“… potential resistance resides immediately overhead at last month’s highs around 4,380. Trendline resistance connecting lower highs since late July comes into the week at 4,407 and at 4,395 on Friday…rallies have been sold since August… it is much cheaper to hedge long portfolios by purchasing index or equity exchanged-traded fund (ETF) put options relative to late October. This is appealing if you are concerned about the resistance levels discussed above coming into play… it is nice buying this protection early in the month to proactively guard against a scenario in which the SPX crashes through its 36-month moving average, with a decent time left until the end of the month when it is best to evaluate its close relative to this trendline.”
-Monday Morning Outlook, November 6, 2023
Last week, I discussed the S&P 500 Index’s (SPX — 4,415.24) rally in the last two days of October to close above its historically important 36-month moving average. I noted in previous commentaries that, in recent years, month-end closes below this level have preceded more short-term selling.
But going back decades, such month-end closes have triggered longer-term sell signals, such as the SPX’s June 2008 close below its 36-month moving average, which preceded selling into the March 2009 trough. The SPX October close above its 36-month moving average, currently sitting at 4,192, preceded a surge in the index in the first six trading days of November of nearly 5%.
However, as excerpted above:
- Rallies since the 2023 peak in July have been short-lived. The SPX went into last week trading just below potential resistance.
- With the 36-month moving average still “in play,” and weeks left to evaluate a month-end close, a hedge to long positions is still very much worthwhile, since portfolio protection is cheaper relative to late October, as measured by the Cboe Market Volatility Index (VIX — 14.17).
After eight consecutive daily wins for the SPX, Thursday brought a selloff. A not-so-impressive 30-year bond auction and Federal Reserve speak were enough to drive the yield on the 10-year Treasury bond higher from a trendline connecting higher lows since early May.
A host of Fed presidents and governors, including Chairman Jerome Powell, reminded market participants that they will raise rates again if incoming data warrants doing so.
The Fed speak wasn’t anything new, but likely carried more weight on Thursday, as most were in the camp that the July rate hike would be the last, especially after soft economic data was released between the November 1 Federal Open Market Committee (FOMC) meeting and late last week.
In fact, Fed funds futures traders increased the odds of a rate cut in May 2024 from 40% on FOMC day to nearly 50% heading into Thursday’s multiple Fed speakers, including Powell. The odds of a rate cut in May moved to only 35% after market participants were treated to the thoughts of these monetary policy decision makers, which helped induce profit taking around resistance levels on equities, and support levels on the Treasury yields.
If you follow candlesticks on charts that display data on an underlying’s open, high, low, close and whether the close was above or below the open, the Monday, Wednesday, and Thursday sessions could be signaling short-term pain for equities.
For example, doji candles occurred on Monday and Wednesday on the SPX, a situation in which the open and close are equal or about equal. Doji candles can signal reversals after a directional period.
In fact, long-time readers of this commentary may remember that on multiple occasions in 2021, “Tri-Star” doji patterns – three consecutive doji candlesticks – appeared prior to major selloffs.
The two doji candlesticks last week preceded Thursday’s bearish outside day on the SPX, in which the intraday high was higher than the previous day’s high, and the intraday and closing lows were below the previous day’s low. A bearish outside appeared near the late-July peak too, for what it is worth.
However, after the SPX failed to overtake key resistance levels on Thursday, it all changed on Friday. In fact, the SPX closed above its 80-day moving average that was supportive in August, as well as trendline resistance since the July peak, giving bulls momentum heading into standard November expiration week.
Upcoming economic reports include data on the consumer and inflation, with the release of the consumer price index (CPI) this Tuesday, and retail sales and inflation data at the producer level coming on Wednesday. These upcoming “known, unknowns” will have a significant impact on interest rates and equities, given how sensitive they have been in recent weeks to the interest rate environment.
Most standard expiration weeks, I give readers a glimpse of what to expect based on SPDR S&P 500 ETF Trust (SPY — 440.61) open interest levels going into the final week of expiration.
Per the chart below, the first thing that stands out is the big blue bar on the far right at the 440-strike, which is equivalent to the SPX 4,400 level. I find this interesting, as 4,400 is sitting just above the October highs, the SPX’s 80-day moving average, as well as the trendline connecting lower highs since the July peak.
The positive for bulls this week is that most of the call open interest at the SPY 440-strike was bought-to-open, which means it could act as a magnet if buyers come in heavy in reaction to macro catalysts, like the upcoming inflation data. In other words, sellers of those options tend to be delta neutral and would be buyers of SPX futures if the SPY begins moving closer to the 440-strike, which could cause a technical breakout.
But just as delta-hedging selloffs related to big put-heavy strikes acting as magnets can generate short-lived technical breakdowns, I would view a technical breakout due to delta-hedge buying as potentially short-lived.
Meanwhile, a point of maximum pain for both put and call premium buyers is at the 430-strike, which is where a significant number of call and put contracts expire worthless.
As such, another scenario is a drift toward this strike, which is equivalent to SPX 4,300. If this occurs, a gap fill would be in play on the SPX, as the close ahead of the Nov. 3 gap higher was 4,317.
Delta-hedge selling risk is in play, with a SPY decline below the 430-strike.
Todd Salamone is the Senior V.P. of Research at Schaeffer’s Investment Research.
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