How $SPY Options Prepared Me For a Pullback Last Week and What’s Up For Next Week.

I have received a couple of questions regarding my tweets last week since it was the first time in a while I had directed caution based on what I was seeing in the SPY options market. I decided to write about it for anyone that wants to know my thought process going into last week.

Anyone who follows me knows that I tweet open interest graphs pretty much every night  (explaination of open interest) on momentum stocks as well as on SPY. I like to track changes and see if it can help give me clues as to where the market may be going near term. It’s not an exact science by any means and I take in many more factors than just the options market when examining what I think might happen. Note that what I think might happen does not dictate my every move, but may give me a bias toward how I approach the market at any given time. I have been one of the more bullish traders on the stream for most of this ride up. It hasn’t been easy as I have never experienced this kind of melt up. Luckily, I follow great traders that have helped keep me confidant being on the right side of the trade. Here are some of them and I’m probably leaving out others that have had impact on me (@harmongreg @chessNwine  @Dmoneydtx  @alphatrends @RyanDetrick @jfahmy @RedDogT3Live).

So last weekend I posted this onto StockTwits and twitter (@rrshasss)

On Monday evening I posted this:

Things got more complicated in the options after that and by Wednesday morning I was less confidant that we would see that pullback below 165 (the market never makes it easy); however, I remained cautious. Here are the details to those tweets and my thought process.

Over the weekend when I graphed the open interest (OI) for SPY I noticed the huge puts sitting at 165. That isn’t completely out of the ordinary. Usually there is a better balance between the puts and calls, but I have seen heavy put buying before so I wasn’t shocked. When I see something like that though, I check the time and sales of the options to see if anything noticeable stands out (basically what I am looking for is institutional buying). What I noticed was large (2 – 3 thousand) blocks of trading at the ask price late in the day Friday. And there were many blocks, accounting for roughly 2/3 of the over 158,000 puts. That told me one of two things. There was either a lot of weekend hedging going on or someone was preparing for a pull-back in the coming week (meaning last week). Keep in mind that I didn’t heed warning solely based on this information. Obviously, we were technically overbought, seeing divergences, and had just experienced two weeks of the funnest trading ever where you can just close your eyes pick a stock and it would likely reward you (I think the term is animal spirits). Below is the graph going into Monday’s session:

We did not get a pull back on Monday and instead went higher decreasing the value of the 165 puts. Had they been bought purely for potential weekend risk then you would think the open interest, once adjusted to Monday’s trading, would show much less puts at the 165 strike. However, they were still there with some more added, but nothing that stood out. Below is the graph going into Tuesday’s session:

That gave me a little more conviction that we would get below 165 because someone with a lot of money wanted to get paid. Typically when I see big block buying (it works better with individual stocks), someone knows something and they end up in the money (ITM). With regards to SPY it works better for calls than puts, but again given all the evidence etc etc.

As I mentioned before, the OI for Wednesday morning was more complicated; however the 165’s were still there with a fresh set of decent size puts at 166. You know the rest of the story. We made new highs Wednesday morning and then dropped from there. The low for Wednesday was 165.17. Although the 165 puts had managed to get back some lost value, it was apparent by Thursdays open interest that they wanted more (i.e. the puts were still there). And low and behold we gap down and those puts go into the money. By Friday morning, about a 1/3 of them had been taken off and although I usually try to predict a somewhat narrow range for Friday’s pinning, the options were too erratic and my prediction was wider giving a range of 164 to 166.5.

Hopefully that helps explain why I gave those 165 puts credence going into last week and heeded caution.

As for next week, before I post what SPY OI looks like I should forewarn you that I haven’t decided yet if I am going to keep posting OI for SPY (I will for other momentum stocks, but may not for SPY and AAPL anymore). The reason I may stop is that someone on StockTwits already has a website dedicated to posting the OI for those names and has been doing it since way before I even graphed them for myself. He had something rather insulting to say about my postings the other day. I realize that he doesn’t have ownership to people posting similar work, but I can understand that he isn’t happy with someone else sharing something that used to be original to him. Either way, I post them for free to give back to all the wealth of information other people kindly share. However, it’s time consuming and may not be worth it if it creates conflict. Having said that, thank you to those of you on StockTwits and Twitter that defended me. I appreciate it.

Ok, now next week. I am first going to show you what next week SPY options looked like going into Fridays session, followed by what it looks like now going into Tuesday morning.

Friday morning OI:

Obviously what stands out is the 166,000 170 calls. I looked on Thursday’s options time and sales to see if I spotted any bulk buying, but there was none. So either there had been major 170 buys prior to Thursday (although I check options time and sales daily and don’t remember seeing anything that striking) or they have been accumulating over time by the masses in general. Given that it’s a round number that people are likely drawn to in there bullishness, I am inclined to think it’s not some type of situation where someone knows something (but that is just my opinion).

This coming Tuesday mornings OI: