Stocks endured another choppy week of trading, as the S&P 500 (SPX – 1,380.90) got a boost from technical support on Monday, and then spent the rest of the week spinning its wheels. As mentioned last week, the SPX and other major indices were in a must-win situation, as they were in the process of challenging key support levels. Without an early bounce in stocks, chances increased that short-term profit-taking would change into short-term bearish conditions for stocks. Despite the bounce seen last week, stocks still face an uphill battle to keep the bullish streak alive, as sentiment continues to suggest some upcoming weakness and the technical picture remains murky.
As I said last week, sentiment has been creeping toward more bullish readings as stocks make their way through what is frequently termed a seasonally strong period. One of the more successful long-term sentiment indicators is the Chicago Board Options Exchange (CBOE) equity put/call ratio. The trend in this ratio often tips the hand of options investors, as it signals whether this crowd is becoming more bullish or bearish, and thus whether cash is flowing into or out of the market. Over the past two weeks, this ratio has been signaling that the market’s cash flow is shifting from coming in to going out. In other words, according to the trend in option volume traded on the CBOE, the market is potentially facing some headwinds, as investors begin to apply selling pressure to the market.
The volatility indices (which measure relative fear among options traders) continue to reflect a mixed market, as some are hitting relative lows while others have farther to travel before hitting their low point. The VIX (10.79) and VXO (10.61), volatility indices for the SPX and S&P 100 Index (OEX – 643.32), spent the week trolling at the bottom of their ranges while the market moved a little higher. A simple analysis of these fear gauges implies that the market should begin bumping against a ceiling. Comparatively, the volatility index for the Nasdaq 100 (NDX – 1751.11), the VXN (15.52), broke through the bottom of its recent range last week and is now moving lower. Given that a volatility index tends to move in a direction opposite to its associated index, the current status of these indices suggests that the Nasdaq has the least congestion above its current prices and should outperform if the market continues to move higher.
As we head into options expiration week, I should point out that such weeks normally produce some significant moves in the major indices. I’m also reminded that major stocks and indices tend to be “pinned” at or near strike prices that hold significant call or put open interest. We also tend to see more exaggerated support from peak put strikes. With this in mind, a quick review of Friday’s peak put open interest strikes for some major ETFs is appropriate: Nasdaq-100 Trust (QQQQ – 43.02) – 42; S&P Depositary Receipts (SPY – 138.24) – 136; Diamonds Trust (DIA – 121.11) – 120; and iShares Russell 2000 Index Fund (IWM – 76.52) – 75. Should the market see some early weakness this week, these ETFs will likely encounter support at these price levels, as the mechanics of these put options begin to attract trading activity. Looking forward to December, peak put strikes for QQQQ and DIA remain the same, while SPY peak put open interest drops to the 135 strike and IWM’s ticks up to the 77 level.
Wrapping it up, while expiration week trading will likely add some volatility, this week’s slew of economic reports should have a bigger impact. Consider the market outlook as cautiously optimistic, as the major indices remain above short-term technical support (the 20-day moving average). However, a move below this trendline will come at a cost, as the market will likely incur more prolonged selling due to building optimism and recent price activity that is showing some signs of weakening.
