Last week’s SPX low was the location of its 50-day moving average as well as its high in early May
“Now, while looking for increased volatility, let’s look at possible pullback zones for the S&P 500 … Another and slightly more obvious level is the 50-day moving average, but this area also brings a support zone between 4,232 and between 4,252, where we hit new highs in June from a two-month consolidation phase and right at the lower end of the price channel that we followed throughout 2021. “
– Monday morning outlook, July 19, 2021
Just in time for the expiry of the options on Cboe Market Volatility Index Futures (/ VXc1) on July 21, the expected volatility pop came to fruition. We mentioned the expiration of the options on the July futures contract last Wednesday because the July futures contract traded for huge put open interest strikes the week before, just over 5:00 p.m. on July 15th .
The settlement of 18.90 on Wednesday morning meant many puts expired worthless, with the 19 strike put being worth just 10 cents. It reminds me of a pattern in earlier years where there was a distinct pattern where many calls expired worthless after being “in play” before expiration. In addition, the July contract high on Monday was 24.76, just below the huge open interest for calls at the 25 strike, which also leaves call buyers with a worthless trade on expiry on this strike.
The Cboe Market Volatility Index (VIX – 17.20) now has some headroom after hitting its moving average of 320 days for the second time since May and closing below its 2020 closing price Monday through Friday for a decline to the 15 area, which acted as the floor in the second quarter, but only preceded short-term trading range behavior or a slight pullback.
$ SPX closed below the channel it has traded mostly or above since then + headlines on vaccines in mid-November … the moves down have been temporary, with today’s lows at 50 days MA and the high in May pic.twitter.com/hXS0wwgD7k
– Todd Salamone (@toddsalamone) July 19, 2021
As we hinted in last week’s comment and on Twitter, a break below the S&P 500 index (SPX – 4,411.79) channel could be temporary due to historical developments as shoppers typically see its rising 50-day rolling Average have surfaced, which rested just below the canal in recent months.
This analysis was spot on as last week’s low was not only the location of its 50-day moving average, but also its high in early May, which was the last time the SPX traded above this channel. If the SPX is to break channel resistance this week it must close above the 4,435-4,453 range. The bottom of this channel is between the 4,300 century mark and 4,320. The 50-day moving average of the SPX, which has bottomed five of the last six pullbacks, stands at 4,256 for the week. With the Fed meeting this Wednesday and the upcoming peak of the reporting season, it is not out of the question that these support and resistance levels will be tested in volatile, choppy trading over the next few days.
“Record stock rally ignores Wall Street’s phobia of optimism”
– The Wall Street Journal, July 18, 2021
In addition to fears about the highly contagious Covid-19 Delta variant, which could stifle the economy, or “bad inflation”, which is more than temporary due to supply bottlenecks, another fear was the growing optimism of investors. As I’ve suggested many times, such optimism poses a risk, but coupled with the bullish price action we’ve seen over the past few months, it’s not exactly a great timing indicator.
If a major technical breakdown occurs amid this optimism, investors should be aware. But as it stands, perceived risks should be managed with hedges when portfolio insurance is cheap and / or call options should be emphasized to take advantage of the current uptrend with less dollar risk.
However, traders do not behave this way. Sentiment reverses at the first sign of a sell-off, although the SPX and other indices have not fallen below major support levels during the various pullbacks this year. For example, the buy-to-open put / call ratio for individual stocks tends to increase as stocks fall, even if such declines have repeatedly proven to be buying opportunities. Additionally, weekly bullish investor surveys will see bullish percentages drop rapidly at the first sign of trouble.
In the options market, a rising number of bears on components of the iShares Russell 2000 ETF (IWM – 219.55) was really pronounced during the recent decline. Even though the $ 210 mark has shown support for pullbacks since February, note the rise in the 10-day buy-to-open put / call volume ratio for IWM components.
While some technicians might view the ETF’s retreat to its 200-day moving average, which is at the $ 208 level, as a buying opportunity, options speculators went into the mountains instead, despite the $ 210 support not yet being broken and the ETF persists above this long-term moving average. In fact, the 10-day buy-to-open put / call volume ratio of the components of the IWM is now closer to its highs in the past two years.
The fact that a healthy number of traders panic before breaking support levels could suggest that optimism is not as widespread as believed. Yes, there will be a time when these support levels collapse when few are expecting it, and then a more pronounced decline in optimism could set in and do more damage to stocks.
But as I have said many times before, the declines so far have not been enough to put the nerves of those who have been in this market for months, including those referred to as “weaker hands”, to the test. When the indices are above or around the support levels, caution should be exercised when trading against the underlying trend. It is one thing to manage risk, but another to fight the market and misplace the effects of bullish sentiment measurements in a bull market.