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S&P 500 Slid Toward Key 3,900 Level But Held Its Ground Thanks to Options

·3 min read

(Bloomberg) -- A chart line where thousands of options trades are clustered put a tenuous floor under the S&P 500 despite being tested repeatedly.

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While the level -- 3,900 on the benchmark index -- was breached for most of the last hour of trading, a last-minute jump deposited the gauge about a point above it. Thursday was still a bruising day for bulls, with stocks losing more than 1% for the second drop in three days.

Traders watching the price action in stocks saw the S&P 500 slide toward the 3,900 level four different times, before holding its ground. The resilience can be attributed to Friday’s $3.2 trillion option expiration, one theory holds.

About 22,000 puts expiring Friday linked to the equity index with a 3,900 strike price changed hands, with the cost, or implied volatility, falling almost 2 points over a span of two hours in early trading, according to Cantor Fitzgerald LP.

The drop in prices suggested that those contracts were either sold for a profit or rolled out to long term options, says Matthew Tym, the firm’s head of equity derivatives trading. Such moves prompted options dealers who were on the other side of the transaction to buy shares to maintain a neutral market exposure, likely acting as a buffer.

“You would take this option that suddenly has value again and roll it down and out to give yourself more time, if you have a desire to keep a certain level of protection,” Tym said. “If someone is buying that put from you, they’d need to buy stocks to be delta neutral.”

The 3,900 level has become a battle line for bulls and bears in recent months, acting as a support in mid-May and then keeping a lid on advances briefly in June and July. After managing to close above the threshold during a retreat on Sept. 6, the S&P 500 embarked on a four-day rally.

The benchmark index fell as low as 3,888 Thursday before ending down 1.1% at 3,901.35, extending its worst week since mid-June. The decline resumed the selloff Tuesday, when a hotter-than-expected inflation reading triggered the worst equity slump in more than two years.

“Two weeks ago, the sentiment would have been ‘buy the dip,’”said Larry Weiss, head of equity trading at Instinet. “Now it’s ‘watch the false rally.’”

While bulls may find comfort in the market’s buoyancy above 3,900, Thursday’s decline took the S&P 500 below a trough that the gauge established on a closing basis earlier this month.

Another level to watch is the intraday low of 3,886.75 reached on Sept. 6, according to Matt Maley, chief market strategist at Miller Tabak + Co. Should it give away, it’d form a lower low that may herald more losses, he says.

“That will confirm that the second leg of the 2022 bear market is in full force and a retest of the June lows will be all but inevitable,” Maley said.

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