“… I have said in prior commentaries, 4,160 has been a menace for bulls going back to May 2022, so the struggle here is not a huge surprise…The options market is flashing a potentially bullish signal for the SPX…the 10-day, buy-to-open put/call volume ratio on SPX components rolled over, after a steady climb since April. To the extent option buyers represent the actions of short-term traders, improving sentiment toward SPX component names after weeks of growing negative sentiment could pave the way higher in the near term…Many puts are out-of-the-money (at strikes below Friday’s close) and thus short covering related to these puts could be a prevailing tailwind.”
- Monday Morning Outlook, May 15, 2023
Unlike the prior six weeks, there was finally a substantial directional move in the S&P 500 Index (SPX – 4,191,98), as the index moved higher by 68 points relative to the prior week’s close. This absolute move was nearly double the highest Friday-to-Friday close seen in the second quarter.
After six weeks of ugly sideways action between 4,060 and 4,160, the resolution of the range was to the upside. From an options-related perspective, the resolution of the range was not a huge surprise either, as short covering related to expiring out-of-the-money put open interest (OI) on the SPDR S&P 500 ETF Trust (SPY – 418.62) was very much a possibility during May expiration week.
Moreover, after weeks of building negativity toward SPX components among equity option buyers, pessimism climaxed two weeks ago, suggesting the coincidental headwind from these market participants slowly became a tailwind. We quantified this change in sentiment by noting the rollover in the 10-day, buy-to-open put/call volume ratio on SPX components, which preceded the breakout.
Now what?
In the interest of brutal honestly, that is tough to say. At the individual stock level, we have seen “fake-out” breakouts above prior highs, but we have also witnessed continuation moves following breakouts above established chart resistance. The best advice I can give is to prepare for either scenario by keeping key levels on your radar, which is a consistent message I have preached for the past several months.
If you were aggressive and went long prior to the breakout, based on our assessment of sentiment indicators that suggested odds of an upside move, you can lighten up a little bit if the SPX moves back below 4,160. You can further lighten up if the March closing high around 4,050 is breached.
Also beware that a pivot or hesitation could occur at two levels immediately overhead: 1) the round 4,200 century mark and/or 2) the 4,225 level, which is exactly 10% above the 2022 close.
If you went long after the move above 4,160, you have less room for error if the SPX pivots right away to the downside and last week’s action proves to be a “fake-out” breakout. Consider placing your stop on a close below 4,120, which was touched many times throughout April and the first half of May, and is a rough midpoint of the narrow range during those weeks.
The most notable risk I see for bulls is that the CBOE Market Volatility Index (VIX -- 16.81) has moved back to its early May lows, which is around the half-high when volatility expectations popped in March, as the first of a few other bank failures occurred.
When the VIX was last at this level, the SPX was at 4,160 and eventually pulled back to its 50-day moving average at 4,055 in a three-day period that encompassed the last Federal Open Market Committee (FOMC) meeting.
While the Fed will remain in focus with the next FOMC meeting about one month away, investors will continue reacting to debt-ceiling headlines, so don’t be surprised if hedging activity occurs that could slow last week’s momentum higher. Hedging activity could create a temporary and mild headwind, especially on the heels of a major VIX futures option expiration last week, standard May expiration, and the VIX around its 2023 lows.
Todd Salamone is the Senior V.P. of Research at Schaeffer's Investment Research.
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