The following is a guest post courtesy of Michael Kramer of Mott Capital Management.
*Disclosure: Michael Kramer and the clients Of Mott Capital Own AAPL, GOOGL, TSLA, & MSFT.
This week could mark a turning point for the equity market with a Federal Reserve meeting and nearly all the mega-cap companies reporting results. Unfortunately, many of these mega-cap companies find themselves in a vulnerable spot for two reasons:
- With the shares running sharply higher into results, that makes them technically overbought
- The shares have a massive amount of gamma rolling off following this week’s options expiration date
Stocks such as Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Facebook (FB), Tesla (TSLA), and Alphabet (GOOGL, GOOG) are the largest stocks in the S&P 500. Together they account for roughly 23% of the S&P 500 market cap. How these stocks respond to earnings results will have a significant influence on where the broader index follows.
Coupled with an S&P 500 trading at historically a very lofty valuation of more than 21x the next-twelve-months earnings estimates, this could be a significant turning point for the market.
Is a market pullback possible?
As noted previously, the equity market has been in overbought territory for some time. While there was a minor 3-day pullback, it wasn’t enough to reset anything. Instead of the broader equity indices at overbought levels, now it is individual stocks that have reached overbought levels. For example, Apple has seen its RSI reach a level above 80. While it is not always the case, when the RSI has hit a level this high, it has resulted in a pullback in the shares.
It isn’t only the RSI signaling a reversal of trend may be near. Equity Hub (available to SpotGamma Pro subscribers) suggests that nearly 25% of Apple’s gamma will roll-off at expiration this week. That means volatility is likely to pick up, and the shares could reverse lower. The model suggests that $150 offers a critical level of resistance from a gamma perspective. At the same time, if shares fall, they might not find support until they reach $140, a drop of about 6%.
Amazon is another stock that has run up these past couple of weeks, with its RSI reaching levels that are approaching 80. Like Apple, when Amazon’s momentum indicator has moved this high, it has also resulted in Amazon’s shares pulling back the majority of the time.
Amazon also has a massive amount of gamma rolling off this week, nearly 28%. Gamma levels for Amazon suggest that if the stock reverses from these overbought levels due to the expiration of options, it may take a decline to around 3,500 before support is found, a drop of about 6%.
But more importantly, if stocks like these start to reverse by 6%, it could act as a significant drag on the entire market.
So far, the S&P 500 has avoided any major correction. That is because when big technology stocks couldn’t carry the load, rising interest rates and wider spreads put the reflation sectors to work.
Things are different now; with yields falling and spreads contracting, these more economically sensitive parts of the market are now falling. If the significant technology sector starts to go down… then a period of heightened volatility could be fast approaching.
SpotGamma Products Used
- Equity Hub (available to SpotGamma Pro subscribers)
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