We head into the July options expiration week on an upbeat note, with recent news coming out on potential coronavirus vaccines and good data on a remedial treatment as well. Although new daily COVID-19 cases continue to surge and the death rate is still climbing, the good news is the slope of the death rate ascent is not. I’m certainly no virologist, but this brings hope that the medical community has a better grasp on the virus, which would corroborate with Friday’s news that remedial treatments are working.
The continued market rally certainly reflects that, to put it bluntly, stocks haven’t shown much concern about health or economic risks since mid-March. I’ve seen this kind of decoupling before at major tops and bottoms in the market, but
by no means am I making that kind of call, as we prefer to be tactical, and there is no way to tell when this bull party will end other than seeing a trend change. But, as we head into the latter half of summer, a known period for market underperformance,
we need to continue to keep a watchful eye out for potential pivots in market behavior.
From a technical perspective, the S&P 500 Index had been coiling inside its price channel and near a triangle apex all week, before finally breaking down late Friday. Luckily for bulls, an area we’ve mentioned before (the round 3,000-millennium level) and the 40-day moving average were just below to save the day and act as support. Potentially, this push lower on Friday could have been a bottom, as it’s the second time we’ve tested these lows over the last two weeks. Bulls will be looking for a breakout type of move higher if this is the case…
- Monday Morning Outlook, June 29, 2020
The triangle breakdown in the S&P 500 Index (SPX -- 3,185.04) two weeks ago was indeed a classic bear trap bottom, which likely got many eager bears trying to front-run short positions on a potential breakdown. Subsequently, we saw the market
rally off that round 3,000-millennium level and break above the short-term downtrend to fill the June 11th gap this week and regain the parabolic price channel. Moreover, the NASDAQ 100 Index (NDX – 10,836.33) broke out of the
9-year price channel that had been acting as resistance, as we previously mentioned in the last few weeks. Immediately after the breakout, it traded to the top of the trendline connecting the April 2019 high with the February 2020 high. Furthermore,
when you look at the NDX/SPX ratio chart, it just broke above the 2000 tech bubble highs, which was an area many (myself included) would have expected some sort of resistance or consolidation. I’ll be watching for a test of the breakout
or even a potential false breakout scenario over the coming weeks, but these types of breakouts show just how powerful this rally has been. With that said, we still need to be mindful and cautious of the rally as we continue to wade further into
the seasonally tepid Q3 tape.
Over the past week, many strategists and pundits have pointed out how extended the Nasdaq is from its 200-day moving average, with most referencing how bearish this is. So we had our Quantitative Analyst, Chris Prybal, do a study to see what the numbers
showed over the past 20-years. Over this period, we’ve had ten signals, which could only be triggered once every 90 days. The study finds that near-term, there can be some flat to bearish price action, especially 21 to 63 days out, but this
is also aided by a recent extreme move on February 6th, 2020. Moreover, the market is about 50/50 when it comes to positive or negative over those near-term time-periods. What is interesting though, is this indicator has worked well
over the past 10-years when looking 42-days out, or two months. On all five occurrences, it was 100% of the time negative by an average of -9.54%. So, will the last decade's trend continue, or will we see a reversion to the norm is what we should
be asking ourselves going forward?
Taking a quick look at our updated sentiment indicators, we continue to see a mixed bag of signals, with our internal 10-day buy-to-open, equity-only, put/call volume ratio remaining in an extreme territory at 0.398 while once again moving lower.
While it can be hard to time, we know from our previous studies that we’re likely heading for some near-term frustration. Yet, as we’ve also indicated numerous times, this near-term negative to the broader markets can be a longer-term
buying opportunity.
But the one sentiment indicator that still leaves the market vulnerable, and has for weeks, is the action of equity option buyers. The ratio of put buying to call buying is still historically low, indicating a lack of fear among these participants who tend to be wrongly positioned at major market turns.
- Monday Morning Outlook, July 6, 2020
Longer to intermediate-term looking sentiment has grown increasingly bearish over the past few months -- as we stated last week -- with the American Association of Individual Investors (AAII) sentiment survey bears percentage of change falling
by -3.2% this week, but still coming in at 42.7% of the survey respondents. This reading still far outweighs the bulls, which increased this past week by +5.0%, yet still coming in at a meager 27.2%. So, while some individual investors and
active managers are getting more bullish on the market’s perspective future, we still see the most bearish responses since the Great Financial Crisis. What I find most interesting is when looking at AAII Bear 10-week moving average and
CBOE 10-day equity-only put/call ratio, you can see there isn’t an instance where these two indicators diverge this dramatically.
With individual investors and active investment managers displaying caution in recent surveys, this represents future demand that could help the market continue to leave investors scratching their heads and ask, "why is it trading higher?"
- Monday Morning Outlook, July 6, 2020
Finally, since we are entering July standard expiration week, it is only prudent that we discuss the S&P 500 ETF (SPY-317.59) open interest configuration. While it remains unlikely with the current market price action, and the fact that we remain above both peak put and call open interest at the 310-strike, we do have an increased chance of a potential delta hedge scenario that could play out. As we approach expiration, gammas can grow rapidly as the out-of-the-money strikes are approached. Therefore, if we were to have an unexpected pullback and a break of the SPY 300-strike, this could start a snowballing effect with a potential drawdown to the 280-strike.
For these reasons, we’re sticking with our recommendations from last week that you might want to add put exposure via pairs options trades or straddles to play the upside momentum with the current market vulnerabilities on display.
Or, you could offset some of your call exposure with directional speculative put purchases on underperforming names. I do believe we are likely in the latter parts of the current bull rally before we go into a consolidation phase.
So, additionally, tightening your stops and trading shorter-term setups will help you control your risk exposure while still maintaining long positioning.
Matthew Timpane is a trader at Schaeffer's Investment Research.
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