“For what it is worth, we saw multi-year highs in optimism among equity option buyers coming into 2018 and 2020… Equites did not fare well in the first quarter of those years.”

          -Monday Morning Outlook, Jan. 4, 2021

“…the 10-day, equity-only, buy (to open) put/call volume ratio hit an extremely low reading of 0.32 last week for the third time since early September.  When this ratio hit 0.32 on September 2, the SPX was trading nearly 10% lower three weeks later. The ratio hit an extreme low of 0.32 again on December 17, and the SPX was flat three weeks later.”

          -Monday Morning Outlook, Jan. 25, 2021

As the S&P 500 Index (SPX—3,714.24) has grinded out for weeks, carving out all-time highs along the way, I have been warning about the growing optimism that we are seeing, whether it was among option buyers or active investment managers. In fact, with respect to options buyers, I have been signaling caution since early December, but the SPX’s momentum continued higher. 

Therefore, what occurred last week with respect to the SPX’s decline, cannot be a huge surprise, as it was only a matter of when, in terms of the broad market showing cracks in its technical backdrop, as trader optimism hit multi-year extremes. 

Admittedly, however, the surprise might be what caused the SPX to backpedal as much as it did. In other words, it was not a specifically Covid-related, stimulus-related, or a Federal Reserve headline that sparked a sell-off. 

“... a first level of potential support remains in the 3,745-3,756 area, which is the site of last year’s close… it might take a move into the red, relative to last year’s close, or a sign that momentum could finally be swinging the other way -- using the 30-day moving average as a guidepost -- for the growing bullish crowd to hit the brakes.”

          - Monday Morning Outlook, Jan. 25, 2021

In fact, the SPX broke below the first level of support that I mentioned last week, as seen in the excerpt above (I should add that it broke below a trendline connecting higher lows since mid-November, when well-received vaccine trial news began positively impacting equites).

In fact, on Friday, the SPX traded as low as the early December level, which is when I first began cautioning about the optimism creeping into the market that made equities more vulnerable than usual to pullbacks. 

What was the cause of the SPX’s decline? It was attributed to a coordinated effort of a social network community that focused on buying low-dollar, small-cap, heavily shorted names. These actions squeezed hedge funds, which were heavily shorted names such as GameStop (GME), Bed Bath & Beyond (BBBY), BlackBerry (BB) and AMC Entertainment (AMC) to name just a few.

So coordinated buying generated a sell-off? Judging by the stocks that rallied and the stocks that plummeted last week, the footprint looks like forced liquidations of crowded long-short pair trades among hedge funds. It appears hedge funds were forced to raise cash by selling long positions to buy back those equites that they borrowed to sell short. For example, heavily shorted Shake Shack (SHAK) -- which hosts a market cap of less than $5 billion -- rallied strong on Wednesday. McDonalds (MCD) -- sporting a market cap of more than $150 billion -- declined that day. A scenario like this would suggest a pair trade unwind in the restaurant group.

And to those that have been reading this commentary since December, what transpired last week should not come as a major surprise either. Since this period, I have been advising that the biggest opportunities reside in the small-cap space, due to the short-covering potential relative to components of the SPX that have already benefitted from short-covering rallies as the economy slowly re-opened after lockdowns in March.

A technical theme that I heard on CNBC on Friday was that the SPX was holding its 50-day moving average, which comes into the new week and month at 3,716. With many retail investors participating in the market and this moving average being so popular, this might be a level to watch. Additionally, the round 3,700-century mark is also key looking forward, which was in play from early December into early January, as the SPX traded sideways in this area before resuming its uptrend.

The Russell 2000 Index (RUT—2,073.64), which I have been more bullish on than the SPX, was not immune to the decline last week. In fact, I find it interesting that the pullback in the RUT last week started from its closing high on Jan. 22 of 2,169, which is just seven points shy of the 2,176 level that is exactly 50% above its September closing low. However, unlike the SPX, it comes into the week still trading above its 2020 close at 1,975, but below its 20-day moving average that acted as support in early January.

“I find it interesting that the mid-December peak was at the VIX’s 252-day moving average. A move above this longer-term moving average in late-January 2020 hinted at major trouble ahead for stocks in February-March and another move back above this trendline in mid-October tipped off a two-week pullback in equities…”

- Monday Morning Outlook, Jan. 25, 2021

The surge in the CBOE Market Volatility Index (VIX— 33.09) caught my eye last week, especially after comments that I have been making in respect to recent highs in the VIX, occurring at its 252-day moving average.

Per an observation that I made on Twitter last week, the VIX pattern since December is eerily like last year’s December-January period. In fact, it was on Jan. 27 in both 2020 and 2021 that the VIX finally surged above this trendline. 

Last year, the move above the 252-day moving average eventually signaled upcoming volatility as Covid-19 concerns and then lockdowns sparked a massive decline in equities in February and March. 

Stay tuned as to what, if anything, last week’s surge above this trendline will mean for stocks in the weeks ahead. If you were not already in caution mode due to the sentiment-based risk that I have identified, consider the VIX’s move as the newest emerging threat to bulls.

If the VIX continues to advance, but the advance is muted relative to last year, consider the 41 (double the December low) and 45.50 (double the 2020 close) as potential peak levels.

I advised weeks ago to hedge the sentiment-based risk while options were cheap, as measured by the VIX. Last week is a good illustration of why. By the time there is evidence of technical damage to the market, options become more expensive, making hedging more expensive.

Lastly, if you are looking to add puts to your options portfolio, focus on the large-cap stocks.

Todd Salamone is Schaeffer's Senior V.P. of Research

Continue reading:

• The Week Ahead: February Kicks Off With Plenty of Economic Data, Earnings.
• Indicator of the Week: What This "Super Bowl Indicator" Says About Market Randomness

investors will be kept extremely busy in regard to both economic data and earnings reports this week. Concerning the former, this week begins strong with manufacturing data and housing vacancies. Heading into midweek, there's plenty of unemployment data to unpack, alongside the latest batch of the regularly anticipated initial and continuing jobless claims. Closing out the week this week, a plethora of data will be reported, including nonfarm payrolls and average hourly earnings. 

The long list of earnings reports for this week includes Alibaba (BABA), BP (BP), Capri Holdings (CPRI), Exxon Mobil (XOM), and Spotify (SPOT), alongside FAANG names Alphabet (GOOGL) and Amazon (AMZN).

Today kicks the new week off with a bang, as the final Markit manufacturing Purchasing Manager's Index (PMI) is due out alongside the ISM manufacturing index and motor vehicle sales.

The following companies are slated to release quarterly earnings reports today, February 1:

Looking ahead to tomorrow, things slow down a bit with just housing vacancies on the docket alongside a slew of earnings reports. All economic dates listed here are tentative and subject to change.

It was a wild week on Wall Street, with GameStop (GME) at the center of the action. Concerns about speculative trading began on Monday, while the Nasdaq Composite (IXIC) hit a record high thanks to Big Tech earnings. The packed earnings session continued into Tuesday, though stocks finished the day muted after the S&P 500 Index's (SPX) record high. Wednesday is when everything seemed to hit the metaphorical fan, with the U.S. stock market becoming an international conversation piece. Heavily shorted GME and AMC Entertainment (AMC) soared thanks to online chatter via Reddit, while the broader market plummeted -- the Dow Jones Industrial Average (DJI) closing over 630 points lower Wednesday evening. Meanwhile, the market's "fear gauge" -- the Cboe Volatility Index (VIX) -- saw its biggest single-day pop since 2018. 

Thursday, investors celebrated upbeat earnings reports from major tech names, while investors' attention remained on the Reddit-fueled speculative trading frenzy. Several online brokerage firms, including Robinhood and Interactive Brokers, began restricting trading on several stocks, including GME, drawing criticism from lawmakers. By Friday, blue-chip Johnson & Johnson's (JNJ) vaccine update weighed on the market, while "Robinhood vs. Reddit" remained in the spotlight. Robinhood allowed limited buying of restricted stocks at the end of the week, while the Securities and Exchange Commission (SEC) announced it would investigate the online brokerage firm's actions. With stocks continuing to crumble on Friday, all three benchmark's are eyeing weekly losses. 

Vaccine Stocks in the Spotlight

Though coronavirus vaccines from Moderna (MRNA) and Pfizer (PFE) are being distributed throughout the world, there is still an open faucet of news out of the pharma sector. Merck & Co (MRK) abandoned its vaccine program after generating inferior immune responses, but will instead focus on treatments for the virus. At the beginning of the week, Johnson & Johnson (JNJ) was lifted to record highs after earnings, however, by Friday the blue chip dipped after its vaccine update. Conversely, Novavax (NVAX) soared on the same day, with J.P. Morgan Securities calling its vaccine as "best-in-class" among other candidates. On a semi-related note, options traders flocked to Biogen (BIIB) stock, after the Food and Drug Administration (FDA) extended the review period for its experimental Alzheimer's disease treatment. 

Earnings Season Continues

Earnings season is still in full swing, with plenty of big-name reports to digest. Before Apple's (AAPL) big earnings beat, the stock hit record highs at the start of the week. On Tuesday, both General Electric (GE) and Raytheon Technologies (RTX) jumped higher after their fourth-quarter reports. Wednesday was a bizarre day for earnings, as the broader market's headwinds left some stocks with unexpected losses -- despite upbeat reports. AT&T (T) saw plenty of options volume after earnings, while Texas Instruments (TXN) and Starbucks (SBUX) received an array of price-target hikes. Meanwhile, VF (VFC) veered lower after mixed quarterly results. Later in the week, Southwest Airlines (LUV) and blue-chip Caterpillar (CAT) reported their fourth-quarter earnings as well. 

A Look at Next Week's Earnings Excitement

Earnings season will continue next week, with reports from Alibaba (BABA), BP (BP), Capri Holdings (CPRI), Exxon Mobil (XOM), and Spotify (SPOT) on the docket. Also set to report are FAANG names Alphabet (GOOGL) and Amazon.com (AMZN). After manufacturing data and housing vacancies, there's plenty of jobs data to unpack as well. In the meantime, see what Schaeffer's Senior Quantitative Analyst Rocky White has to say about the "Super Bowl indicator" and the pitfalls of plausible-sounding theories. 

President Biden was sworn in last week, thankfully without much fanfare. The immediate necessities of curbing the Covid-19 pandemic take centerstage, but many investors are intrigued by some of Biden's longer term climate change goals. Already in the first week, Biden has reversed Trump administration environmental and energy regulations, while rejoining the Paris Climate Agreement. The new administration has lofty $2 trillion goals to fight climate change, and that includes a heavy investment in solar and hydrogen economies.

That means stocks such as Plug Power Inc (NASDAQ:PLUG) and First Solar, Inc. (NASDAQ:FSLR) could stand to see some legislative tailwinds in the coming years. Shorter term, both PLUG and FSLR are two of Schaeffer's top 2021 picks in the alternative energy space.

PLUG has had a historic year, scoring a 1,553% year-over-year gain. That's not a misprint. And if the COVID-19 vaccine sends oil prices higher in 2021 -- as the economy reopens and demand increases -- the security may become even more popular, with investors quickly moving into renewable energy stocks as U.S. consumers experience sticker shock after a long period of low gas prices.

While Plug Power stock is currently trading below record levels, the shares broke out above multi-year highs in August, when the security rallied past potential resistance at the $12 level – the site of its 2011 and 2014 peaks.

A short squeeze could fuel additional gains for the security going into 2021, too, as this year’s positive price action did very little to convince shorts about the company’s growth prospects. In fact, short interest hit a multi-year high halfway through November, and the 66.53 million shares sold short account for a whopping 28.9% of the stock’s available float.

FSLR also emerged as a strong performer in 2020 and closed out the year with a 61.3% year-to-date gain. Even better news is that the stock is already bouncing off its 50-day moving average. What’s more, declining short interest has acted as a tailwind since the security’s March 18, three-year low of $28.47. And given that 8.9% of the stock’s available float is still sold short, traders are likely to continue hitting the exits going forward. In fact, short interest has already dropped 3.5% during the past two reporting periods.

Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, January 24.

The shares of blue-chip heavy machinery manufacturer Caterpillar Inc. (NYSE:CAT) are inching higher this morning, up 1% at $186.20 at last check, after the company reported fourth-quarter earnings of $2.12 per share, which easily cleared Wall Street's estimates. Revenue for the fourth quarter, meanwhile, also topped forecasts. The company cited strong liquidity and said it was well positioned to emerged from the pandemic even stronger, though it declined to provide guidance for the current year. 

The stock looks to be recovering nicely from the bear gap it suffered during Wednesday's broad-market selloff, with the 60-day moving average acting as support. The security is now testing the 30-day moving average after two consecutive closes below the trendline. And while it has a ways to go before reclaiming its Jan. 13, all-time peak of $200.17, CAT still boasts a 12-month return of 37%. 

Analyst remain cautious, with 11 of the 17 in coverage calling Caterpillar stock a "hold" or worse. Plus, the 12-month consensus price target of $190.45 is a slim 2.9% premium to current levels. 

Despite today's earnings report, options on Caterpillar are still reasonably priced. This is per the equity's Schaeffer's Volatility Index (SVI) of 39% which stands higher than 20% of readings from the past year, suggesting option traders are pricing in relatively low volatility expectations at the moment.