Analysis, Perspective, Trading Strategy
At the Edge of Chaos: The Three P’s: Powell, Putin, and Puts Will Roil Stocks Next Week.
Duarte in the Money Options
March 13, 2022
Aside from the stress and discomfort of the return of Daylight Savings Time, the financial markets are heading into a crucial period as the three P’s: Powell and the Fed, Putin and Ukraine, and Puts – the action in the options market all converge as the future of the markets, and perhaps the world hang in the balance.
Market internals are shining a light on the relentless selling that’s taking place in the S & P 500 (SPX) and the Nasdaq 100 (NDX) as neither index has shown any tendency toward staging a credible reversal anytime soon. See below for details.
In other words, prepare for the unexpected and then trade what you see.
Oil Pulls Back. Vastly Lower Prices Likely When Reversal Takes Hold.
Last week, in this space I suggested that the parabolic rise in the price of oil might have gone as far as it could in the short term.
And yes. I was right. But I’m not taking a victory lap, although I am holding on to my short position at the moment; albeit with very itchy fingers.
Certainly, the situation is fluid. But these are major reasons for the decline in oil to possibly reverse:
- The Iran nuclear deal could falter. Russia is leading the negotiations between the U.S. and Iran. Enough said here.
- The U.S. is negotiating with Venezuela as a possible alternative source of oil. Same here, as this is a highly unpredictable situation.
- U.S. Oil companies are not keen or restarting production at the moment.
- The war in Ukraine could take a turn for the worse.
As a result, if you’re short crude oil, as I am, keep a short leash on the position and if you’ve got a profit don’t be afraid to reduce the position size.
The chart for the U.S. Oil ETF (USO) shows that crude has worked off its overbought state and that there are some dip buyers coming in, although that could change in a hurry.
Here are the current pertinent technicals to consider:
- RSI is well down after being well above 80 – an exceptionally overbought level
- ROC is also well off its highs after its parabolic adventure
- USO is back inside the Bollinger Bands but has not tested the 20 day moving average as of yet
- Most important – There is weak support at $70 given the small size of the Volume by Price (VBP) bar.
Putting it all together, it looks as if the oil market is now playing a wait and see game as the geopolitical game intensifies. But what we do know is that if peace breaks out, the price of crude is likely to fall hard and fast.
That’s because there is very little support at $70 on USO with the next big VBP bar being at $60.
Crude oil for May delivery has support at the $100-$104 area. A break below that would likely lead to lower prices in a hurry.
The Three P’s
The combination of options expiration (3/18/22), the FOMC meeting (3/15-3/16/22) and the general state of the Ukraine situation promise to make next week a potential mess.
Powell - The Federal Reserve
First the Fed. Mr. Powell has made it clear that he will be raising interest rates by 0.25 basis points (1/4 point on the Fed Funds rate).
That’s in the market already.
However, the post announcement press conference usually provides fireworks. And given the current situation, it could make for more volatile trading.
Puts – Options Expiration
The next concern is Friday’s options expiration for equities, equity indexes, ETF and ETN options, which has been valued at $3.3 trillion.
Traders are going into the expiration with big profits in short positions. The recent pullback in VIX shows that some profit taking has taken place. But as the Put/Call ratio shows (see chart) put volume rose ahead of the weekend, which means that enough traders remain bearish.
Thus, whichever way they decide to unwind those short positions during next week will impact the market.
I suspect that by Wednesday, after the Fed meeting, we will get a clue as to what lies ahead.
The composite chart of the CBOE Volatility Index (VIX) the Put/Call Ratio (CPC) and the S & P 500 (SPX) shows the tight correlation between put volume and stock prices.
Note that over the last few days, a rise in the CPC has shown high correlation to falling SPX prices and a rise in VIX. That’s because, as I explain below of the relationship between the market and the market makers.
Aggressive closing of put purchases would leave a big vacuum in the market which could put call buyers in control and move prices higher in the short term. A re-establishment of short positions could move prices lower.
Putin - Russia-Ukraine
And then of course is the Russia-Ukraine situation itself. Any development, positive or negative will impact all the markets, equities, commodities, bonds, cryptos and currencies.
All of which brings me back to options. If there is a major development in Ukraine, I would expect options expiration to magnify the market’s response.
Finally, as I’ve noted here on multiple occasions; if the prevailing market conditions lead to a liquidity crisis, then all bets are off.
Thus, whatever Mr. Powell says and does will add to the already convoluted mix
Welcome to the Edge of Chaos:
“The edge of chaos is a transition space between order and disorder that is hypothesized to exist within a wide variety of systems. This transition zone is a region of bounded instability that engenders a constant dynamic interplay between order and disorder.” – Complexity Labs
For more on how to develop a trading plan and how to approach this market have a look at my latest Your Daily Five video here.
For more on a risk averse approach to trading stocks consider a FREE trial to my service. Click here.
Market Breadth Breaks to New Lows. Sellers in Charge.
The New York Stock Exchange Advance Decline line (NYAD) closed at a new low on 3/11/22 confirming the continuation of the down trend is likely. This is despite the lack of a new low on RSI, which usually means that we are in a situation where a panic low is forming.
The chart for NYAD, below, clearly shows a bearish lower high, lower low pattern is well established at the moment.
So, no matter what, it’s hard to argue with the fact that if this is a panic low, it’s taking its sweet time before delivering a significant market bottom.
VIX Rolls Over. Are Put Buyers Tapped Out?
Stocks remain in a volatile trading range but the CBOE Volatility Index (VIX) rolled over for most of last week, although it perked up at the end of trading on Friday. See above for full explanation of what this may mean.
A rise in VIX signals that put option volume (bets that the market is going to fall) are on the rise. What follows when put volume rises is that rising put volumes cause market makers to sell puts and simultaneously hedge their bets by selling stocks and stock index futures.
Speaking of VIX, in my recent video, I expanded, in detail, as to how this process works.
The S & P 500 (SPX) failed to make a new low and remained above key support. That’s the good news.
Unfortunately, as I’ve noticed here multiple times, On Balance Volume (OBV) is falling rapidly, which mirrors the action in the NYAD. This suggests that the selling remains steady and that any type of rally would be temporary and likely would be replaced by more selling fairly soon.
4100-4300 remains the key support band.
The Nasdaq 100 index (NDX) is showing a similar and equally negative picture where On Balance Volume (OBV) is on a decidedly downward path suggesting that the sellers here are also in control.
The S & P Small Cap 600 index (SML) continues to show relative strength as its volatility has been dampened over the last few weeks. This suggests that small stocks may be an important component of any future rally.
But at this point, it’s not an emergent situation, meaning there is no rush to buy small cap stocks.
To get the latest up to date information on options trading, check out Options Trading for Dummies, now in its 4th Edition – Available Now!
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