“This (4,160) level is one to watch closely, as it marked the February high before the benchmark lost more than 7% during a six-week period. Prior to February, the 4,160 level acted as resistance in late May and early June, ahead of a two-week, 12% selloff. In other words, bulls and the 4,160 level have not mixed well in recent history... The 4,160 level is also important because it is 10% above the December closing low. It should continue to be on your radar since sellers have emerged here multiple times since May 2022... ”
- Monday Morning Outlook, April 17, 2023
“It is also standard expiration week…In fact, call-heavy strikes are now in play, and could act as a lid as we move into expiration Friday.”
- Monday Morning Outlook, April 17, 2023
If you read this commentary during the past two weeks, you may not be surprised by the recent highs in the S&P 500 Index (SPX — 4,133.52) and S&P 500 ETF Trust (SPY—412.20). Since April 14, sellers have emerged at the SPX’s 4,160 level, and this has been the case multiple times since last May.
As we moved into Thursday and Friday’s trading last week, the 4,125 area was a magnet in narrow sideways action. This was driven by options-related factors during April expiration week. Further, the SPY 412 and SPX 4,125 strikes area were the point of maximum pain for option buyers when analyzing open interest at strikes, specifically in the immediate vicinity of this exchange-traded fund and equity benchmark.
As a side note, SPY $412 marked the high on the first trading day of the month and after a period of mild selling, was touched again on April 12. Nearly every day since then, the $412 level has been touched, the implication being that a narrow range has been in place this month. This is music to the ears of option sellers and a horror show in the eyes of option buyers.
The 4,160 level has been a thorn in the side of bulls for nearly one year, but the past six plus months have not exactly been a picnic for bears, with the SPX up 15% since mid-October. This also came alongside four interest rate hikes and a few high-profile bank failures at home and overseas. But the since-October rally has been anything but smooth, with significant selloffs in December, February, and March.
Until SPX 4,160 is taken out, the bears remain in control. Lingering just overhead at the 4,200-century mark is the SPX’s 24-month, or two-year, moving average, which acted as a lid after a two-week bounce higher in mid-September. It happened once again in February following a late-December through January rally.
But bulls are hoping that the latest pullback from SPX 4,160 is minimal, with the index coming into this week’s sitting almost 10 points above a trendline connecting the March 13, March 24, and April 20 intraday lows. A break of a trendline that looks like the current trendline in December 2022 led to a sharp short-term selloff and, as such, the bulls risk a trendline breakdown resulting in similar action after last week’s rejection at a known resistance level.
If a steep selloff occurs (keep in mind we are about to enter the six weakest months of the year, historically, beginning in May), bulls will be looking for long-term support to contain pullbacks.
For example, the 36-month, or three-year moving average, has marked many lows in the past and is currently sitting just 15 points below the round 4,000 millennium mark. As such, the area between 3,970 – the January breakout level above a trendline connecting major highs last year – and 4,000 remain important levels of support for bulls.
That said, if this trendline proves to mark a trough following Thursday’s doji candle in which the open and close are the same and Friday’s near doji candle, the next area of potential resistance is between 4,200 (24-month moving average) and 4,230, which is 10% above the year-end 2022 close.
From a short-term perspective, the action of option buyers on S&P 500 component stocks does not look like that which occurred when the SPX last failed at 4,160 in February.
Per the chart below, the 10-day, buy (to open) put/call volume ratio on SPX components is still declining, implying the unwinding of climactic pessimism on March 20 (the ratio’s recent peak) that occurred right after the March trough is continuing.
Heading into February, this ratio turned higher as the SPX ran into 4,160, implying put buying relative to call buying was increasing, creating a headwind as the SPX tested resistance. If call buying continues to predominate in the days ahead, we could see a breakout above 4,160 as the SPX benefits from option buying tailwinds instead of falling prey to option buying headwinds, which occurred in February.
Above said, this environment continues to warrant being open to sudden reversals, as trends have failed to persist very long. This could change, but a recent pick up in call buying on Cboe Volatility Index (VIX—16.77) futures is a red flag for bulls that is worth paying attention to since resistance is just overhead.
As such, think about hedging long exposure or balancing long exposure with some put exposure. This would be in case the see-saw battle continues, as we head into inflation data at the end of this week and a Fed meeting in the middle of next week.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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