We’ve had quite a week so far, and it’s only Thursday morning. Once again, I’ll let a chart do much of the talking:

4 Day S&P 500 Index (SPX), 4 Minute Bars

Source: Bloomberg

We see an uneventful Monday and much of Tuesday, only to see a late drop that afternoon. The drop continued through Wednesday morning, after which a combination of dip-buying and a benign reaction to the Fed minutes took hold. We now have regained the levels that prevailed early in the week.

Yesterday we asserted that while the crypto plunge got most of the headlines (rightly so), the real culprit for SPX was the morning expiration of VIX futures.Those can be difficult to hedge on a normal expiration, and even more so on a panicky morning. Bear in mind that the natural hedge for VIX futures is the SPX Index options complex. The VIX Index is based upon those options. The open interest in those options explain much about the levels of Tuesday’s close, Wednesday’s open, and today’s rally (so far). 

Pay special attention to the open interest (OInt) column on the 4075, 4100, 4150, and 4175 lines in the table below. We can see that there are disproportionately high levels of open interest in those puts and calls on those lines. 

SPX Index Options Snapshot

(Click on image to enlarge)

Source: Bloombergtar

We know that hedging tends to occur around lines with high levels of volume and open interest. They can often be used as support or resistance targets, and levels through which moves can accelerate. It makes sense that Tuesday’s drop went abruptly from the 4175 to 4150 region quite quickly. It also makes sense that we opened around 4100 yesterday and found support around the 4060-4075 level (the 50-day moving average is in the 4060 area). It also explains why 4150 acted like a target today, and why it would not surprise me if we moved towards 4175 either this afternoon or on tomorrow’s open if the rally continues. 

By that same logic, I would keep an eye on the 420 level in SPY tomorrow. Unlike SPX Index options that expire on the open, ETFs like SPY expire on the close. The open interest on the 420 line is over 150,000 contracts today, which is far above any other pair of strikes that expire tomorrow. The lack of concentration below that level means that pullbacks tomorrow afternoon would have no natural strike level for support – at least as of now.