A Playbook for Last Week's Pullback

"2,907: this is coincident with the round -10% year-to-date (YTD) return and vicinity of the 2,900-century mark. (In 2019, the +10% YTD return marked brief resistance in February and support in early March and early June)"

-Monday Morning Outlook, April 20, 2020

Additionally, on the hourly chart of the SPX's year-to-date (YTD) percentage gain/loss immediately below, note the importance of the round minus 10% level. The action around this level represents how the psychology of the market has changed since the rapid descent into the March lows that shaved nearly 35% from closing peak to trough. In February, investors quickly bought the 10% pullback from the January 2019 close. But after sharp selling occurred after the break of the -10% YTD level they are now quick to sell here, content with taking a year-to-date loss of 10% versus the 2020 paper losses of a much larger magnitude just weeks ago.

"Looking ahead, I added up open interest on SPY options expiring through June expiration, including Friday weekly options. The open interest configuration for this period looks somewhat similar to May's standard open interest configuration, with heavy put open interest from the 220 through 280 strikes. If the SPY continues to hold its head above 280 in the coming weeks, a tailwind of gradual unwinding of short positions related to the those put strikes could help support the equity market."

-Monday Morning Outlook, May 11, 2020

Expiring options through June expiration on the SPY represent the mountain of caution toward the economy and the stock market that we witnessed last week, as I excerpted at the beginning of this commentary. In the coming weeks, to the extent that the SPY can hold its head above the $280 level -- equivalent to the 2,800 SPX support area -- a slight tailwind could push it higher, as short covering related to huge out-of-the-money put open interest could emerge. Such short covering could lend a hand in a retest of the upper end of the range.

Meanwhile, stick to your long positions if you are a longer-term investor. The publicized caution that we saw last week may have had a negative coincidental impact on stocks, but the caution creates a lower bar to hurdle ahead. Moreover, the negativity on stocks confirms that some big hedge fund managers have low equity exposure, which represents future buying power.

Continue to follow the road map I had laid out several weeks ago, keying to monthly closes on the SPX relative to its 36-month and 80-month moving averages. Last week's low, in fact, was the site of its 36-month moving average, but we continue to emphasize monthly closes with respect to both trendlines.

You can also use the CBOE Market Volatility Index (VIX-31.89) as a cue to another major volatility pop being imminent. It is interesting that last week's VIX closing low occurred on Monday at 27.57, with 27.56 representing exactly double the 2019 close. This will be a level to watch if the VIX declines in the immediate future. The VIX remains below half its 2020 closing high at 41.35, hitting a high of 39.28 last week. A VIX close back above one-half its 2020 closing high heightens the chance of at least a retest of the SPX lows and would be an invitation to hedge against such an occurrence.

Todd Salamone is Schaeffer's Senior V.P. of Research

Continue reading: