“Bears have exerted control in the 6,000 area and immediately above, whereas bulls have exerted control in the 5,840-5,880 area below, with 5,880 representing the mid-October high, the 80-day moving average and, coincidentally (or perhaps not), the 2024 close at 5,882… non-directional action occurred on the heels of a bearish ‘outside day’ that came after the Fed cut the federal funds rate by 25 basis points on Dec. 18, and suggested that rate cuts in 2025 may be fewer than initially forecasted.”
-Monday Morning Outlook, January 6, 2025
For the first three days of the week and going into Friday’s payroll data (the market was closed on Thursday to honor late president Jimmy Carter), the S&P 500 Index (SPX —5,827.04) continued to ping in a range that has largely been in place since the index gapped higher on news of the election results in early November. The Monday high was at 6,021, an area of other short-term highs since mid-November.
Wednesday’s low was 5,875, in the vicinity of the 2024 close, its 80-day moving average, and the mid-October high. But Monday through Wednesday’s trading came before a payrolls numbers released Friday morning that were far above expectations, further cementing what we heard from Federal Reserve officials in December when they downgraded the number of forecasted interest rate cuts for this year.
$SPY closed around put-heavy 1/17 expiry 590-strike Wed, ahead of payrolls data. A notable negative reaction to report could spark both technical selling (on break of recent lows) and delta-hedge selling, with multiple heavy put open interest down to 540-550 strikes
— Todd Salamone (@toddsalamone) January 9, 2025
The day prior to the release of the payrolls data, I posted on X the technical and option-related risks that I saw if the market reacted negatively to the data. The SPDR S&P 500 ETF Trust (SPY — 580.49) was trading around the put-heavy January standard expiration 590-strike, with multiple strikes below that were also put heavy.
The implication of this is that big put open interest (OI) strikes are more apt to act like magnets amid market weakness and as expiration approaches, which is the case this week. Sellers of those puts who want to be neutral are forced to sell more SPX futures, as the SPY approaches each put heavy strike.
Such option-related selling is better known as delta-hedging, and the 590-strike represents the leading edge of a potential storm as January expiration approaches. Note that after the selloff below 590, the 580-strike was already in play by Friday’s close. Plus, there are several put-heavy strikes below 580, too. This means delta-hedge selling is very much a heightened risk for bulls in the short term, especially if the SPY breaks below the 580-strike.
“…the SPX’s 5,830-5,850 area represents the neckline of a potential ‘head and shoulder’ topping pattern… a move below the neckline… would complete a bearish ‘head and shoulder’ top… If the SPX closes below the neckline, the pattern would be complete with a target to 5,580 in a two-month period.”
-Monday Morning Outlook, January 6, 2025
“…equity put buying relative to call buying on SPX component stocks continues to increase from a multi-year low in the ratio last month. Market weakness usually occurs when this ratio turns higher from an extreme low. This sentiment-based tool is waving a red flag with the short-term direction of the market lower.”
-Monday Morning Outlook, January 6, 2025
A sentiment graph that continues to wave a caution flag for options bulls, but for a different reason than last week, is the 10-day, buy-to-open put/call volume ratio on SPX components. In the context of the SPX failing to take out resistance early last week and closing slightly below the December lows on Friday, the ratio is back at levels that point to extreme optimism.
From a contrarian perspective, the extreme optimism amid another technical breakdown is bearish in its implications.
In other words, one can interpret this reading as indicative of short-term option buyers positioning themselves for significant upside in the market, even though the SPX is vulnerable to a move down to 5,580 in the next couple of months after a close below it.
Since equity option buyers are usually on the wrong side of major moves at optimistic and pessimistic extremes, this risk is one that should not be ignored, especially if the SPX is below the neckline area (5,830-5,850) of the bearish “head and shoulder” topping pattern.
Todd Salamone is Schaeffer's Senior V.P. of Research
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
