Did last week’s rally bring stability to Wall Street?

Bears in no rush to unwind bearish bets right now

“…potential support levels were breached on the sell-off, including the removal of the June lows, which is not a huge surprise on the delta-hedge sell-off…If the delta-hedge sell-off -hedge was a major culprit for the magnitude of the stock market decline in a short time like June, I would expect stocks to find some stability in the coming days… If the market doesn’t stabilize soon with the expiration tied selling, this should be seen as a major red flag for bulls.This could suggest that momentum sellers could do even more damage to the market in the coming weeks.

Monday Morning Outlook, October 3, 2022

Looking at my comments from last week, one might wonder if the action in the stock market is considered stability. For one thing, the equity market did as I expected, rallying strongly in the aftermath of the September quarterly expiry. This is normally the case after a sell component in the days or weeks leading up to it.

The Federal Open Market Committee (FOMC) raised the federal funds rate an additional 75 basis points on September 21 and strongly hinted that the fight against inflation was far from over. From that close to the last day of September – which coincided with the quarterly options expiration – the S&P 500 Index (SPX – 3,639.66) continued to sell strongly. But at last Tuesday’s close, the SPX impressively erased all losses since the FOMC’s decision close.

From this perspective, the market has stabilized as the SPX easily climbed back above its June lows in this timeframe. fierce two day rally, and closed the week at these lows, implying a close above previous weeks. However, you could say that the SPX is clearly not out of the woods and the finish was ugly, which is a potential destabilizing factor.

For example, many sellers viewed the two-day lead to the FOMC decision close as their second chance to get rid of stocks. Additionally, a trendline connecting lower highs from the mid-August peak marked intraday highs on Wednesday and Thursday, implying that this technical hurdle should continue to be watched in the coming days (this trendline starts the coming week at 3,760 and closes the week at 3,700).

“…last Monday morning’s gap decline produced another bearish technical omen known as the bearish ‘island reversal’ pattern, in which the August 10 gap upper was followed by the lower gap of August 22..

Monday Morning Outlook, August 28, 2022

There are more potential technical headwinds. Friday’s spread decline was prompted by a negative reaction to a stronger-than-expected September jobs number, dampening hopes among some that a Fed pivot to looser monetary policy could come. produce earlier than expected.

The gap has created another bearish island reversal pattern, which occurs when a jump up is followed by a sharp drop down, and the gap up is not filled in the intermediate days. This is the third time a bearish island reversal has occurred on the SPX since August 22nd. It should be noted that the price action in the days following such a pattern has been far from pretty from a bulls perspective.

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With just two weeks to go until the standard October expiry, delta hedge risk is already back after Friday’s strong sell-off. As you can see from the SPDR S&P 500 ETF Trust Open Interest setup chart (SPY – 362.79) below, significant open interest resides at the 360 ​​strike, and there is even heavier open interest as well. at strike of 350, equivalent to SPX 3,500.

The greater the open interest of the put, the greater its magnetic effect during periods of market weakness. With the proximity of the SPY there is not much room for error if you are a bull. And the overnight risk is significant, with inflation data due out Wednesday and Thursday morning before the opening bell.

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There could be a silver lining for bulls if market participants view inflation data positively, given that near-term sentiment data is at levels from which V-shaped rallies have emerged. But again, after watching the action over the past week, be skeptical of rallies, at least until the first and second of many potential layers of resistance are cleared. Right now, bears have no pressure to unwind bearish bets, and those sitting on the sidelines have no pressure to put money into the market yet.

The first level of SPX resistance sits at the trendline connecting the lower highs since August. Another layer of resistance is last week’s highs in the 3,780 area, with other potential areas of resistance marked on the SPX chart above. If you have a longer term horizon, continue to be hedged or mostly cash as the SPX remains below its 36-month moving average at 3,808, following the close below last month and a failed attempt. to go back over last week. . If you are short-term, be open to all possibilities, with “known, unknown” multiples moving in the market, such as inflation data and retail sales.

Todd Salamone is senior vice president of research at Schaeffer’s Investment Research

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