“With more focus on the 200-day moving average among market participants, I think a move above the trendline connecting significant highs since January could be of more value to bulls. This is due to there still being a risk that the 200-day moving average crossover will prove to be a bull trap, given its popularity and a major trendline in its vicinity. In other words, if you were looking for a 200-day moving average cross-over for permission to add to long positions, you may as well await a close back above trendline resistance currently located just above this moving average.”
- Monday Morning Outlook, December 5, 2022
My caution about the S&P 500 Index’s (SPX—3,934.38) surge above its 200-day moving average proved timely, as anyone buying on this crossover is already in the red. In fact, it was the trendline connecting lower highs since the SPX’s all-time high in early January that proved to be the level that did in the bulls, at least for now. A near 4% decline from the Dec. 1 close to last week’s intraday low followed the failure at trendline resistance. During the course of the week, Fed funds futures increased the odds that the Fed funds rate would be between 5.00% and 5.50% after the mid-March 2023 meeting, as the probability increased from 38% to 45% from the Dec. 2 close to Friday’s Dec. 9 close. Higher-than-expected November wholesale price data on Friday morning added to the increasing odds of a Fed funds rate in this range.
With trendline resistance at work, the SPX moved back below its 200-day moving average, which in addition to fears of higher rates and a slowing economy, may have contributed to an overall disappointing week for bulls.
However, the SPX comes into this week at an area of potential support between 3,900 and 3,950. A risk is the close below 3,950, as it represents a breakdown level in September below a trendline that connected higher lows during a counter-rally from June through early-September (see chart below). Since Nov. 21, this level has marked lows for the most part.
But just below this level is the 3,900-century mark, which is also important and potentially supportive. Not only is this a round number, but it was the July breakout level above a trendline connecting lower highs from March through early July. It marked a short-term peak in early November as well.
Additionally, and as I noted on Twitter, the SPX’s 30-day moving average came into play last week and the benchmark comes into the week sitting just above this moving average.
While not on the radar of market participants as much as the 200-day moving average, the 30-day moving average has had significance going back to late-June. For example, it acted as short-term resistance on three separate occasions and support after a sharp three-day decline in early November. During this period, crosses above and below the 30-day moving average have proven to be valuable buy and sell signals.
This support area between 3,900 and 3,950 is one to keep an eye on in the week ahead. A move below 3,900 should be viewed as a time to de-risk if you are long.
Additionally, the SPX’s break below 3,995 on Tuesday could be viewed as a win for the bears, as this was the site of a trendline connecting higher lows since October at the time it was violated. As such, 3,995 should be viewed as a potential resistance point on rallies, with the potential that this breakdown could lead to sharper selling in the days ahead. And remember the trendline that marked the recent highs is still in play, as it comes into the week at 4,050 and ends the week at 4,041.
The week ahead brings key market-moving events, including November Consumer Price Index (CPI) data Tuesday morning and a decision from the Federal Open Market Committee (FOMC) Wednesday afternoon, when the Fed is expected to raise the Fed funds rate by 50 basis points.
On Thursday morning, market participants will weigh November retail sales and initial and continuing jobless claims data as they evaluate the impact of the cumulative effect of Fed rate hikes this year. This data will come as some are building recession into their forecasts.
“These end of quarter expiration months (March, June, September and December), from my experience, tend to have the biggest open interest builds relative to months where it isn’t an end of the quarter. The implication is that with more put open interest on equity index and exchange-traded fund options, in periods of market weakness, there could be more selling related to big put open interest strikes. Outside of the February 2020 Covid selloff, the two biggest declines I remember that could have been exacerbated by the options market was December 2018 and June 2022 (there may be others, but those two remain freshest on my mind).”
- Monday Morning Outlook, September 6, 2022
As noted above, not only is this week a standard expiration week, but it comes during the last month of the quarter, when there is a heavier build than normal in option open interest, particularly put open interest that is related to those looking to hedge long positions or speculative activity. The implication, as I noted prior to September expiration week, is that options open interest on index and exchange-traded funds can exacerbate selling, as those that sold the puts have to short S&P futures to remain neutral when heavy put strikes come into play or are violated to the downside. Plus, there are quarterly options, which can be used to protect portfolios into quarter end or, in this case, yearend. These options can also exacerbate selloffs, as we saw in September.
While one might argue we are in better technical shape now than prior to September’s expiration, when looking at the SPX relative to its 30-day moving average, which acted as resistance prior to September expiration week, the CPI data and FOMC meeting are events that could trigger a gap or quick move down to and through put-heavy strikes. This, in turn, would likely lead to more selling as heavy put open interest strikes act as magnets.
But not all quarterly expirations are as bad as we witnessed in December 2018 or June and September of 2022. While risk of sharp downside related to the put open interest is heightened, a neutral or positive reaction to the upcoming events could spark covering of any short positions related to these puts as standard and quarterly expirations approach, which would create a mild tailwind for stocks as long as the put-heavy strikes remain out of the money.
With the above said, the SPDR S&P 500 ETF Trust (SPY -- 393.28) is trading significantly above the 380-strike, which is the first strike where put open interest exceeds call open interest by more than 100,00 contracts. As such, it is the first strike below the current SPY price that, if penetrated, could lead to major selling that begets heavier selling as other heavy put strikes act as magnets. For bulls, the good news is we come into the week significantly above this strike, which reduces the odds of magnified selling related to options open interest.
But because this is a week chock full of potentially significant market-moving events, with the SPY and SPX coming into week the just above key levels on a chart, it doesn’t eliminate the risk of option-related selling occurring. If technical levels are broken in response to this week’s monetary and economic data, selling related to a technical breakdown could precede selling related to options open interest. Stay in tune with the market’s reaction to these events and where the SPY is relative to both chart levels discussed earlier and its 380-strike.
With the “known, unknowns” in the week ahead (known events, unknown outcome), and the Cboe Market Volatility Index (VIX—24.23) coming off a multi-month low just over one week ago, a hedge to your long positions using SPY puts or VIX calls is worth considering as we head into a potentially volatile expiration week and year end.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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