“…the SPX’s move above the July, August, and pre-FOMC rate-cut highs completes a bullish inverse ‘head and shoulder’ breakout…the bullish pattern suggests that we could be on the cusp of a near 10% rally in the coming months…
–Monday Morning Outlook, September 23, 2024
“…the SPX has been dancing around the 5,725 level that I have discussed in prior weeks, as it is coincident with being exactly 20% above last year’s close. Such round-number percentage gains often mark pauses or pivots. As of now …,it has marked only a pause”
–Monday Morning Outlook, October 7, 2024
Last week’s inflation numbers, a hotter-than-expected Consumer Price Index (CPI) report, a plethora of commentary from Federal Open Market Committee (FOMC) members, and minutes from the last FOMC meeting did nothing to knock equities off course — even as election uncertainty looms.
In fact, the probability of a 25-basis point rate cut at the Nov. 7 FOMC meeting moved lower over the course of the week from 97% to 86%, as implied by Fed Funds futures traders. But the S&P 500 Index (SPX – 5,815.03) climbed to another all-time high on Friday, perhaps finally sustaining a move above 5,725, or 20% above the 2023 close, where it paused for about three weeks.
The all-time high occurred despite election uncertainty and the next FOMC decision that comes on back-to-back days in the first full week of November. There are hints of caution ahead of these events, most notably the Cboe Market Volatility Index (VIX – 20.46), which is still north of the 20 level even with the SPX carving out new all-time highs. For perspective, when the SPX made a new all-time high in mid-July, the VIX was trading just above the 13 area.
In other words, portfolio protection is roughly 50% above that of July, even though in both cases the SPX hit all-time highs. This caution in the options market is bullish from a contrarian angle. I would be more concerned if the VIX was at current levels, coincidental with a technical breakdown in the broader market.
“With a bullish technical pattern in place, it’s best to identify a potential source of fuel… there are more stocks participating in the rally, so it’s likely more and more shorts are losing the battle, and thus represent short-covering potential.”
– Monday Morning Outlook, September 23, 2024
When I identified the inverse bullish “head & shoulder” breakout on the SPX in late September, I mentioned that the measured target is about 6,200, or nearly 10% above the neckline at 5,666. Since the breakout above the neckline, the SPX has rallied about 2.5%, following a three-week pause just after the breakout occurred.
The projected move is a sharp advance in a short period and, as such, I commented that for a pattern like this to live up to expectations, there must be an identifiable source of fuel.
One of multiple sources of fuel that I identified was short interest, new figures as of the end of September that were released last week. I continue to be amazed, even after a brief downtick in short interest in the second half of September, that total short interest on SPX component stocks is at levels not seen since fear gripped the market when the economy was shutting down due to Covid-19.
In other words, there is a lot of short covering potential, and the slight decline in the last report might be small evidence that shorts are feeling pain with each move to new highs, as they are not aggressively building positions.
Looking ahead to standard October expiration week, market participants will weigh more economic reports, including jobless claims, retail sales, industrial production, business inventories, and housing starts. Additionally, the start of earnings season continues, with financials like Bank of America (BAC), Charles Schwab (SCHW), Citigroup (C), Morgan Stanley (MS), and Interactive Brokers (IBKR) on deck to report, in addition to a host of other companies.
With it being standard expiration week, something that stands out is the relatively low call and put open interest (OI) in the vicinity of where the SPDR S&P 500 ETF Trust (SPY – 579.58) closed on Friday. In other words, trading this week may not be impacted by option expiration at the exchange traded fund (ETF) level, relative to other weeks.
The upside of this for bulls is no evidence of a “call wall” that will act as potential option-related resistance. Nor is there an immediate threat of a delta-hedge selloff, which occurs when big, out-of-the-money put open interest strikes act as magnets when declines to those strikes occur.
If a catalyst of some kind drives stocks sharply lower, the risk of a major delta-hedge selloff would occur if the SPY approached the 550-strike, which is roughly equivalent to SPX 5,550.
The downside of the current open interest configuration for bulls is that there is not a lot of short-covering potential associated with out-of-the-money put open interest, which is set to expire this week. In fact, the SPY rally last week above its recent range could be attributed to the unwind of short positions associated with heavy or elevated put open interest at the SPY October 550-, 558-, and 560- and 570-strikes. Such unwinding associated with these put strikes is likely over, which again implies little chance that SPY options expiring on Friday influence the market this week.
I continue to see the potential for a move to SPX 6,200 by year end. Support in the days ahead is between 5,665 and 5,725. The 5,665 level is the July closing high and the upward-sloping 30-day moving average. The 5,725 level is where the SPX paused, which is 20% above the 2023 close.
Todd Salamone is the V.P. of Research at Schaeffer’s Investment Research.
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