S&P 500 Option Open Interest Analysis

Here we are in another option expiration week. The major markets have broke through their respective old highs and are trading at or near record levels (except for the NASDAQ which has another 45% to reach its record highs, but is still trading at a six year high). Traders are trading with the bullish disposition that option expiration weeks typically show. But where will we fall at the end of the week? Although we would quit our day jobs if we knew the answer, we will do our best to at least give some thoughts on the forecast using open interest in the options market.

First, let’s take a look at how the S&P 500 cash index has fared over the past six option expiration weeks (see below). Notice that March is the only month where we have closed lower for the expiration week. During this time, the market was extremely nervous as just a few weeks prior the markets tumbled nearly 4% in a single day; therefore, the 1% drop is respectable. On average, expiration weeks in 2007 have traded higher by 0.84%. Although this data only represents 2007, you would get similar results (although maybe not as bullish) if you were to do the leg work with the historical data. (click to see a large image)
So, what does this have to do with forecasting where we finish the week? It doesn’t necessarily give us an outlook, but if you take into account 2007’s history it gives us a good chance of moving higher over the next few days. Next, we want to check the open interest on the S&P 500 options to see where traders are placing their bets. For that analysis, we will use the S&P 500 e-mini options.
The table below is an option chain for the July S&P 500 e-mini futures which expire this Friday. The middle column (black) shows the strike price of the options with the calls on the left side and the puts on the right side. The open interest we will be using is noted by “Opint”. I have gone ahead and highlighted the strike prices for puts and calls with higher amounts of open interest. The idea is that during an expiration week, the market tends to settle near the options with the highest amount of open interest. This is by no means a rule of thumb, but a theory that occasionally works and helps predict future movements. (click to see a larger image)
Let’s take a look at the call side first. The highest open interest is in the July 1590 (25 points above the current futures price of 1565) with nearly 18k open positions. This is followed by the at-the-money July 1565 calls with 12.5k open positions. What about the put side? Well, the highest open interest puts are well below the current futures price of 1565. While we won’t take into account anything below 100 points of the futures, price, the 1480 and 1500 puts both have an open interest of nearly 10k. In a close third and fourth are the 1510 and 1490 puts. The calls are predicting a move higher while the puts are looking for a move lower.
One of the reasons we may be seeing the highest open interest in the puts well below the market is because of last week’s 1.5% rally. Prior to breaking out to new highs, we were trading in a fairly narrow trading range of 1500-1550. With worries abound, traders were not willing to open short put positions above the lower bracket of the range at 1500. The open interest in the calls are where we might expect them to be; near-the-money. So there we have it, we can say the open interest in the puts are predicting the week’s close around 1500 while the open interest in the calls are predicting a close around 1575. When we have done this same analysis in the past, we have noticed the put and call positions highest open interest were trading closer to the same strike and sometimes the open interest was highest at the same strike price. The following market moves might be a little more predictive in the latter case. However, it is what it is and we have to forecast according to our theory.
The data we analyzed are suggesting the market to trade between 1525-1575 by week’s end. Although the S&P has the opportunity to break well above that market to 1600, we do not see it moving past there without first consolidating some gains by week’s end. It will be interesting to see how the open interest in the puts and calls change by Thursday afternoon. They could start to tighten the range by 10-15 points over the next few days, so watch your option chains and be aware of the market’s current risks. You can also use this same analysis for other markets such as the QQQQ’s

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