Last week here (and for several weeks) I discussed some breadth divergences that are unfortunately not a timing tool, but a caution sign. More importantly I discussed the risks of so many expirations and analysed both the Wednesday and Friday SPY expiration. Wednesday (the first ever SPY Wednesday expiration) did not disappoint and pinned almost perfectly. Friday on the other hand, breached the high put level that I clearly spelled out to watch out for. That level was the start of many put strikes that I warned could rapidly increase the pace of the sell off to 215 or lower. If you are unfamiliar with open interest and delta hedging, I strongly suggest you read last weeks post (the part under the open interest section).
I’m not going to claim that I was able to predict when it was going to happen, but I repeatedly warned about it in my weekend posts. The way I went about it with my members is by reducing long positions and having starter swing short positions. Although my members and I got stopped out of those few longs on Friday, the caution signs over the last couple weeks had us in a much better position to take advantage of Friday then anyone that chased the start of this week. At the present time and based on the Friday close, this is most likely a sell the rip market and not yet a buy the dip one unless 1) you are playing for short term bounces or 2) we continue lower right off the bat and find a bottom similar to after Brexit. Alternatively, cash is a position to wait for a bottom which may not take very long (see bottom of the post for explanation).
Next week is Quad Witching and monthly OPEX where most of the momentum stocks will pin. You can read more about that at the bottom of this post. SPY open interest will likely also remain the same, which is outlined below.
Breadth: These are all showing signs of being oversold, but not of a bottom.
SPX stocks at 20-day highs: This is now clearly oversold. This particular measure has a tendency to stay oversold for a bit or revisit very low levels several times before a bottom.
SPX stocks at 20-day lows: For weeks I have been discussing that when these start to spike more frequently it is a warning sign. It is now almost at Brexit levels and will very likely lead to many stocks bouncing soon. During the Brexit sell-off this measure only had one large spike, but note that over the last 5 years, there is usually two or more fairly large spikes (often spread apart) before the low is in.
SPX stocks below their 20-day MA: Clearly oversold when considering where it has come from, but has room to get more oversold.
SPX stocks above their 200-day MA: This measure is important to keep an eye on because it will help determine if the longer term bullish trend is intact. At this point it just looks like a simple pullback or backtest etc. Also, as I mentioned last week, after such range bound movement, many 200-day MA’s probably were not too far away from price so one large drop could get them there rather quickly. Thus, for the time being this seems as if this is a pull/back correction within a bullish trend.
Open interest: As I discussed last week there is now Wednesday and Friday expiration. I will show Wednesday, but note that these just came out and have very light volume compared to Fridays. Fridays open interest takes much more precedence since they have been available for much longer.
SPY-W: Currently it shows lots of calls at 216 and pretty much nothing else. There really isn’t any put support.
SPY-F: Taken at face value suggests a close between 215 and 220 next week. Seeing that SPY closed under the 215’s it makes SPY susceptible to further selling if price can’t quickly get back over 215 at the start of the week. The next main put support isn’t till 210 so unfortunately next week isn’t as clean cut as last weeks open interest. A gap below 210 could again exacerbate selling, but a drift toward it during the regular trading session would likely act as support (at least initially). During the Brexit sell-off SPY opened under high strike puts, bounced big in the first hour and then continued to fall hard closing way under the puts. The following day was a gap up and a rip higher to end the week back over the high strike puts by Friday. Keep in mind though quarterly expiration was also that same week and there were a lot of volume on SPY put strikes that very likely helped speed up the move to close over those puts.
How long will the correction last? I saw an interesting chart by Dana Lyons that suggests no longer than three weeks. If this situation is not an anomaly than be vigilantly watching for a bottom over the next few weeks.
In sum, there are signs of the market being oversold, but likely not enough to suggest a bottom is in. Any bounces next week that occur before moving lower will most likely fail and thus provides shorting opportunities. Unless SPY 215 is quickly taken back at the start of the week, don’t trust that it will bring price back up. However, if those 215 puts remain there all week and the market finds footing then remember it can do a Brexit by putting in a lower low early in the week and not look back. I wish I could give more clear cut information, but next week is one of those that needs intra-day analysis and quick thinking.
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