Triple Witching Could Trap Bears in Strong Bounce

Monday marks the start of first quarter triple witching options expiration week, culminating with Friday's simultaneous expiration of stock options, index options and index futures. This period has a well-deserved reputation for volatility and contrary behavior, setting the stage for a strong bounce that could trap overeager bears. As a result, it's a perfect time to review positions, deciding how aggressively you're willing to play the downside.

Major benchmarks turned sharply lower last week after China and the U.S. failed to meet the March trade deadline. Washington DC happy talk has failed to improve sentiment, but triple witching could do the trick, potentially generating an oversold bounce that has the power to test first quarter highs. The highly regarded McClellan Oscillator reinforces this bullish view, dropping into the most deeply oversold reading since the Dec. 24 low.

Shareholders trapped in losing positions could use the next bounce to get out, so it isn't wise to expect a rapid advance to new highs, even if a trade deal is announced. As a result, traders looking to play a triple witching bounce should maintain tight stops and take profits at predetermined resistance levels, while those with longer-term holding periods may choose to place break-even stops and walk away, allowing the market to play its hand.

The SPDR S&P 500 ETF (SPY) posted an all-time high at $293.94 on Sept. 20 and turned lower, finding support at $270.25 at the end of October. A bounce into November reversed twice at the Oct. 17 high above $277, while the decline into December broke six-week support, dropping the fund to the lowest low since April 2017. Buyers returned in force in January, carving a V-shaped pattern that completed a 100% retracement into October resistance on Feb. 25.

A Fibonacci grid stretched across the 2018 decline places October resistance at the .786 retracement level, which is notorious for printing lower highs within corrective and topping patterns. The 100% retracement levels mark strong resistance as well, reinforcing a barrier that may not budge in the coming weeks. However, positive sentiment still abounds, supporting a two-sided tape that benefits actively traded short-term positions.

The Invesco QQQ Trust (QQQ) posted an all-time high at $187.52 on Aug. 30 and carved a lower high on Oct. 1. It broke down from a small double top a few sessions later, entering a decline that carved additional lower highs near $178, $175 and $173, ahead of a vertical rout that reached a 15-month low in late December. The bounce into March showed less enthusiasm than the S&P 500, reversing at the November high near $175 last week.

The rally stalled between the .618 and .786 Fibonacci retracement levels while failing to reach the Oct. 17 swing high, which has narrowly aligned with the upper retracement level.  The fund bounced at the .618 retracement on Friday, indicating support that could presage a final buying thrust up to $178. As a result, this popular instrument may book greater upside in the coming sessions than its big-cap rival.

The iShares Russell 2000 ETF (IWM) hit an all-time high at $173.39 on Aug. 31 and eased into a modest pullback that escalated into a full-blown sell-off in October. It posted swing highs at $159, $158 and $154 and dropped like a rock into the Dec. 24 two-year low at $125.84. The fund turned higher with other benchmarks in January and posted impressive gains into late February, when it may have topped out at $158.27.

This price structure shows similar technical characteristics as SPY and QQQ, reaching the Oct. 16 high while stalling between the .618 and .786 Fibonacci retracement levels. However, the decline into March has broken support at the lower retracement, limiting potential gains during an oversold rally to the $155 level. The fund could reach this barrier late this week if triple witching's typically contrary behavior kicks into gear.

The Bottom Line

Major benchmarks could bounce strongly during triple witching expiration week, squeezing overeager short sellers.

Disclosure: The author held a position in IWM and no positions in the remaining aforementioned securities or their derivatives at the time of publication.