Gapping On Expiration

Posted At 9:15 AM EST

Good morning...We begin the day with some buying interest in the pre-market futures as traders awake to see how some of their expiring options contracts are going to be priced.  There are always a lot of games played with these opens, as we'll see below.

As a matter of course, when volatility and volume dies down, emotional extremes do to, and we're certainly seeing that among some of the indicators we follow.  That lack of movement has created a lack of topics to discuss, so today's comment is going to be extremely short.

Yesterday we overviewed a few short-term and longer-term timing indicators, and the conclusion was that we should bounce near-term but the intermediate-term is still questionable because of a multitude of signs of excessive speculation combined with waning momentum.

The indexes did bounce OK yesterday and look to continue that this morning.  In an intraday update yesterday, I noted that the signs that were pointing higher into today were dropping off, and a few negatives were popping up, so any move into 925-930ish today should be at least partially given back early next week.

As further support of that idea, the table below shows other times over the past 9 years when the S&P 500 futures have gapped up +0.5% or more on an option expiration morning, when looking through Monday's close.

We can see an obvious negative bias there, with only 5 positive trades out of the past 30 occurrences, and the risk over the next two sessions was tilted almost 3-to-1 over the maximum reward.

That becomes even more exaggerated if we remove the outlier from last November 21st.  Without that instance, the average return from Friday's open to Monday's close was -0.9%, with an average risk of -1.7% compared to an average reward of +0.3%.

So this is very short-term only, but it does fit with the other stuff we went over yesterday - the short-term bullish edge is dissipating quickly, and a move back into the middle of the recent range may run into trouble heading into early next week.  If we do happen to roll over soon and violate the recent lows, then given some of the longer-term concerns we have to be worried about a bigger-picture pullback.

Bottom line - Intermediate-term Outlook: Neutral (since April 9, SPX 843)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

During mid-April, several of our measures like the Indicator Score and Dumb Money Confidence reached levels that usually result in either a flattening out of the price rally, or an outright decline, especially during a bear market.

But the market held up extremely well in spite of some of these overbought types of indications.  This is very rare during an ongoing bear market, and is important to keep in mind especially given many of the "this time is different" kinds of studies we reiterated in early May.

While there have been - and continue to be - many reasons to consider this rally something different than we'd seen previously in the bear market, I've been looking for the S&P to run into trouble if it traded into 940-950, which it happened last week.  I wasn't expecting any kind of waterfall decline to new lows, just more of a pullback than we'd seen.

What's made this juncture so difficult is that despite so many signs of "this time is different" and the market doing nothing wrong, there are some troubling signs out there.  We touched on a couple very recently, like the surge in speculative trading and the return of bullish opinion.  Because of that, I've been leery of the S&P's chances to hold a breakout above 950.

With the most recent surge in the spread between the Dumb Money and Smart Money Confidence, and the tendency for initial breakouts from volatility coils to be "false", I was looking for the first breakout above 950 to be beaten back, which occurred last week.  From here, we'll have to see how the market responds to oversold conditions in order to get a better handle on whether we're seeing just another correction, or the possibility of a larger trend change.

Bottom line - Short-term Outlook:  Neutral (since June 3, SPX 924)

Over the past couple of days, the bias has been mostly bullish due to a variety of factors, but those are expiring today.  Given that, what we went over above, and nearly overbought short-term guides, I'm pulling back on that bullish bias as the S&P looks to open in the 925 - 930ish zone.

All the best,