Downside Remains Limited

Volatility could be boosted by the quarterly expiration of futures and options this week

By Paul Cherney

Sideways price action and some basebuilding would still be natural. This is the week when the monthly stock and index option expirations coincide with the quarterly expiration of stock and index futures contracts. Hedges and cross hedges can see prices move in one direction and then reverse course after leveraged positions have been abandoned.

Downside risk on a closing basis appears limited, a dip in prices not accompanied by a bearish headline universally recognized as a long-term problem will probably not be able to keep prices down for long.

There was so much "good" positive momentum generated by the recent breakouts above the trading ranges that there should be a residual positive effect that should prevent prices from making a dramatic drop, but an intraday shakeout cannot be ruled out.

The psychological weight of the earnings confessional season might be contributing to the lack of volume and the hesitancy to commit to the longside.

This is the week of the quarterly expiration of futures and options, traditionally referred to as the Triple Witch. The week, and expiration Friday have earned a terrifying reputation for volatility, especially in the pre-1987 market. The CME started to stagger the expiration of the futures so index futures and index options and options on individual stocks did not all settle as of the close on the Friday of expiration.

It was in June, 1987, that the CME tried to lessen the intraday volatility at the expiration by using a special settlement price for equity indexes. The Special Settlement price was based on the opening values of an index's component stocks. For example, the special settlement value for the S&P 500 would be based on an artificial price level for the S&P 500 calculated by taking the opening prices for each of the 500 component members and then calculating an S&P 500 value based on only those Friday openings (for the individual stocks in the index).

(This is probably a contributing factor to the huge volume and some delayed openings which can happen at the open of trade on Triple Witch Fridays.)

This is September, a month with a poor performance record. I wondered how the September Triple Witches fared, so I looked at S&P 500 data from 1986 through to September, 2002. I looked at only September Triple Witches. Volatility is synonymous with big price moves which can rattle nerves intraday, but what was the outcome by the close of the sessions?

I looked at the number of times that the S&P 500 managed to close with a gain or a loss of more than 0.99% in a single day during the trade days of the September Triple witch; only 20% of the time was the close for the S&P 500 changed by 1.00% or more (up or down). Based on Data since 1986, here's the breakdown by each trade day of the week:

Mondays up or down by 1% or more 3/17, 17.6% of the time.

Tuesdays up or down by 1% or more 4/17, 23.5% of the time.

Wednesdays up or down by 1% or more 2/17, 11.8% of the time.

Thursdays up or down by 1% or more 5/17, 29.4% of the time.

Fridays up or down by 1% or more 3/17, 17.6% of the time.

Historically, based on these datapoints, Thursday has the best chance of seeing a move of 1.00% or higher.

The S&P 500 has a focus of immediate support at 1,015-1,008. The Nasdaq's immediate intraday support is 1,843.51-1,829.19 with a focus 1,836-1,831. Additional support is 1,825-1,799.

Immediate Nasdaq resistance is multi-layered, which is why a substantial jump higher does not appear likely right now.

Immediate Nasdaq resistance (intraday) is 1,853-1,861.74.

The S&P 500 has resistance at 1,015.87-1,021.51 The next well-defined layer is directly overhead at 1,023-1,026.76.

Intermediate and Longer Term Resistances

The Nasdaq has additional resistance 1,874-1,893, this layer of resistance is based on intraday trade (60 minute bars) from March 18 and 19 of 2002. The further back in time you go, the less important short-term intraday price ranges become but this market has not moved above the 1,893 level intraday.

S&P 500 resistance (daily bar charts) was established by price action in June, 2002, it is 1,008-1,041 with a focus at 1,020-1,031. The index has been unable to close above the 1,031 level. The next resistance is big at 1,048-1,107, from March, 2002. Two different measures of the potential upside for the current break above the 1,015 level target 1,047 and 1,070 as potential upside prints.

On a pure chart basis, the Nasdaq's breakout of its trading range has created the potential for a test of 1,912-1,954. The S&P 500 has the potential to print 1,047-1,070. There is no time schedule for these potential moves.

Cherney is chief market analyst for Standard & Poor's

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