As we continue to navigate the stormy seas of the deep winter freeze, we enter options standard expiration week (OPEX) coming off an intra-week reversal for the S&P 500 (SPX – 4,418.64). The bulls' expectations have been muted once again, but what has history told us about this upcoming week?
For the past 20 years, February OPEX week has predominantly been bullish, even when the markets have been battling downtrends and volatility. The seasonal stats for the SPX this week have provided a return of +1.33% on average. Typically, I’m on the lookout for downside risk. Maybe it's the contrarian in me, but perhaps OPEX is a contrarian week to the most recent trend? We’ll see if the seasonality data can hold true amidst the headwinds.
Negative headlines consumed the second half of the trading week after the consumer price index (CPI) came out hotter-than-expected yet again, and up 7.5% on a year-over-year basis, which is the highest rate since February 1982. In addition, Federal Reserve President James Bullard commented he supports a 100bps move in the next three Federal Open Market Committee (FOMC) meetings. Rates will continue to be a headwind until we see inflation data slow down.
At that point, markets could absorb marginal rate hikes and enter a period where slow and steady rate hikes are bullish once again. That is, if hard economic data can remain robust, supporting a strong economy, until the inevitable point that the Fed moves too far and thrusts us into a recession.
This is certainly a tale we have heard before. However, the University of Michigan's consumer sentiment index fell to 61.7, versus the estimate of 67.5. This is the lowest reading since 2011, as consumers fret about the rising cost of goods. In fact, we’ve never seen readings this low without a recession.
Plus, rumors swirled on Friday that Russia was on the cusp of invading Ukraine. Naturally, the idea the United States could get involved in another military conflict produces volatility, so maybe this is the catalyst the markets needed to retest those January lows, or go even lower.
Typically, military conflicts only produce volatility for a short period, but this could be different from most conflicts. Russia is still considered a superpower country, and they supply an abundance of natural gas and crude oil to Europe. Any type of constrained production could continue to be the tailwind commodities need to keep going higher, especially those that are energy-related, which will only add pressure to inflation.
“Potential resistance in the week ahead between 4,525 and 4,600. The 4,600 level is where the peak of dealer buying related to options open interest diminishes and is the site of last week’s high. Plus, bulls must contend with former resistance (August 2021 closing high) and support (intraday mid-December low) at 4,536. Moreover, a trendline connecting lower highs since this year’s early-January peak lies at 4,570 today and ends the week at 4,525.”
- Monday Morning Outlook, February 7, 2022
With the SPX trading lower Friday and closing below its 200-day moving average as fears began to mount, investors wanted to de-risk from any potential weekend market-moving information. Three key areas throughout the past week were giving us potential signs that we could see a risk-off move.
First, there was resistance at 4,600. Then, the short-term downtrend line that the SPX has been unable to sustainably move above, as highlighted last week. Finally, the 125-day moving average has been capping the index. This is the same trendline that marked recent October lows. Bulls would welcome a confirmation candle above these levels to solidify that late January was indeed the bottom for stocks.
I would not be surprised to see a short-term bounce before a potential fade early in the week towards the 4,480-4,500 area, after the late-week rout, as 4,400 has proven to be a critical level. It marked the August pullback low in 2021, the gap down level on Sept. 20, and the gap up a level weeks later on Oct. 14.
Moreover, this area recently was the pivot level for stocks to move higher off those January lows. Four consecutive sessions could not get past that level, until the fifth session gave us a firm close above it, allowing us to claw back +3.5% in the following days.
If 4,400 fails, we could see a swift move lower towards the 4,300 area, as well as the 260-day moving average, which coincides with the SPX’s newly formed lower rail in a price channel. This would be a logical point bulls should hold to maintain the uptrend, despite all the negative catalysts they’ve been dished recently.
If that level breaks, we open up a vacuum, as there isn’t any significant support until the 3980-4000 range, with the peak put for the SPX residing at the 4,000-strike for February and March expirations.
The Cboe Volatility Index (VIX – 27.36) spread has entered backwardation for the second time in the past 30 days as of Friday, which has been a fairly solid indicator that the bottom for stocks could be near, should the bull market remain intact. The risk is always there that it could be the next 2000, 2008, or 2020. Those won’t ever go away, but knowing the VIX couldn’t hold above 30 on Friday at least gives bulls some hope that this was a late surge of volatility to shake out weak hands, as it’s done so many times before.
“With climactic sentiment apparently unwinding, and key indices such as the NDX and SPX holding above support levels, emphasize long positions. However, resistance levels linger above, so keep a tight leash if using equities, or use call options in lieu of equities to minimize dollars at risk, while leveraging the potential for upside movement in the weeks ahead.”
Monday Morning Outlook, February 7, 2022
From a sentiment standpoint, bulls still have contrarian catalysts to make an argument for long equities. As we have noted before, bulls have an unwind taking form in put/call volume ratios that we monitor.
Specifically, the SPX's 10-day buy-to-open put/call volume ratio came in at 0.56 this week, seeing a further unwind from its highest peak since March 2020. What's more, the Nasdaq-100 (NDX – 14,253.84) 10-day buy-to-open put/call volume ratio is experiencing a further unwind, coming in at 0.65 and coming off its highest levels since March 2020.
Additionally, the Investors Intelligence (II) survey data is nearing extreme pessimism levels you typically look for in major bottoms. While we are not in the optimal zone yet, we are extremely close, with the bull minus bear ratio coming in at 8.2% last week -- the lowest reading since the March 2020 Covid-19 crash. As you can see, there is still plenty of pent-up pessimism to fuel a rally if bulls can take control.
While many traders rightfully call topping a process, bottoming is too. We all love the V snapback bottoms, but the fact is most V-bottoms are not straight up. They’re extremely sloppy as the market attempts to fake out traders on both sides.
To be clear, we are still in no-man’s land. It’s not easy trading in these spots, and broken technical levels often create violent reactions in either direction. While volatility certainly can provide bountiful rewards, traders need to pick their spots wisely, and honor those stops to ensure survival during periods like these.
Matthew Timpane is Schaeffer's Senior Market Strategist
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