Headlines have driven sharp intraday movement, though net directional movement has been limited
"Given the heavy put open interest around current SPY levels, and the other major technical levels also in play, we could be in store for another few weeks of volatile daily movements that result in little net movement..."
-- Monday Morning Outlook, April 2, 2018
As I speculated in last week’s report, the Monday-Friday action in the stock market was comprised of volatile daily movements, but this week there was a downside bias, undoing the upside bias of the prior week. It is a market clearly being driven by headlines -- specifically, words emanating from President Donald Trump or key Chinese officials -- that transpires into sudden and sharp intraday movement. However, since these words have amounted to no actions thus far, there has been little net directional movement.
President Trump and China are volleying threats via proposed trade tariffs. In addition, the president began last week by hurling another shot at Amazon (AMZN), sending ripples throughout the technology sector as fears of regulation moved front-and-center. But nothing has been done on additional technology regulations up to this point, and as Larry Kudlow, the president’s chief economic adviser, has reminded us, proposed tariffs are just that -- proposals -- as the U.S. and China have not begun negotiations.
Below, the 30-minute chart of E-mini SPX futures last week -- which includes trading outside the New York open and close, in addition to regular trading hours -- gives you a perfect glimpse into investors’ sensitivity to headlines. In fact, the S&P 500 Index (SPX - 2,604.47) was trading at or just below a resistance area that I have been discussing these past few weeks immediately prior to multiple nosedives last week.
For example, S&P futures were trading in the 2,650 area late Friday morning, but they plunged immediately after President Trump’s Twitter post accusing the World Trade Organization (WTO) of being "unfair." Other sharp declines were related to new tariff proposals by Trump and counter-proposals by China. Meanwhile, rallies were related to headlines about White House officials attempting to soothe investors by pointing out that the "trade war" has been all about words and no actions.
Last week was indeed one of much daily volatility, but with little relative movement. For example, if you add up the absolute points gained or lost in last week’s five trading days, it amounted to nearly 200 SPX points. However, the net move was only 36 SPX points week-over-week. Again, very little direction amid big daily moves.
"[M]ultiple resistance levels now lie overhead, which reduces the appeal of stocks at this moment. For example, there is the SPX 2,650 level that gave it trouble last week on rally attempts, and the year-to-date breakeven level at 2,673 that acted as support in early March but could now act as resistance on rallies.
"...[T]he SPX comes into the week sitting near the round 2,600 level, which is also an area that is: 1) 10% below the 2018 high; 2) site of its 200-day moving average; and 3) home to a trendline connecting higher lows since this time last year. No doubt, we enter the week at a major pivotal level.
"...If the market falls below the aforementioned support, those who bought around these levels last month are prone to sell, and this could help fuel a further delta-hedge sell-off down to SPX 2,450."
-- Monday Morning Outlook, March 26, 2018
Despite a few treks below 2,600 last week that hit lows around the half-century mark of 2,550, the SPX managed to close around support at 2,600. Therefore, we have come full circle to where we were two weeks ago, with the SPX entering this week's trading just above a major support area.
The lows in the 2,550 area were interesting not only from the perspective of it being a half-century mark, but 2,550 is equivalent to the 255 strike on the SPDR S&P 500 ETF Trust (SPY - 259.72). I looked into the make-up of the option activity at this strike in the past several weeks, and found that sell-to-open put activity was predominant at the put-heavy SPY 255 strike.
The implication is that those who bought the 255-strike puts to make a market are likely buyers of S&P futures as the SPY approaches this strike, if indeed they have to remain delta-neutral. In other words, because the 255-strike put option becomes more sensitive to the underlying SPY’s movement, the market maker needs to be long more S&P futures as the SPY approaches that strike.
Therefore, as we look ahead to the next couple of weeks, the SPX 2,550/SPY 255 area becomes an important support zone if SPX 2,580-2,600 (SPY 258-260) breaks again on an intraday basis. This half-century region is supportive not only from an options-related perspective, but also a chart perspective, after the index carved out lows in this area in early February and again last week.
If the 2,550/250 levels break and momentum selling takes over, there is another heavy put strike at the SPY 250 level. Much of this open interest was sold to open, too, implying it is likely to be supportive. However, if the put sellers at this strike panic and opt to close their positions (which I would find to be unusual), this would fuel massive selling as the unwinding of these trades would spark selling of S&P futures. This concept applies to the SPY 255 strike, as well.
Expect more of the same -- headlines generating sharp daily movements, but solid support and resistance levels above and below keeping a volatile range environment intact. Volatility pops should create index premium-selling opportunities, but be aware that if the Cboe Volatility Index (VIX - 21.49) closes above 25.15, half its 2018 intraday high, even higher volatility could be ahead, which would make it difficult for bulls.
The big daily swings also generate nice day-trading opportunities, in line with the advice last week about shortening your time frame to profit from the added day-to-day volatility.
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