My Stock Winners

A mixed slate of economic reports and earnings news failed to halt the broad-market rally last week, though stocks did pull back sharply on Thursday. At the close of the week, the Dow Jones Industrial Average (DJIA) finished with a gain of 0.46% while the S&P 500 Index (SPX) edged 0.02% higher. Furthermore, since the start of 2007, the Dow has racked up 6.9% in gains and the SPX has added 6.2%. And yet, pessimism reigns from a sentiment perspective despite this strong rally.

As we head into another options expiration, we have seen a steady rise in put positions on the various broad-market exchange-traded funds (ETF). During the same time frame, call open interest has increased by fewer than 370,000 contracts. As a result, the ETF’s Schaeffer’s put/call open interest ratio (SOIR) has risen to 2.21, its highest level since April option expiration.
Meanwhile, put open interest on the Standard & Poor’s Depositary Receipts remains at robust levels.
This building of put open interest is not only significant because its underscores the continued caution from institutional investors toward the market’s uptrend, as investors remain heavily hedged against a pullback, but also this wealth of put positions has accumulated as we approach expiration this week. In the past, we have seen an upside bias in expiration weeks due to the unwinding of heavy out-of-the-money puts that accelerates during that week. Since January 2006, the SPY finished only five expiration weeks in negative territory, while the average return during the week comes in at a gain of 0.55 percent.

One immediate obstacle that will need to be hurdled on the road to the all-time high I expect in the S&P 500 Index (SPX) this year is round-number resistance at the 1,500 level. The SPX has been dancing around 1,500 for about a week now, which is not surprising since this level had great significance as the SPX traced its major top in the first 9 months of 2000.

Checking in on the latest Commitment of Trader (CoT) report, it appears that large speculators in S&P e-minis haven’t quite finished covering their huge short position that we highlighted a few weeks ago in this space, as the net short position comes off its biggest level in five years and is now at levels consistent with the bottom of 2006 correction. Meanwhile, small traders of SPX futures are maintaining a short position that is hovering near 5-year highs.

This week has a number of key economic reports on tap, which could steal the spotlight. Inflation concerns will take center stage on Tuesday with the release of the Consumer Price Index (CPI). Last Friday saw a tame core Producer Price Index hit the Street, which helped to soothe fears. A benign CPI report could add some lift to the market. Meanwhile, Wednesday sees the release of industrial production and capacity utilization numbers, which will help the Street gauge the health of the economy. After the release of disappointing April retail sales and a larger-than-expected increase in the trade gap, expectations are relatively low on the Street regarding the economy. Any reports than come in better than the consensus estimate could result in a sharp rally in the market. Meanwhile, in the event of more disappointments on the economic front, declines should be modest, as heavy ETF put activity makes investors less apt to panic selling.