Market Bulls: Technical Indicator Concerns!
The VIX and Round Numbers!
Short Interest Continues to Favor Higher Prices!
by Ian Harvey
August 13, 2012
The buzzword of the week was "stimulus," with expectations for additional policy accommodation pushing stocks higher around the globe. By the time the stock market closed on Friday, in fact, the major equity indexes were definitely on the positive side of some significant round-number milestones.
As we head into August expiration week, it is recommended that the investor keeps a close eye on those notoriously stubborn ‘round numbers’ -- particularly since there are now a handful of technical indicators to provide cause for short-term concern for the market bulls, including the presence of possible options-related headwinds for the Spiders.
TOP OPTIONS TRADES SINCE JUNE 01, 2012
|HLF July 47.50 Calls||53%||APPL Aug 650 Calls||67%|
|DLTR Aug 110 Calls||32%||UIS Oct 17 Calls||79%|
|HSY Aug 70 Calls||56%||TSO Nov 25 Calls||54%|
|NKE Oct 92.50 Calls||49%||HLF July 47.50 Calls (again)||38%|
|FB Aug 25.00 Puts||500%||DISH Sept 30.00 Calls||100%|
|APPL Jan 13 650.00 Calls||71%||CSTR Oct 42.50 Puts||400%|
|LNKD Aug 92.50 Puts||30%||LNKD Aug 100.00 Calls||250%|
Short-Term Risks for Market Bulls
"…..The options fear gauge on Wednesday was currently hovering around 16, at the lower end of its range since June as the S&P was within striking distance of the 1,422 multiyear high set in April. 'Now is a good time to buy downside puts on the S&P 500 index because they can increase in value if the market falls and if volatility moves up,' said WhatsTrading.com options strategist Frederic Ruffy."
- Reuters, August 8, 2012
“…..As we are well aware, this is a market that can and will react to both positive and negative headlines from day to day and week to week. But looking at the bigger picture, you have to be impressed with the price action, even as…..”
- Investor Expectations Low but Stock Market Impressive, August 06, 2012
In last week's article, I listed some bigger-picture reasons (as per excerpt above) why the equity market's risk/reward equation favors the market bulls. To summarize: In the context of strong price action this year, the sentiment backdrop is one of caution and fear among most market participants -- a sentiment environment that would suggest the Standard & Poor's 500 Index (SPX - 1,405.87) is down double digits for the year, instead of the reality of being up double digits in 2012. For all those contrarian investors, this perspective, providing dichotomy between price action and sentiment, is bullish.
With this in mind, there are a few notes of caution, from a technical perspective, that short-term traders should be aware of as we enter August expiration week. After five consecutive weeks of SPX gains, it's worth noting that:-
1. The SPX, Russell 2000 Index (RUT - 801.55) and Nasdaq Composite (COMP - 3,020.86) are simultaneously trading around key round-number levels that mark potential resistance. Since these indexes traded above their respective round-number levels this past week, they have gone sideways as very short-term realized volatility has imploded. The caution for market bulls would be realized volatility spiking if these round numbers indeed act as resistance. Plus, the SPX's high close on Friday last week was nearly flat with its early-May closing peak, and only about 13 points below the 2012 calendar-year closing high.
2. In addition to the SPDR S&P 500 ETF (SPY - 140.84) entering the week near potential call-related resistance at the round 140 strike (see the SPY open-interest configuration chart immediately below), there are a few sector-related exchange-traded funds (ETFs) -- such as the SPDR S&P Retail ETF (XRT - 60.10) and Financial Select Sector SPDR Fund (XLF - 14.94) -- trading just below heavy call open interest, such as the round 60 and 15 strikes, respectively.
3. The CBOE Market Volatility Index (VIX - 14.74) is trading just below 15, a level from which it has popped several times during the past two years. Moreover, the CBOE Russell 2000 Volatility Index (RVX - 19.99) has experienced only one other weekly close below the 20 level since August 2007 and the RVX comes into next week trading right at this support area. In fact, per the table below the accompanying VIX chart, SPX returns over a five-day period since 1990 have been negative, on average, after the VIX breaks below 15. But note that breaches of the 15 level mean very little beyond Day 5.
Market participants seeking portfolio protection -- or looking to replace expiring portfolio protection -- may view the VIX pullback as an opportune time to hedge. Increases in VIX call buying or index/ETF put buying would be a coincidental headwind for the market bulls, as sellers of portfolio insurance short SPX futures to hedge their risk.
4. Active investment managers have above-average exposure to the market, according to the most recent National Association of Active Investment Managers (NAAIM) survey National Association of Active Investment Managers (NAAIM) survey -- similar to that of April, which preceded a correction.
The NAAIM risk would be of bigger concern to the market bulls if confirmed by other sentiment indicators. For example, short interest at present is a lot higher than the April period, suggesting demand from short covering is stronger. Furthermore, equity option buyers were purchasing more than two calls for every put in April, which marked a one-year high at the time. At present, 1.5 equity calls are being purchased for every one equity put -- which is around three-year lows.
Short Interest On All Optionable Equities
As noted, over the past few weeks, the overall trend in total short interest on all optionable equities (about 2,600) has peaked and is moving lower.
The theory behind this action is that increasing short interest can act as a headwind to any rallies, but once the shorts begin to cover, it can be very good for market bulls.
As mentioned earlier in the article, “ Investor Expectations Low but Stock Market Impressive – August 06, 2012”, the last time short interest was this high and rolled over, it sparked a 30% rally in about five months. Well, it dipped yet again, but not by much – only 0.18%. This doesn’t seem much, but check out the overall trend. It looks like short interest has peaked, and as long as it keeps moving lower, this is another bullish tailwind.
Taking a look at the data over a wider period of time, you can see that this has a pretty nice track record. Higher short interest is bearish, while decreasing short interest is bullish. It may seem rather simplistic, but as long as this trend stays lower, I think siding with the market bulls makes sense.
There are technical risks for the market bulls in the near term, but if a pullback does occur in the week ahead, it should be viewed as a buying opportunity. Short interest is declining from the kind of highs last seen in September 2011, when short covering drove an impressive rally that lasted into March of this year. Few expect a repeat of the September-March rally -- which is exactly why the upside probabilities into yearend are favorable, even though there are technical speed bumps overhead.
Further Articles Relating to the Week Ahead
1. The Week Ahead in the Stock Market - August 13, 2012
2. The Economy and Earnings in the Week Ahead – August 13, 2012
3. The Past Week Stock Market Results – August 13, 2012
4. The Major ETFs in the Week Ahead – August 13, 2012
5. The AAII Reports Bearish End - Indicator of the Week – August 13, 2012