The markets closed the week on a positive, gaining back a good portion of their losses from Wednesday & Thursday but the S&P500 posted its first negative week of the year. While the bounce Friday was encouraging and rewarding for those who went long vs 1,495, it bungee jumped the risk/reward back in favor of the bears. We’re closer to resistance in the 1,520-1,530 range than support at 1,495 so I believe you’ve gotta start shorting at what looks like the top end of the market’s recent range.
- Wide daily ranges have returned — Time to give the short trade another shot until volatility dissipates
- A bearish take on AMZN — Something’s gotta give at current levels, and my analysis of the recent volume pattern suggests that it could be to the downside
- What to expect if the market does pullback — Seems like everyone is looking for a top here, if it is in place I’ll examine some areas where a bottom might occur
The end of February is acting a lot like the beginning of February in which the S&P500′s daily ranges exceed 10 points a few days in a row and set up a small pullback at the time, albeit while still holding key support at 1,495. The main difference between then and now is that the VIX is holding above 14 after making a significant move higher. Should SPX remain below 1,520 then the odds are good that we test 1,495 again this week. However, if SPX starts trading in a 6-8 point range somewhere between 1,510-1,520 and the VIX moves back towards 13 then I suspect you’ll see the market retest 1,530.
On an individual stock basis AMZN is one that looks ripe for a short. The chart is in a long term uptrend but the most recent price action has to be considered bearish given that AMZN is off of its most recent highs (all time highs at that) by 7%. In addition, the stock traded the most volume it had on back-to-back days on 1/29-1/30 in a range of $258ish-$284ish and has been remaining below the $271 midpoint of that range for the most part since. A continued ability to stay below $271 and a subsequent move below $263.30ish (roughly the mid point from Friday’s range) and AMZN looks ripe to fall towards $250 in the near term. Above $271 and all time highs are back in play.
In determining where the S&P500 might fall too in the event a break below 1,495 does play out, I wanted to examine some open interest on SPX option strikes. Open interest represents the amount of contracts that have been bought to open (long) or sold to open (short) on a particular option strike, be it puts or calls. The greater the open interest levels, the more likely it is such strikes can act as supports or resistances the closer the index gets to them, or ‘magnets’ if you will.
Looking at March 16th expiration on the put side of an $SPX option chain and you’ll notice that peak open interest resides at 1,500 with over 188,000 contracts open. The 1,450 put strike is home to 3rd most open interest of 171,000 (behind 1,400 around 175,000 contracts). My thesis is that that 1,500 has acted as strong support due to the huge open interest on the puts there. This is tricky because it involves counter intuitive thinking, but bear with me.
Funds and institutions are the most active participants in $SPX options and they will often buy puts to hedge long positions. The fact there is huge open interest at 1,500 is supportive because as long as SPX remains above 1,500 they are not worried about their long positions and can endure the losses they’ll receive from their hedged position on the 1,500 put premiums they are holding.
Should 1,500 start to give way though ahead of March 16th expiration, as in a move below that key 1,495 support then you could see this open interest turn into a headwind for the market. Why? Because those same hedged positions on the premiums will become profitable, and the holders of them will become even more so if they start dumping their long positions, causing a deeper market pullback. In that scenario I’d expect SPX to pullback between 1,450-1,475 as that is home of the 3rd & 4th most open interest on the put side.
Looking at calls for the same expiration, peak open interest is also at 1,500 with 1,550 also boasting a hefty amount of contracts opened, 98,854 to be exact. So just like you have longs using the 1,500 puts as a hedge you also likely have shorts using the 1,500 calls as a hedge. If the market is able to remain above 1,500 and push above 1,520 short covering could fuel a greater rally.
All the while the open interest on the 1,550 strikes would likely increase as shorts hoped to cover some losses by betting on premiums that will do well in the event of a move up towards the all time highs. This to me is one of those ‘magnet’ scenario’s where you could see the open interest at 1,550 act as a magnet should the market be able to advance beyond the 1,520-1,530 resistance zone established this last week. Bottom line, my analysis of open interest on options expiring March 16th for $SPX has me targeting a move to 1,450-1,475 on a 1,495 breakdown or 1,550 on a 1,520 breakout. This would be based on either the breakdown or breakout happening with enough time before expiration, say the next 7 trading days or so.
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