Opinion: Even as stocks break out, the overwhelming trend is down
The stock market, as measured by the S&P 500 SPX Index,
has traded in a small range – these days 100 points is a small range – in a volatile fashion since May 27.
This range is approximately 4070 to 4170 dots. A breakout either way would likely generate a follow.
There was some deterioration in internal metrics while SPX was in this range, but not much. The range is indicated by a red square on the attached SPX map. A break up could reach 4300, where not only has there been resistance since early May, but it is also where the “modified Bollinger Band” (mBB) +4σ has descended. Pausedown should find support in the 3800-3900 area – this year’s lows.
Note that this range and its potential breakouts do not constitute a change in trend. The trend is still bearish as shown by the blue lines on the SPX chart. This current rally and trading range falls into the general category of “oversold rally” and not “change in trend”.
Equity put-call ratios only remain on buy signals. There’s been some sideways movement on the charts lately, and they’ve even curled upwards a bit.
However, the computer programs we use to analyze these charts were consistent in their prediction that the buy signals would persist, and they did. Now the ratios are reaching new relative lows and falling faster again. As long as this is the case, it is bullish for stocks.
The width had been dramatic at the start of the oversold rally in late May, but it was unable to hold. As a result, the NYSE width oscillator fell back to a sell signal.
However, the breadth of “stocks only” has improved a bit and is still hanging onto a buy signal. The two will not diverge for long. Either way, the width deteriorated as SPX hovered in that narrow 100 point trading range.
The NYSE’s new 52-week highs have outnumbered new 52-week lows for the past nine consecutive days, beginning May 26.
However, the absolute number of new highs has yet to exceed 100 every day. So, the improvement in this indicator is the result of new lows falling to almost nothing, but that alone is not enough for a buy signal. We need to see new highs above 100 for two consecutive days to generate a buy signal. This indicator remains in a neutral state for stocks.
VIXVIX,
generally declined while SPX was within the trading range. The May 12 “spike” buy signal is still in effect. It lasts for 22 trading days (until June 14) unless interrupted by VIX returning to spiking mode.
Conversely, the orient oneself of VIX remains on the rise. In other words, the VIX and its 20-day moving average (MA) are above the rising 200-day MA of the VIX.
However, VIX is approaching 200 days, as VIX is just below 24 and 200 days is at 23. The two oval areas on the attached VIX chart show the last two times VIX has probed below 200 days . Both times, the 20-day MA of VIX failed to cross the 200-day mark and the bear market resumed soon after.
The construction volatility derivatives remains slightly positive in its outlook for equities. In other words, the term structure of the VIX futures contracts is slightly higher – through October – and the term structure of the CBOE Volatility Index is also higher.
In summary, SPX’s major trend is still down, and VIX’s major trend is still up (although it’s starting to be challenged).
This is enough for us to maintain a “basic” bearish position. We are trading confirmed short-term signals from the other indicators around this central position.
New Recommendation: Kodiak Sciences (KOD)
We couldn’t buy calls last week at our limit. K.O.D. had a strong volume of options, then soared on June 7 after a shareholder bought an additional 572,000 shares, bringing its total to 16 million shares. We adjust the recommendation as follows:
Buy 5 July KODs (15e) 10 calls
At a price of 1.00 or less.
KOD: July 9.48 (15e) 10 calls: offer of 0.75, offered at 0.95
We will hold without stopping, initially.
New recommendation: SPY straddle buy
The conditional buy signal we had in place for a few weeks, based on the NYSE’s new 52-week highs versus new 52-week lows, did not meet our criteria, and we are now rescinding that recommendation.
Instead, we will position ourselves for the breakout of the SPX trading range. SPY straddles aren’t cheap, but SPY’s realized volatility remains above VIX, so by this measure, a straddle buy is statistically viable.
Buy 2 SPY July (15e) calls at par and buy 2 puts at par (i.e. buy 2 straddles)
As a follow-up, use these guidelines:
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if SPX closes above 4170, then sell the SPY puts in the straddle
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if SPX closes below 4070, then sell the SPY calls on horseback
In the event of a false breakout and a reversal, both of these instructions would take you out of the entire position, but we are looking for SPX to call its breakout. In the case of a continuation, we will be looking to roll the profitable side of the straddle on a follow-up move from SPX. These instructions will be given in the weekly letter.
Follow-up actions:
All stops are mental closing stops unless otherwise stated.
We will implement a “standard” rolling procedure for our SPY spreads: in any bullish or bearish vertical spread, if the underlying hits the short strike, then roll the entire spread. It would be rolling at the top in the case of a call bull spread, or roll down in the case of a bear put spread. Stay in the same exhale and keep the same distance between strikes unless instructed otherwise.
Long 2 SPY June (17e) 389 puts and Short 2 SPY June (17e) 364 put options: we initially bought this spread in line with the sell signal of the orient oneself of VIX. It was canceled whePY was trading at 401 on May 9e then rolled up and out at the May expiration. This is our “basic” bearish position. We will exit this position if VIX falls below its 200-day moving average, which is currently rising towards 23.
Long 1 SPY June (17e) 412 call and court June 1 (17e) 432 calls: VIX confirmed a “peak peak” buy signal at the close of trading on May 12e, and we bought a bull spread call. This spread had a high strike of 412, so as per the standing instructions above, it was rolled up on May 27ewhen SPY negotiated at 412. We will now use a “return to doping mode” VIX as a backstop. In other words, stop if VIX closes at least 3.00 points higher over a 1, 2 or 3 day period. At this point, the VIX’s recent lowest closing price is 23.96 on June 8.e. So the current stop is a VIX close at 26.96 or higher. Additionally, this system is designed to remain in trade for 22 trading days, if not halted, which means the last day would be next Tuesday, June 14th.e.
Long 3 BKI June (17e) 70 calls: continue to hold as the spread in this trade remains wide. The deal is 63.20 + 0.2*ICE, which is worth $83.47 with an ICE trade at 101.39. BKI is trading at 67.60, so the gap remains wide. Keep holding.
Long 5 MX June (17e) 20 calls: continue to hold as the rumors unfold.
Long 2 SPY July (1st) 402 calls and Short 2 SPY July (1st) 417 calls: this spread was originally purchased on May 26e, based on the combination of new equity-only put-call ratio buy signals and extended buy signals. It was then rolled up on June 2n/awhen SPY traded at the high spread strike.
The width oscillators have pulled back to sell signals, so sell half the position now. We will close the other half when the equity-only put-call ratios move to a sell signal.
Long 2 EA June (17e) 137 calls: we bought these calls on may 27the, because it was the first day they traded at our 5.00 limit. We will hold on non-stop for now.
Send your questions to: lmcmillan@optionstrategist.com.
Lawrence G. McMillan is President of McMillan Analysis, a registered commodity trading and investment adviser. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of the bestselling book, Options as a strategic investment.
Disclaimer: ©McMillan Analysis Corporation is registered with the SEC as an investment adviser and with the CFTC as a commodity trading adviser. The information in this newsletter has been carefully compiled from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Officers or directors of McMillan Analysis Corporation, or accounts managed by such persons, may hold positions in the securities recommended in the advisory.