“One area of the market showing increased optimism is equity option buyers, as the 10-day, buy (to open) put-call volume ratio on SPX components is decreasing and around levels that have marked a few pullbacks in the market in the recent past. This group has been positioned wrongly at key short-term turning points, so this is something to keep an eye on and perhaps one of the bigger short-term risks.”
– Monday Morning Outlook, October 21, 2024
If you are tuned into the financial media, you are likely aware of the fact that the S&P 500 Index’s (SPX – 5,808.12) six-week win streak ended last week.
Coincidentally, or perhaps not, it occurred when option buyers on SPX components were at their most optimistic since early July, as I observed last week. Early July was prior to a three-week decline in the SPX, which quickly resulted in a spike higher in put buying on SPX components, relative to call buying. This eventually marked the August trough.
While there has not been technical damage amid the SPX’s first loss in six weeks, a short-term risk to bulls is the turn higher in the SPX component 10-day, buy (to open) put/call volume ratio.
A turn higher from a relatively low level in this ratio is when correction risk runs highest, albeit there have been instances when the SPX went sideways (late-November/December 2023) amid a build in speculative option buyer pessimism.
The Oct. 15 candle is one that stands out to me. While it was not officially a bearish “outside day” like the multiple ones that have preceded imminent weakness in the SPX on multiple occasions this year, it might be viewed as “close enough” because the SPX has been unable to make any headway since this candle.
In fact, since mid-October, when viewed through the lens of an hourly chart, the SPX has incurred notable resistance at the 5,860-5,870 area, which marked intraday highs on Monday, Tuesday, and Friday last week.
“… the outlook remains bullish into the rest of the year, but bulls may get tested along the way. If sellers do overwhelm buyers in the near term, the first point of potential support is in the 5,725 area (20% above the 2023 close), where there was congestion immediately after the neckline breakout. The 30-day moving average has also moved up into this vicinity, a trendline that has been of importance multiple times since October 2023.”
– Monday Morning Outlook, October 21, 2024
Per the excerpt above and the chart below, the SPX did not come close to testing that first level of potential support in the 5,725 area, as last week’s low was at 5,762, in the vicinity of the late-September highs during a brief congestion period.
With the SPX’s 30-day moving average ascending from 5,725 at the beginning of last week to 5,760 at the conclusion of last week’s trading, another layer of potential support has formed, as buyers could key to both last week’s lows in the 5,760 area and the 30-day moving average.
Admittedly, the 30-day moving average was meaningless as a support and resistance level in the summer during a choppy and volatile phase. But long-time readers are aware of the importance of the 30-day moving average beginning in October 2023. This trendline was acting as resistance prior to the last leg of the decline and into the late-October trough, while also acting as support in January and May of this year, with the July cross below marking a “sell” signal. It also saw a late-July retest and failure at this moving average ahead of the early-August delta hedge selloff.
If a deeper selloff is in the cards, the 5,725 level is another level of support, where sideways movement occurred in September. This came as buyers were somewhat hesitant to accumulate stocks, as the SPX was 20% above last year’s close.
The final short-term support level is 5,665, site of the July high and neckline of the inverse “head and shoulder” breakout in mid-September that targets 6,200 by year end. A break below this level would likely mean all bets off on 6,200 being achieved by year’s end.
Uncertainty into the early-November elections and Federal Open Market Committee (FOMC) meeting could result in choppy trading as short-term. What’s more, wrong-footed option buyers usually become more disenchanted with the short-term outlooks of individual stocks after a hiccup the prior week.
I have said on several occasions this year that this is a highly shorted market, which is bullish amid a technical backdrop of several all-time highs being achieved and a broadening in the number of stocks participating in the rally.
Perhaps adding stability to the market could be continued short covering, as short interest data as of mid-October was released by the exchanges last week. It showed a 3.6% decrease in short interest, but note in the chart below that the decline is from levels that approached the mark of 2020, when Covid fears were running rampant.
Momentum has slowed and short-term option buyers are reacting to this loss, which could feed coincidental headwinds as put buying, relative to call buying on individual equities, picks up. But the recent short-covering action that was evident in October’s first half could put a floor on individual stocks if it continues.
The technical backdrop still favors a year-end rally, as long as the multiple support levels discussed above hold if there is more selling on the immediate horizon.
Todd Salamone is the V.P. of Research at Schaeffer’s Investment Research.
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