Seismic Waves

Last week definitely shook up the system.  On Thursday and Friday, it appears that all the podshops decided to suddenly unwind their long NDX, short RUT trade.  With last week's Russell 2000 outperformance, you have a bunch of market "experts" who are suddenly bulled up because small cap stocks have outperformed large caps for the past 2 trading days.  CNBC was about as bullish as I've heard from them in recent memory, as they were touting the suddenly strong breadth in the market.  Seeing the strong outperformance of heavily shorted stocks last week, it looks more like a de-grossing of hedge fund positions than a new trend of high demand for small caps.  

You will often see these violent moves up and down at inflection points, where eager buying is met with eager selling.  This is not only happening at the index level, but at the spread level between indexes, as uncle points get reached and stop losses get hit.  These are classic signs of an imminent trend reversal.  You can feel the tension as the FOMO fast money gets hot and heavy, being met with supply from corporate insiders and longer term players gladly selling into these  high price levels. 

We're now near the end of a positive seasonal tailwind that lasts until July opex which is this Friday.  Considering the low put/call ratios and the rampant call option speculation over the past few weeks, I expect a big hangover as you get close to this monthly opex.  The ISEE index showing the call/put ratio of opening transactions reveals the stretched nature of the options activity.  The ISEE index 20 day MA is now the highest in its history, higher than even the go-go speculative days of 2021.  

I am seeing similarly high levels of opening transactions in calls vs puts in the OCC data that comes out weekly.  Options speculators are heavily betting on more upside, aggressively buying call options in the most liquid, high beta names.  Here is the call activity in IWM on Friday, the highest daily call volume ever for this ETF.  The net deltas and overall premiums paid for IWM call options were extreme. 

The overbought and overextended charts in SPX is a powder keg, waiting to trigger at the slightest hint of weakness.  The markets often trade in symmetry, so when prices go up rapidly, they are apt to fall rapidly.  Its been quite a steep uptrend over the past several days, and big picture, for most of 2024.  A couple of markets this reminds me of are July 1998 and January 2018.  Sharp blowoff tops that reversed even more quickly than they went up.

SPX July 1998

SPX January 2018

 

Over the weekend, after studying the Commitment of Traders data in more detail, it was an eye opener to see how long the asset managers have gotten in SPX futures, with the net long as a percent of open interest much higher than even the highest levels in 2021.  And those asset manager net long levels in 2021 were much higher than previous highs seen in early 2018.  Most of the increase in asset manager net long exposure has come from a huge decrease in the number of short positions.  SPY and QQQ short interest also keep going lower and lower.  The Street is very lightly hedged for downside at the present time.  I didn't think it was possible so quickly after the everything bubble in 2021, but in many ways, this current AI bubble is more frothy and dangerous for long term stock investors.  For sure, the positioning in SPX futures and SPY/QQQ ETFs is definitely more ominous than in 2021. 

COT SPX Asset Manager Short Position

SPY/QQQ Short Interest

A confluence of indicators are lining up to present a high risk/reward opportunity on the short side for SPX and NDX.  Technical, seasonal, and positional indicators are flashing amber lights here.  I am hearing many traders and investors who view July as a slam dunk up month, pointing to seasonality, and many of them are planning to sell at the end of the month.  I would not be surprised to see a sudden rush for the exits over the next 2 weeks as the uptrend tops out and post opex forces come into effect after a huge call buying spree over the past several weeks.  

Add to the mix the suddenly bullish news flow (Trump assassination attempt bumping up his election odds) and you have the ingredients for a good news topping process (cooler CPI, more Fed rate cuts priced in, Trump odds of winning going up, stronger breadth, etc.).  This it's "so bright, you have to wear shades" kind of news flow over the past week with the volatile price action catches my attention.  Based on pure instinct, I want to short more.  I plan on adding more SPX shorts early this week to get to a max short position.  I have not seen such a good risk/reward opportunity on the short side in SPX since late 2021.