"A full-fledged V-rally would push the SPX back to highs in the 2,950 area, but during the next two weeks -- up until June standard options expiration -- the SPY must first overcome peak call open interest at the 290 strike, which is equivalent to SPX 2,900. Many of the SPY 290-strike calls were bought to open, which means this strike could be a magnet like the put-heavy strikes, and a move through the 290 strike could generate additional futures buying as the call sellers look to hedge."
-- Monday Morning Outlook, June 10, 2019
The S&P 500 Index (SPX - 2,950.46) completed a two-month round trip since achieving an all-time closing high in late April. Following its 6.5% decline in May, it has rallied by about 7% this month, pushing it barely above its highs in September 2018 and April 2019.
Macro headlines with respect to the Fed and darkening trade tensions pushed stocks south in May, but positive headlines on both fronts in June "undid" what was done last month.
In fact, per above, a Tuesday tweet from President Donald Trump got the ball rolling to the upside, early during options expiration week. After stalling the previous week at the call-heavy 290 strike, the SPDR S&P 500 ETF Trust (SPY - 294.00) burst through this level after the tweet was perceived as positive progress on trade. Given it was expiration week, the move may have been exaggerated somewhat by the options market, as those shorting the 290-strike call were likely forced into buying S&P futures to hedge -- generating a nice upside gap and "breakout" above the previous week's highs.
Dovish comments after the Federal Open Market Committee (FOMC) meeting on Wednesday pushed the SPY to the last heavy call open interest strike at 296, which again acted as a magnet, as those short the calls were forced to buy S&P futures to hedge a big move through this strike. Unsurprisingly, based on the open interest configuration graph below, the expiration-week rally peaked at this strike, as there were no more catalysts and no more call open interest magnets immediately overhead on the SPY.
For example, after the FOMC held interest rates steady in early May amidst deteriorating trade relations with China, market participants were looking for Fed Chair Jerome Powell to indicate the possibility of a future interest rate cut. He did anything but, as he opined that inflation would return to 2% over time on the back of a strong job market and continued economic growth. This mindset unnerved investors, sending stocks sharply lower shortly after a break into new all-time high territory.
Fast forward to last week, when the Fed again remained on hold -- but Fed members, including Chairman Powell, indicated rate cuts could be coming due to the impact of continued trade uncertainties weighing on the economy and slowing global economic growth. In other words, the Fed "pivoted" from its stance of pausing on future rate hikes to giving a strong indication that a rate cut was in the near future, effectively cheering investors who sold stocks in May on fears that the Fed might be too late in responding to the ill effects of a trade war.
While options expiration week likely played a role in the bullish action last week, the open interest at these call strikes was not near the levels of put open interest that tend to build from month to month. In other words, the magnet effect of S&P futures buying was not nearly as heavy as we have seen when put strikes act as magnets during sharp moves to the downside.
The upside to this is that if there is any unwinding of the S&P futures that were bought related to the call open interest on the SPY, it will be minor relative to the unwinding of short futures positions that build during expiration-week pullbacks.
That said, since September, the SPX has become unstable when it ventures into the 2,950 area. This is obvious to anyone with a chart, and therefore might invite profit-taking or bring short sellers into the picture. A minor win for bulls, then, with the G-20 meeting set to begin at the end of this trading week, would be a bout of consolidation.
If you are a short-term trader, don't be surprised to see pre-meeting remarks by world leaders that could either upset or comfort market participants. There is really no edge to predict what the next tweet or remark might be, or what the outcome of the Trump-Xi meeting will be, which is even more reason to use options to manage risk.
On another note -- and I have not seen many traders and investors discuss this -- the SPX could be in the process of completing a bullish inverse head-and-shoulders pattern. If the neckline in the 2,940-2,960 area is taken out in the coming weeks, the target would be a move to 3,550 in the next nine to 10 months -- a move of 20%. This would certainly take many by surprise, especially fund managers that raised a lot of cash during the month.
"Goldman Sachs Group Inc., Nomura Holdings Inc. and JPMorgan Chase and Co. are among those pricing-in a greater chance of a protracted trade war. One China analyst sees both sides stuck in a cycle of 'fighting and talking' until 2035."
-- Bloomberg, May 23, 2019
"A bullish sentiment driver that we uncovered this week is the action in the SPY's 10-day, equity-only, buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), which began to roll over from a high level..."
-- Monday Morning Outlook, June 17, 2019
"... investors are holding more cash than they did a month ago, which means there is still some degree of pessimism. They held 5.6% of their portfolios in cash in June, up from 4.6% in each of the past three months, the biggest one-month jump since 2011, according to the latest survey of global fund managers from Bank of America Merrill Lynch."
-- The Wall Street Journal, June 21, 2019
The good news for bulls, however, is that the FOMC held rates steady last week and came across dovish, ready to act if necessary. While the market did not do well after the previous action to hold rates steady, it has typically displayed bullish price action in instances in which the Fed held rates steady since it began tightening in December 2015.
Moreover, the sentiment backdrop currently favors the bulls, as the market sits around all-time highs. Fund managers made a big move into cash during the past few weeks, and equity option speculators -- while unwinding from an extreme in pessimism last month -- are not nearly as optimistic as they were when the SPX was trading at similar levels in the past (see chart below).
Finally, the latest American Association of Individual Investors (AAII) survey checked in at 29.5% bullish vs. 32.1% bearish (more bears than bulls!). This is a sentiment backdrop that looks more like a market trading 10% below its highs than around all-time highs, which means a further unwinding of negativity could be supportive.
Todd Salamone is Schaeffer's Senior V.P. of Research.
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