 10-day moving average (currently located at 2,083.26).

SPX Year-to-Date (YTD) with 10-Day Moving Average

SPX Year-to-Date with 10-Day Moving Average

Moreover, call open interest was nearly three times that of put open interest at the February 210 strike on the SPDR S&P 500 ETF Trust (SPY - 211.24), which is roughly one-tenth (1/10) the value of the SPX. Those options expired on Friday. Therefore, round numbers and a "call wall" at SPY 210 likely influenced the sideways pattern that we witnessed throughout most of the week -- which, for bulls, was better than a violent rejection from this area. The call wall was penetrated late Friday afternoon on positive news with respect to the Greece situation in Europe.

SPY Open Interest, Standard Feb. 20 Expiration
"Call wall" at 210 strike acted as resistance until late Friday

SPY Open Interest, Standard Feb. 20 Expiration

But the bears and those waving caution flags may be feeling more and more pressure. The S&P MidCap 400 Index (MID - 1,516.84) has now closed above potential resistance at 1,500 for five consecutive days. While MID hasn't made a huge move through 1,500, neither have sellers made a bold statement at this level.

Moreover, the Russell 2000 Index (RUT - 1,231.79) finally moved into new all-time high territory this past week, taking out the 1,220 area that has capped rallies since March 2014. While the RUT hasn't taken on a leadership role, it is no longer lagging like it did throughout much of 2014, which gave some market watchers reason to wave the red flag.

"At its peak, technology stocks represented 70% of the [Nasdaq Composite], today they are 55%. Healthcare now makes up 15% of the index, up from just 5% in 2000. Today the dividend yield on the index is 1.1% which is one thousand percent higher than it was just a decade ago."
-- The Irrelevant Investor on Yahoo Finance, February 19, 2015

One sector displaying clear leadership is technology, as measured by the Nasdaq Composite (COMP - 4,955.97). This index is up more than 4% in the first two months of the year and, on Wednesday, cleared 4,900. Barring a pullback back below 4,900, the next major round-number area is 5,000, which hasn't been touched since the technology bubble burst in 2000. From a technical perspective, the march to 5,000 is not taking on the "bubble-like" parabolic move that it did 15 years ago, and as described in the tweet above.

Another way to quantify the difference in today's technical backdrop is by measuring historical volatility. The COMP's 10-month historical volatility in March 2000 was a whopping 38%, whereas now it is slightly below 10%. The bottom line is that investors seem to be accumulating technology stocks at a much more measured pace, in contrast to the aggressive pace that preceded the bubble.

Despite the COMP's march to levels not seen in 15 years, technology names seem to have lost their appeal among investors and traders. Whereas you cannot trade options on the COMP, note that open interest on the PowerShares QQQ Trust (QQQ - 108.41) options, an exchange-traded fund (ETF) with a heavy technology tilt, has imploded over the years.

The QQQ debuted for trading in early 1999, so option activity was relatively light in the early years. But open interest on the QQQ exploded as the fund clawed its way out from a bear-market bottom. Once total call and put open interest reached about 10 million contracts, disappointing sideways action emerged.

Plus, there was record open interest of 12-13 million contracts on this ETF ahead of the 2007-2008 peak. Right now, there are barely 3 million put and call contracts open on the QQQ. This would suggest that interest in the technology sector has cooled considerably, which could have bullish implications, even as the QQQ and COMP approach old highs.

Total Call and Put Open Interest on QQQ Options

Total call and put open interest on QQQ options

As is evident by the latest Commitment of Traders (CoT) report, it appears large speculators (typically, hedge funds) continue to cover their bets on declining volatility, as they also continue to reduce short positions on CBOE Volatility Index (VIX - 14.30) futures. The short covering has created a net long position among VIX futures players, and this long position has grown, per the latest CoT report.

CoT Net VIX Futures Positions (Large Speculators) since February 2010

CoT Net VIX Futures Positions (Large Speculators) since February 2010

The nervousness among these players may be related to any number of factors, including uncertainty overseas. However, in the minutes ahead of Friday's close, markets rallied as Greece was granted a four-month bailout extension by its European creditors. It is possible that the late news out of Europe generates a change in the views among this group, and shorting of VIX futures takes hold again.

VIX 30-Minute, Feb. 17 - Feb. 20, 2015

VIX 30-Minute, Feb. 17 - Feb. 20, 2015

With the VIX below the 15.53 level -- half its October 2014 high -- aggressive speculators could make short-term bets on declining volatility in the days ahead, on the heels of the four-month extension granted to Greece. A pickup in VIX call volume, indicative of hedging related to growing short volatility futures positions or an increase in equity exposure, would signal that a volatility decline is imminent. So, we will be monitoring VIX call volume closes in the days ahead, looking for daily volume of 500,000-plus.

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