How Open Interest Can Signal a Trend Change

Last week here I stated “there is no reason not to expect another new high to be made as the edge continues to reside with the bulls.” That worked out nicely and I am now making a similar statement regarding next week. There is one wild card that can derail the bull run (namely Trump addressing Congress on Tuesday), but that can also accelerate the bull run so betting on an end to the run seems arbitrary.

Thursday’s action in some high beta names and Friday morning’s gap down was surely cause for  concern to the bulls, but early into the trading session there were clues that the action was not the end of the current move. In fact, one of the main reasons was exactly the same as last week, which I mentioned in my post then and why I’m reiterating again. From last week: “the market got a little overheated, there were lots of open calls, and more often than not, that is a recipe for a raid on premium.” Point being, if you were one of the crash callers Friday morning or at any sign of trouble, keep in mind the open interest as it can offer some valuable information (btw, that doesn’t just mean the SPY open interest. Looking across several high beta names that account for a large portion of SPX or other indices can also be very helpful).

For example, why did AAPL gap down Friday? I would propose that it had a lot to do with all the open calls that still existed Friday morning. AAPL happens to account for a large portion of SPX. See where I’m going with this. These may be small nuances, but they offer important information. 

Open Interest:

SPY-W: (19 of 24 pins since Wednesday expiration inception)* The current best pin for Wednesday is between 235 and 236 with resistance levels both at the 237 and 239 call strikes. If SPY gaps or gets over 237 and holds, then that pin may shift so it’s not a good idea to blindly fight it. To the downside there isn’t much put support till 235. Since Trump is addressing Congress on Tuesday, it is probable that this open interest will shift. 

SPY-F: (12 of 19 pins. I counted last week as a failed pin although it could be considered a success. Read below my reasoning)* Regarding next week, the current best pin for Friday is also between 235 and 236, but this one has more put support than call resistance. Put support begins at 236, but is more prominent at 235. Below 235 there is a decent amount of puts on several strikes all the way to 232. I would note that if price does get below 235, the puts would likely grow much higher on those strikes, in which case I would update my analysis of the open interest.

In sum, the current environment favors higher highs being made next week; however, unless SPY gaps over or closes over the 237 calls and shifts the open interest, any rally might be muted the first few days of the week due to Wednesday’s expiration. Friday, on the other hand, currently has a decent amount of put support. Looking through my notes, I noticed that the last time SPY closed under its high puts was October 28th. Until it does (and it will at some point), there is no evidence to suggest every dip won’t be quickly bought. Lastly, watch out for changes in the open interest after Trump addresses Congress Tuesday.

If you find yourself caught up on the wrong side of the market and missing small but important nuances consider a subscription. I offer lots of intraday commentary regarding the market as well as daily open interest analysis for several stocks and real time trade alerts. 

*An explanation as to how I define pinning can be found here.

Wednesday 2/22: Successful pin.

Friday 2/24: Failed pin. The reason I counted it as a fail is the gap down could have easily allowed it to pin at lower levels and yet it rallied instead (even if it the bulk of the rally happened the last 20 minutes of trading). Basically I am being conservative by not counting it.

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