The 'Call Wall' We're Watching for SPY This Week

A recent candlestick doji and glut of open SPY calls are on our radar for the days ahead

Senior Vice President of Research
Mar 2, 2015 at 8:37 AM
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"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 ... From a technical perspective, the march to 5,000 is not taking on the 'bubble-like' parabolic move that it did 15 years ago ... 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."
-- Monday Morning Outlook, February 23, 2015

The Nasdaq Composite (COMP - 4,963.53) continued to grind higher last week, but the celebration remains on hold, as the high last week was 11 points shy of the 5,000 millennium mark. As most of you know, this level has not been touched since March 2000 (although, for some of us, it may seem like only yesterday).

So, after closing out February on Friday, we enter the month of March. Perhaps it is fitting for this index to revisit the 5K millennium mark for the first time in 15 years in the month of March once again, but -- hopefully, for bulls -- with different results. In March 2000, the 5,000 area essentially marked the beginning of the end. As we discussed last week, we aren't seeing near the speculative froth that was evident ahead of the bubble's burst 15 years ago. While 5,000 could act as resistance in the near term, it is less likely that 5,000 marks a major top, as it did in 2000.

Moreover, on Wednesday, the COMP ended a 10-day winning streak. Historically, after a long winning streak like this ends, the COMP quickly picks up where it left off. This suggests a higher-than-normal probability that 5,000 will not only be touched this month, but we could see the index advance well above, if historical tendencies play out. For more on this, review "Indicator of the Week: Nasdaq Hot Streaks," by our Senior Quantitative Analyst Rocky White.

30-Minute COMP Chart since Feb. 9, 2015

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

"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 ... 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."
-- Monday Morning Outlook, February 23, 2015

With round numbers cleared on many indexes, the Fed indicating a rate hike is not imminent, and a little uncertainty related to Greece lifted last week, we are seeing indications that some market participants have become more constructive on the market -- specifically, option speculators and hedge funds.

The good news for bulls is that these participants were in caution mode previously, so they could be in the early stages of increasing equity exposure, which would be supportive of the market during the coming weeks.

For example, in the Commitment of Traders (CoT) report -- which comes out weekly, with the latest data being reported as of Feb. 24 -- there is evidence that large speculators (typically, hedge funds) are again shorting CBOE Volatility Index (VIX - 13.34) futures. In other words, they are again betting on lower volatility, although the number of short positions is relatively small. If shorting of VIX futures continues, it would be a coincident tailwind for the S&P 500 Index (SPX - 2,104.50).

As this group shorts VIX futures, call buying on VIX futures has increased -- perhaps as hedges to those short VIX futures positions, or to long equity positions being initiated. But while VIX call volume has increased relative to January, when the market struggled, it still remains lackluster overall. This relatively tepid VIX call volume might indicate that only a few hedge funds are becoming constructive on stocks. For bulls, the prospect that more of these managers will increase their equity exposure in the weeks ahead is encouraging.

CoT VIX Futures Positions: Large Speculators Back to Net Short

CoT VIX Futures Positions: Large Speculators Back to Net Short

Also, we are seeing an increasing number of bought-to-open put positions being initiated, relative to calls, on key equity exchange-traded funds (ETFs) -- such as the SPDR S&P 500 ETF Trust (SPY), iShares Russell 2000 ETF (IWM), and PowerShares QQQ Trust (QQQ). To the extent that some of this put activity is related to hedging as stocks are accumulated by hedge funds, it would further suggest that these market participants are in the beginning stages of accumulating stocks once again, which could prove supportive in the weeks ahead.

The graph below reflects the increasing put activity relative to call activity on these equity-based ETFs, which also includes SPX options. Our theory is that when this ratio is turning higher amid higher stock prices, hedge funds are in accumulation mode. And when the ratio turns higher from a low level, as it is now, strong advances usually follow, as the accumulation is in its early stages.

Put buying strong relative to call buying on major equity ETFs and SPX -- hedge funds in accumulation mode?

SPX-SPY-QQQ-IWM 20-day put-call ratio since 2013

Looking ahead to next week, there is a plethora of economic data due out, beginning with today's reports on personal income and spending, the Institute for Supply Management's (ISM) manufacturing survey, and construction spending, and concluding with February's employment report on Friday.

If the market rallies strongly, one potential area of resistance is 215 on the SPY, which -- as you can see on the chart below -- is home to more than 130,000 call contracts for the 3/6 weekly option series. We point this out because last week, the peak was around the 212 level, which for most of the week represented the peak call open interest in the 2/27 weekly option series. In other words, the 212 strike proved to be a "call wall." As we move into this week, the notable call wall is at the 215 strike.

One short-term risk we see is that on Wednesday, the SPY experienced a candlestick "doji," in which the open and close were nearly the same. Such candlesticks will sometimes indicate increasing risk of a reversal. So, from this perspective, bulls beware. If recent support from the SPY's 10-day moving average at 210.79 is broken, look for a move back to the December highs in the 209 area.

In fact, in looking at each expiration series through mid-April, the SPY 3/6 weekly option expiration series has the lowest ratio of put open interest to call open interest. From this perspective, this suggests that there is more optimism than usual for the immediate days ahead, which may put the market more at risk of an early March pullback within the context of our bullish bias for the month ahead.

SPY Open Interest Configuration for 3/6 Weekly Expiration

SPY Open Interest Configuration for 3/6 Weekly Expiration

Read more:

Indicator of the Week: Nasdaq Hot Streaks

The Week Ahead: All Eyes on Jobs Data


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