Option Investor
Index Wrap

Leap'n Leprechauns!

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If you were skeptical that Leprechauns really existed, or uncertain that a pending option expiration, let alone a Triple Witch expiration might add a little volatility to the market, then you might believe in Leprechauns, option expiration-related volatility, or both, after today's trade.

With a last name of "Bailey," you know I believe in Leprechauns. I was looking for one to strangle earlier today, when power at my home office would go out, then go back on, then go off, then back on, then off in intermittent 15-minute spurts.

Option expiration week is tough enough on a trader, without having some pointy-eared little creature playing with the power switch.

One can never say for certain that a market's trade was dictated by option expiration, but there were too many things that took place in today's trade, which highly suggest there was some unraveling of options, and index futures, which most likely had great impact on today's session.

Hold onto your lucky charms, as we aren't through yet, and there's always tomorrow.

Yes... this is "short-term" observations, or commentary towards the shorter-term, but I think if we can get some background on what is going on, it will help us over the next several months.

If you're a bear, and I'm taking on a more bearish outlook for the next couple of months, then all you can do at this point is manage your trading with account risk in mind. In the meantime, find a piece of shoe leather and bite down hard.

Market Snapshot / Internals - 03/17/04

I'd say today's trade represents a "St. Patrick's Day bounce." When reviewing my QCharts U.S. Market Watch screen, only the Pharmaceutical Index (DRG.X) 323.71 -0.66% and Dow Jones Home Construction Index (DJUSHB) 667.74 -1.45% showed a decline, while Internet (INX.X) 177.57 +4.10%, Airline (XAL.X) 54.15 +3.39% and Networking (NWX.X) 273.06 +2.72% lead a long list of sector gainers.

Pivot Analysis Matrix -

While I would NEVER put on a trade SOLELY based on the theory of "Max Pain" into options expiration, it is notable that the broad S&P 500 Index (SPX.X) traded a session high of 1,125.76 today, where a rally appeared seemingly out of nowhere. I'm certain that we started discussing "Max Pain" levels last week. Tomorrow is index expiration for the SPX.X.

Now, does the actual "Max Pain" level of 1,125 for the SPX mean that this is it? The SPX will now just sit here at 1,125 tomorrow? NO IT DOES NOT!

If you read this weekend's Ask the Analyst, then the following chart of the SPX.X might make some sense as to what an options market maker might be looking at. He/she has the advantage over you and I, but if I simply take a retracement Monday's low, and fit the 50% retracement at my "Max Pain" level of 1,125.00, then we might be able to get a feel for tomorrow's trade. Remember that option/futures expiration isn't over, until it is over!

S&P 500 Index (SPX.X) Chart - 30-minute intervals

At the open, when the SPX jumped above 1111.62, a next level of upside risk could have been established at 1,119.89 (that's pretty close to tomorrow's DAILY PIVOT). When 1,119.89, or the prior 30-minute bar was taken out to the upside, the next level of upside risk was 1,125.00, or the March "Max Pain" level.

I don't want to just focus on the in the money put holders, who obviously experienced some PAIN today, but what do you think some of the March 1,150 put (SPTOJ) are thinking tonight? Let's also take into consideration the open interest (OI) of approximately 40,622 March 1,100 call holders. How are they feeling tonight! You're darned right in thinking that they believe in Leprechans, as long as the SPX stays above 1,119. A break below 1,119 could have all of today's gains being at risk.

Do you see how we should still expect, or be prepared for volatility, and how the unraveling of some futures or options trades can just build on itself?

e-mini March S&P futures (es04h) - Daily Intervals

We can perhaps see how some unwinding in the futures market took place today, when the e-mini gapped back above 1,112, where risk was immediately assessed to 1,129.50-1,131.25 "zone of resistance" where I would have to have a BEARISH bias. Is 1,130 in play tomorrow? Certainly! DAILY R1 in the SPX is 1,129.44, and WEEKLY Pivot of 1,128.79 is also close. Add to that the 30- minute chart, and we still be alert to a potentially higher trade, especially if today's highs are taken out.

Now here is where I would really start taking some notes as to my more bearish thoughts (based on market internals, bullish % deteriorating) into FRIDAY's close.

If it is true, that much of the gains found are being largely driven by option/futures expiration, then SMART MONEY in the MARKET that KNOWS the major indices still have some downside (below the lows set this week) will most likely be positioning themselves with a BEARISH bias around the 1,130 level.

At least I think so.

NASDAQ-100 Tracking Stock (QQQ) - Daily Intervals

One observation I'd make tonight is the rather notable drop-off in volume today, but boy did we make some notes as to higher levels of option volume! Again, this suggests to me that today's trade was highly impacted by option/futures trade.

I also made note today that the Market Volatility Index (VIX.X) 18.11 -10.96%, NASDAQ-100 Volatility Index (VXN.X) 24.75 -9.47% and the VXO.X 18.14 -12.4% imploded today, and it wasn't just on call buying, but put options were also very active, and to get such a drop in the volatility indicators, with heavy put volume, that has me believing that today's gains for the indices was influenced by an unraveling of positions in the options market.

Tomorrow, I'm going to begin building some further observations and trading plans, which surrounds the VIX.X. There are some VERY GOOD ties we can make between the S&P 500 Bullish % ($BPSPX) and the VIX.X. If you were with us in March of 2003, you know what I'm talking about.

Jeff Bailey

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