Stocks Dodged a Delta-Hedge Decline — Now What?

“…after the selloff below 590, the 580-strike was already in play by Friday’s close. Plus, there are several put-heavy strikes below 580, too. This means delta-hedge selling is very much a heightened risk for bulls in the short term, especially if the SPY breaks below the 580-strike.”

          – Monday Morning Outlook, January 13, 2025

Last week’s S&P 500 Index (SPX — 5,996.66) price action was extremely rewarding to anyone that stepped in during Monday morning’s selling, when the index was dangerously close to being in the throes of a sharp, delta-hedge selloff.

The SPDR S&P 500 ETF Trust (SPY — 597.58) had gapped below the put-heavy 580 strike, which could have easily led to a quick 100-point decline to the 570-strike, potentially mirroring the Monday prior to last, when the SPY gapped lower after closing the previous Friday session in the vicinity of its put-heavy 590-strike. In the blink of an eye, the SPY was around the 580-put strike, equivalent to 100 SPX points within only a couple of hours, with delta-hedge selling the likely culprit.

Monday morning’s action was suggesting that a “head and shoulder” topping pattern was in place, but that was not the case at the close of that day’s trading (which is why we emphasize closes). Bulls can take some comfort in the fact that for the most part, a bullish inverse “head and shoulder” breakout in September led to strong gains. But a brief bearish “head and shoulder” breakdown early last week only lasted a couple hours before the neckline was retaken, implying this pattern has not yet taken hold officially.

Amid delta-hedge selloff risk, $SPX trading around its close ahead of the post-election gap in early November at 5,780. Bulls trying to defend it.

— Todd Salamone (@toddsalamone) January 13, 2025

As I observed on X Monday morning, it was immediately apparent that bulls were defending the SPX 5,780 area. In my view, this was a big level, representing the close that preceded the gap higher in early November when election results were clear.

The gap and follow-through action from early November through early December became known as the “Trump Bump.” However, from early December through last Monday morning, one might have called the price action the “Trump Dump.” After all, since early December, traders have begun to fear the Trump administration’s policies may be inflationary. Plus, it did not help when the Federal Reserve suggested in mid-December there may not be as many interest rate cuts as it originally forecasted. As such, stocks sold off as bond yields rose.

Bulls successfully defended the close ahead of the pre-election results and a “V” rally commenced the rest of the week. The major catalyst for the advance was interest rates reversing lower on the heels of multiple benign economic reports from Tuesday through Friday. The data included reports on inflation, retail sales, and housing.

Moreover, I suspect the major put open interest (OI) in the vicinity of the SPY that was a delta-hedge selling threat added a boost, as the unwinding of short positions related to those puts – particularly at the 570 through 590 strikes –  likely exacerbated the rally.

Nonetheless, the rally was significant. In fact, on Friday afternoon, CNBC commentators noted that a trendline connecting lower highs since the SPX peak in early December had been cleared, which was viewed bullishly. 

However, amid the impressive advance last week and the close above this trendline, one might also note that the mid-November high and this year’s peak at 6,013 were not yet cleared.

If we see a drift lower from 6,013, a first level of support could be at 5,940, which is where that trendline extension will be at week’s end. This was also the close ahead of the Friday trendline breakout.

“Bears have exerted control in the 6,000 area and immediately above… non-directional action occurred on the heels of a bearish ‘outside day’ that came after the Fed cut the federal funds rate by 25 basis points on Dec. 18 and suggested that rate cuts in 2025 may be fewer than initially forecasted.”

          – Monday Morning Outlook, January 6, 2025

One might best describe the action since early November as directionless. Short- and intermediate-term moving averages have not been helpful during this period, suggesting there is no short-nor intermediate-term trend in place. As a result, I removed the 20-day, 50-day, and 80-day moving averages from the graph, so that there is less clutter.

You will find that since early November, the SPX 6,000-6,100 has been sold, while the 5,780-5,880 area has been bought. If this pattern repeats, the technical picture would suggest less reward relative to risk for bulls as we enter this week’s trading. and having escaped a larger-than-normal possibility of an option-fueled decline last week.

On the sentiment front, an interesting data point came into view on Wednesday after the SPX’s big rebound from 5,780. There had been a big drop in the percentage of bulls and a big increase in the percentage of bears in the weekly Investors Intelligence (II) survey, which measures newsletter advisor sentiment.

The bulls minus bears reading took a dramatic fall from about 33% to 10%, the biggest drop in that reading since December 2018. The SPX gained almost 8% during the next month and 13% in the next three months. We typically consider readings below 0% or above 40% to be extreme pessimism or optimism, respectively.

By this sentiment measure, the SPX is not nearly as vulnerable to a decline as it was in the past few weeks. In fact, the current reading suggests there could be more upside after many capitulated away from the bull camp.

The 10-day SPX component buy-to-open put/call volume ratio also increased a little bit last week, but the change in sentiment was not as dramatic as that in the II survey. The ratio increased from 0.44 to 0.48 and is still in a range, which pints to optimism among option buyers, who are usually on the wrong side of moves when sentiment amongst them is at an extreme.

Finally, with Inauguration Day on Monday, one might be wondering what to expect in the first 100 days of President Donald Trump’s second term. You may get more data on this later in Rocky White’s “Indicator of the Week,” but as for the first month, since World War II when a Republican non-incumbent takes office, the first month has historically not been rewarding for bulls.

With the SPX near the top if its range and option buyers still optimistic, this is a risk in the immediate days ahead.

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

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.