“… the bears are pinning their hopes that an area between 2,900 and the 3,000-millennium level proves to be harder to overcome than the levels I mentioned last week as potentially dangerous….With the SPX at roughly 2,874 as of Friday’s close, it's in no-man’s land from a short-term technical perspective, as a wide area between 2,630 and 2,800 represents potential support.”
-Monday Morning Outlook, April 20, 2020
I am again referencing technical-related observations that I made three weeks ago about the S&P 500 Index (SPX-2,929.80) trading between a plethora of potential support and resistance levels after a huge rally from the March low. But as the SPX has been engaged in choppy price action since this commentary -- respecting the upper end of the support zone and the middle of the resistance area along the way -- these levels are just as important now as they were then.
Specifically, the low during the first week of the month occurred around the 2,800-century mark, and as I mentioned on April 20, “The 2,800 area is now a possible support zone – round century mark, former resistance in 2018, and a 50% retracement of this year’s closing high and low.”
Prior to the late-April and early-May pullback, the SPX found resistance at the 2,950 area, which came as no major surprise. Per my April 20 observations, I listed two levels around 2,950 as ones to watch, with the 2,940 level at the time representing its unpopular but historically significant 320-day moving average, and 2,948 the site of a 61.8% retracement of this year’s closing high and low, in addition to a half-century mark that acted as resistance in the fall of 2018 and April-May of 2019. For what it's worth, the rising 320-day moving average is now at 2,950. Furthermore, the 295-strike is home to one of the bigger call open interest strikes that expire this Friday in the immediate vicinity of the SPDR S&P 500 ETF Trust (SPY-292.44). This strike is equivalent to the SPX's 2,950, and will be important this week from an options perspective.
As if this the above was not enough for the SPX to overcome these past few weeks, the rolling year-over-year (YoY) SPX breakeven point has come into play since mid-April, acting as resistance up to this point. However, given the YoY breakeven level changes daily based on the SPX’s close one year ago, it is possible that this level turns into support if there is a near-term pullback again. Specifically, the YoY breakeven resides at 2,876 at the end of this week and 2,758 at the end of the month.
In the days and weeks ahead, even if the SPX breaks above or below these levels I focused on above and in the following graph, please refer to the April 20 commentary as a guide to where the SPX could find additional support and resistance. On that note, add the 2,700 century mark as a potential area of support, as this coincides with the 38.2% Fibonacci retracement of the 2020 closing high and low, in addition to its 40-day moving average, a trendline that acted as support just weeks before this year’s top.
While we are seeing pretty firm potential support for the SPX at the 2,700 to 2,800 region, the one caveat I should mention is related to standard expiration week, which is now upon us. While a low probability occurrence – albeit higher-than-normal probability - is a sharp move down to the March lows. Sharp moves like this are sometimes option related and driven by delta-hedge selling related to the big put open interest strikes that build up over time. As it stands with the May expiration series, there is big put open interest stacked down to the SPY 220 strike in the May series, which is equivalent to SPX 2,200.
In other words, if negative news were to hit the market and spark enough selling to push the SPY below the 270 strike, or SPX 2,700 support discussed above, big put open interest strikes below 270 could act as magnets, as sellers of the puts unwind positions or are forced to short more and more S&P futures (delta hedging), as the SPY approaches each strike. To emphasize, such a possibility grows on a noticeable move below the SPY 270 strike.
In again reviewing the May open interest configuration, one has to seriously wonder part of the rally we saw since the March bottom was related to the unwinding of short positions related to these still open puts. As the SPY moved further above these strikes and closer to expiration, the puts at these strikes became less and less sensitive to the SPY’s movement, generating short covering of S&P futures. Now that most of the short covering related to May options has occurred, the SPY has gone directionless during the past few weeks, as the May expiration short-covering tailwind has subsided. I realize this topic might be somewhat complex. But suffice to say, short covering usually takes place as expiration nears and heavy put strikes are further below the underlying’s price.
Looking ahead, I added up open interest on SPY options expiring through June expiration, including Friday weekly options. The open interest configuration for this period looks somewhat similar to May’s standard open interest configuration, with heavy put open interest from the 220 through 280 strikes. If the SPY continues to hold its head above 280 in the coming weeks, a tailwind of gradual unwinding of short positions related to the those put strikes could help support the equity market.
Per the chart below, we know there has been a lot of put buying relative to call buying, as the 10-day cumulative ratio of SPY put buying to call buying is headed slightly lower after weeks of meandering around its highest levels of 2020. When put buying is heavy, it can act as a slight coincidental headwind, as those selling the puts to put buyers will hedge the position by shorting a small number of S&P futures, if the put strikes are far out-of-the-money when the trade was initiated. But if the slide does not come, a tailwind for stocks is created as those shorts are slowly covered as expiration gets nearer. But if the out-of-the-money put strikes come into view, especially as expiration nears, a sharp sell-off related to delta hedging can take place.
The bottom line is the big put open interest build on SPY and other index/exchange-traded fund options can be partly responsible for slow grinds higher well after the build occurs, or steep, quick selloffs as expiration nears. This makes pair trading equity options and straddles viable plays in this uncertain environment. You can also consider selling short-term SPY options around strikes that correspond to support and resistance areas as discussed in this commentary during the past few weeks, as the CBOE Market Volatility Index (VIX-27.98) continues its descent, closing below 30 on Friday for the first time since February 26.
Todd Salamone is Schaeffer's Senior V.P. of Research
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