Notice: To view this week’s big picture outlook, click here.
What Happened: After a brief liquidation during Monday’s session, U.S. index futures traded flat overnight, with the S&P 500 rotating within an 8-session balance-area.
What Does It Mean: During Monday’s regular trade in the S&P 500, market participants were unable to break through to new highs; profile structures denoted a market that wasn’t paying longs that were late to the party.
Further, the Monday morning liquidation cleared the inventory of those participants that bought too much, repairing some poor structures left in the wake of last week’s upside discovery.
Given that the $3,824.25 balance-area high (BAH) was rejected, upside conviction remains intact (graphics 1 and 2 confirm this).
As a result, attention is drawn to the $3,852.50 ledge which has attracted responsive sellers numerous times over the past 8-sessions.
Graphic 1: Order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500Graphic 2: Speculative derivatives activity for Monday, January 25
What To Expect: Tuesday’s regular session (9:30 AM – 4:00 PM ET) will likely open inside of prior-balance and -range, suggesting higher volatility and limited directional opportunity.
As stated earlier, participants have to contend with the $3,852.50 ledge. In today’s session, (1) a lack of upside continuation increases confidence among responsive sellers to transact below the ledge or (2) the level cracks, and initiative buying surfaces. In the latter case, the best outcome would include a test of the $3,859.75 overnight all-time high (there is a low probability that overnight all-time highs end the upside discovery process) and $3,884.75 price projection, or double the width of the balance-area, the typical target on a balance-area breakout.
The go/no-go for upside is the $3,852.50 ledge. The go/no-go for downside is $3.821.50 overnight low.
Levels Of Interest: $3,852.50 ledge, $3.821.50 overnight low.
What Happened: After prices were advertised below balance in the week prior, responsive buyers in the S&P 500 began a rally that found acceptance back inside a larger balance-area, near the $3,800 high-open interest strike.
Thereafter, initiative buyers extended the S&P 500’s rally, breaking the index above its $3,824.25 balance-area high (BAH), before establishing acceptance near the $3,850.00 price extension, an upside target, and auctioning back into range, repairing poor structures left in the wake of discovery.
What Does It Mean: In light of a failed breakdown in the week prior, U.S. stock indexes were best positioned for further downside discovery. However, after what appears to be aggressive buying in response to prices below value, it was clear that was not the case.
This leads to the following question: why did selling stop on January 15? One answer, aside from a positive start to the earnings season and prospects for further stimulus, may be OPEX, the January 15 option expiry. On expiration days, delta and gamma exposures change — depending on how derivatives exposure is removed or rolled — which causes dealers to adjust hedges.
According to SpotGamma, the January 15 expiry “resulted in a ~50% reduction in single stock gamma … [which] creates volatility because, as large options positions expire[], are closed and/or rolled, dealers have large hedges they need to adjust. There is a trove of data to suggest that the bulk of single stock call activity is long calls, and based on that we believe dealers (who are short calls vs long stock) therefore have long stock positions to sell.”
Put more simply, the price action may have been attributable to the sale of long stock that hedged expiring short derivatives exposure above the market (i.e., call side).
Per the SpotGamma S&P 500 dealer hedging graphic for the January 15 expiry below, “The black line was the mark on Thursday evening, with the red line being the forecasted position on Tuesday. This red line being substantially lower than the black suggests that dealers had to reduce delta exposure as a result of expiration. Note there is a larger shift at overhead prices suggesting this was a ‘call heavy’ expiration.”
Graphic 1: SpotGamma S&P 500 dealer hedging graphic for the January 15 options expiry
After the VIX (i.e., CBOE’s Volatility Index) expiry on January 20, alongside the inauguration of President Joe Biden, the prospects for a rally improved as “event premium in IV dries up … [and] put values drop, which allows dealers (who are short puts) to buy back short hedges … [fueling] a quick rally up to the 3850SPX/385SPY level (green arrow).”
Graphic 2: SpotGamma S&P 500 Gamma Levels
Adding, the number of put options sold to open exceeded the number bought to open, per SpotGamma, suggesting increased confidence in higher prices as market participants look to options for income, and not insurance.
Historically, the returns after such developments are mixed — more often the appearance of strong initiative buying surfaces (e.g., August and January 2020) before a liquidation helps correct excess inventory, and bring sense back into the market.
What To Expect: During Friday’s session in the S&P 500, responsive buying surfaced after a test of the $3,818.25 High-Volume Node (HVNode), above the $3,813.50 ledge (below which is a pocket of low-volume).
In the simplest way, high-volume areas can be thought of as building blocks. A structurally sound market will build on past areas of high-volume. Should the market trend for long periods of time, it will lack sound structure (identified as a low-volume area which denotes directional conviction and ought to offer support on any test).
If participants were to auction and find acceptance into areas of prior low-volume, then future discovery ought to be volatile and quick as participants look to areas of value for favorable entry or exit.
After the S&P 500 found acceptance above the $3,813.50 ledge and $3,824.25 BAH, it encountered responsive selling near the $3,840.75 HVNode, the site of a downtrend line. Since the selling transpired at a visual level, market participants know that technically-driven, short-term traders in control. In other words, institutions (e.g, funds) tend not to transact at exact technical levels.
Given the aforementioned dynamics, participants will come into Monday’s session knowing the following:
The S&P 500’s higher-time frame breakout remains intact, per graphics 7, 8, and 9.
Late last year, JPMorgan Chase & Co. (NYSE: JPM) strategist Marko Kolanovic suggested equities would rally with the S&P 500 auctioning as high as $4,000 on the basis of low rates, improved fundamentals, buybacks, as well as systematic and hedge fund strategies. Since then, Kolanovic downgraded growth and expressed the limited potential for further upside.
The earnings of heavily weighted index constituents suggests participants discount improved speculative flows and delta (e.g., presence of committed buying or selling as measured by volume delta). Please see graphics 4, 5, and 6.
Graphic 4: Supportive order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500, on January 20 trend day.Graphic 5: Supportive order flow in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500, on January 22.Graphic 6: Speculative derivatives activity for the week ending January 23, 2021.Graphic 7: Daily candlestick chart of the cash S&P 500 Index
Given the above dynamics, the following frameworks apply for next week’s trade.
In the best case, the S&P 500 takes back Friday’s liquidation and auctions above the $3,840.75 HVNode. Expectations thereafter include continued balance or initiative buying to take out the $3,859.75 overnight all-time high (there is a low probability that overnight all-time highs end the upside discovery process). Thereafter buying continues as high as the $3,884.75 price projection, or double the width of the balance-area, the typical target on a balance-area breakout.
In the worst case, any break that finds increased involvement (i.e., supportive flows and delta) below $3,824.25 BAH, would favor continuation as low as the $3,763.75 BAL.
Graphic 8: Profile overlays on a 15-minute candlestick chart of the Micro E-mini S&P 500 Futures
Conclusions: Despite broad-market indices being in a longer-term uptrend, the odds of substantial upside resolve are low. Participants ought to look for favorable areas to transact, such as those high-volume areas in the S&P 500 featured in graphic 8.
All in all, the risk and reward dynamics, at these price levels, are poor.
Graphic 9: 4-hour profile chart of the Micro E-mini S&P 500 Futures
Notice: To view this week’s big picture outlook, click here.
What Happened: Alongside uncertainty surrounding Senate runoffs and new COVID lockdowns, U.S. index futures balanced overnight after Monday’s rapid sell-off.
What Does It Mean: During last Thursday’s session, initiative buying, in the S&P 500, diverged prices from value. This dynamic resolved itself in Monday’s regular trade.
Overnight, prices recovered off their lows, but encountered responsive selling at the $3,705.00 low-volume node (LVNode).
What To Expect: Tuesday’s regular session (9:30 AM – 4:00 PM ET) will open inside of prior-balance and -range.
Adding, participants will come into today’s session knowing the following: (1) short-term, technically-driven market traders were not able to defend last week’s advance on tapering, holiday volumes, (2) weekend trade established a new all-time high (i.e., historically, there is a low probability that overnight all-time highs end the upside discovery process), (3) increased capital was not committed into the lows, evidenced by a divergent delta (i.e., the difference between buying and selling pressure), (4) the auction is resisting the low-volume area above $3,705.00, leaving a ledge, (5) a proxy for buying derived from short sales (i.e., liquidity provision on the market making side) rose, (6) bearish activity was concentrated in shorter-dated options.
Pictured: Speculative derivatives activity on Monday, January 4, 2021. Pictured: DIX by Squeeze Metrics suggests divergence between price and buying. Pictured: Divergent delta in the SPDR S&P 500 ETF Trust (NYSE: SPY), the largest ETF that tracks the S&P 500.
Given the above dynamics, the following framework applies:
The S&P 500 will likely open within prior-balance and -range, so volatility will likely be high. The go/no-go level for upside is the $3,705.00 ledge which has repeatedly attracted responsive selling. Should prices auction off the ledge, into the low-volume area, the likelihood of continuation increases substantially. In such case, participants would then monitor for a response at the $3,727.25 high-volume node (HVNode), which also corresponds with a 61.80% fibonacci retracement.
Noting: High-volume areas represent value and have the tendency to attract price. Should the market auction into the high-volume area, then prices should slow as balanced, two-sided trade takes over (i.e., the region offers attractive entry and exit). Auctioning through the high-volume area would be the most positive outcome.
Breaking below Monday’s regular-trade low would be the most negative outcome. In that case, participants would monitor for responses at the high-volume node near $3,610.00 and the $3,597.50 anchored, volume-weighted average price.
Levels Of Interest: $3,705.00 LVNode.
Overall: The higher-time frame breakout in the S&P 500 remains intact. Caution warranted.
Pictured: Daily candlestick chart of the cash S&P 500 Index.
What Happened: After a day of balance, and a brief overnight liquidation alongside news that President Donald Trump would not sign a coronavirus relief bill until the size of stimulus checks is increased, U.S. index futures rebounded, with the S&P 500 returning to the $3,691.00 ledge, a level that’s repeatedly attracted responsive sellers.
What Does It Mean: During Tuesday’s session, participants accepted the prior day’s recovery, evidenced by the two-sided trade at prices where the most activity occurred during the prior day, or point of control (POC).
Given that participants deem the high end of Monday’s range fair to do business in, participants will come into Wednesday’s session knowing that the $3,691.00 high-volume ledge is a key upside reference. The aforementioned ledge denotes a pause in discovery, likely attributable to the declining participation ahead of the holiday weekend.
That said, below the ledge, responsive buyers continue to resurface at the $3,667.75 high-volume node (HVNode) on long liquidations (i.e., those events that are caused by overly committed short-term participants that trim positions in panic because they lack the wherewithal or conviction to follow-through).
Pictured: Visual of /MES $3,691.00 ledge.
What To Expect: In light of the overnight recovery and trade near the $3,691.00 ledge, the following frameworks apply for today’s trade.
In the best case, buyers hold the the index above its $3,667.75 HVNode. Holding said reference would be indicative of continued balance after Monday’s recovery; in such case, participants would look for signs of follow-through above the $3,691.00 ledge. Once the ledge cracks (i.e., participants initiate and accept, spend more than 15-minutes above the level), it ought to (1) offer support and (2) draw in buyers to continue the upside discovery process up to, at least, the $3,700.00 and $3,707.75 HVNodes.
Anything higher targets the $3,724.25 overnight rally high.
Levels Of Interest: The $3,691.00 ledge, $3,667.75, $3,700.00 and $3,707.75 HVNodes, as well as the $3,724.25 overnight high.
Bonus: Big-picture breakout remains intact. See below for opportunities unfolding.
Pictured: Daily candlestick chart of the cash S&P 500 Index
What Happened: A day after major indices established record highs, futures remain outside of a bigger balance-area, suggesting acceptance of higher prices and improved odds of further upside.
What Does It Mean: In Tuesday’s regular trading, initiative buyers extended range, further confirming the break from last week’s balance area.
Thus far, there were two significant attempts overnight to auction back into the balance area. Auctioning below the upper balance boundary, below the $3,640 ledge, would be the most negative outcome, and could foreshadow a test as low as the lower balance area boundary, near $3,590.
Given that the S&P 500 remains outside of the week-long balance area, above the $3,640 ledge, participants know that initiative buyers remain in control and pullbacks are buyable. Auctioning into and below the balance area boundary, puts the rally on hold, and suggests further balance.
Levels Of Interest: $3,640 ledge.
Bonus: The S&P 500’s higher timeframe breakout remains intact.
Pictured: Daily candlestick chart of the cash S&P 500 Index
What Happened: Alongside optimism surrounding a coronavirus vaccine and the economic recovery, stock index futures are trading out of range and balance, improving the prospects for further upside.
What Does It Mean: In Monday’s regular trading, responsive buying surfaced after the repair of poor structures left behind the November 24 upside discovery process.
Simply put, the S&P 500 established a v-shaped recovery — 100% retracement of the November 30 session high — after a test of the high-volume node near $3,600 offered responsive participants a favorable buying opportunity.
Overnight, buyers further extended range, breaking a week-long balance area.
Given the bullish break above the responsive selling ledge at $3,640, participants now know that initiative buyers are firmly in control, and the primary target remains the $3,668.75 all-time rally high.
Due to the gap’s size, the odds of range expansion during the day session are lower. As a result, participants should monitor whether the resistive $3,640 ledge now turns into support. Breaking below that level puts the rally on hold, and suggests further balance.
