Stocks can keep going up - as long as this one key indicator stays down

MW Stocks can keep going up - as long as this one key indicator stays down

By Lawrence G. McMillan

Low VIX readings continue to vex market bears

The U.S. stock market, as measured by the S&P 500 index SPX, registered a new all-time closing high, keeping the bull market in place. The S&P 500 has a strong support area at 5,050-5,180, an area where the index traded in late February and early March. There are multiple support levels beneath that level as well, but a close below 5,050 would be viewed as quite negative by many traders, and we would expect that sell signals would emerge from our indicators if that happened.

One upside target might be the +4<SIGMA> "modified Bollinger Band" (mBB). A close above that would potentially set up a sell signal, although even with a close above the band, a sell signal is not guaranteed. Currently that band is rising and is approaching 5,300. On the day of the intraday high (March 21), SPX nearly touched the +4<SIGMA> band but did not close above it.

Equity-only put-call ratios continue to move sideways, and at very low levels on their charts. This reflects an overbought state in the stock market but is not a sell signal yet. We would prefer to see these ratios rise sharply in order to confirm a sell signal. That has not happened, as they instead continue to oscillate with very small "waves." Both charts are marked with a "S?" to indicate that a sell signal is possible from these levels but is not yet confirmed.

Market breadth has been a bit frustrating as well. Three strong days, leading into the March 21 all-time intraday highs, had pushed the breadth oscillators back onto buy signals. But then breadth weakened considerably, nearly generating sell signals, before another strong day of breadth on March 27 kept these breadth oscillators on (weak) buy signals.

Breadth has just not been all that strong this year, even though SPX keeps making new all-time highs. That's obviously because many stocks are not participating in this rally. A measure that is more reflective of this particular stock market is cumulative volume breadth $(CVB.AU)$ - a daily running total of the volume on advancing stocks minus the volume on declining stocks. That measure made another new all-time high on March 27. So, volume-wise, breadth seems fine, and that is because the "best" stocks are being chased with heavy volume from institutional buyers.

On the NYSE, new highs continue to dominate new lows. This indicator remains bullish as it has since last November, for the most part. This buy signal would be stopped out if new lows outnumber new highs on the NYSE for two consecutive days.

The entire volatility complex continues to remain bullish on the stock market, to various degrees. VIX VIX itself remains at a low level, so stocks can continue to advance as long as that is the case. The previous "spike peak" buy signal expired profitably. Now, VIX and its 20-day moving average (which has turned downward) are both below the 200-day MA once again, meaning that the trend of VIX is downward. That is bullish for stocks.

Meanwhile, the construct of volatility derivatives remains bullish for the stock market as well. The term structures of both the VIX futures and of the CBOE Volatility Indices slope upwards, and the futures are trading at a substantial premium once again.

In summary, we are still maintaining a "core" bullish position. We will roll calls up to higher strikes when the become deeply in-the-money, and we will trade any confirmed signals around that "core" position.

Recap

For the past few weeks we have made some conditional recommendations that have not all been filled. The only remaining one at this time is a longer-term potential buy signal from Walgreens Boots Alliance $(WBA)$. We are keeping this recommendation open.

If WBA closes above $22.50, then buy 4 WBA (June 21) 22.5 calls in line with the market.

New recommendation: Short volatility

VIX continues to hover at a low level. When we talk about the construct of volatility derivatives, we often mention the term structure of the VIX futures, but it's less often that we mention the futures premium - that is, the price of the VIX futures contract minus the price of VIX.

That premium decays as time passes, and when the premium is large, it is possible to "short volatility" - hoping to capture that decay. In reality, we are not "shorting volatility" as much as we are trying to short the time-value premium. We have a measure for that premium, around which we have built a trading system, and late last week it moved to a large enough premium to consider a trade.

The most straightforward trade is to buy the ProShares Short VIX Short-Term Futures ETF $(SVXY)$ SVXY. Our indicator has had good success with buying SVXY over the past year as the premium on the VIX futures has gotten high enough to capture as time passed. We have not been using the indicator's trade previously, but we are going to do so now.

The methodology can go long volatility as well, although that has been rare. In any case, the system is now calling for purchase of SVXY. So we are going to recommend it, using options.

Buy 2 SVXY (April 19) 113 calls in line with the market.

Stop out of this trade if the front-month April VIX futures settle (close) at a discount to VIX.

Final comment: The predecessor short volatility ETN $(XIV)$ imploded when volatility nearly doubled in one day. While the multiplier on SVXY is lower at 0.5 and not 1.0 as it was with XIV, there still is a danger of something similar happening. If VIX futures were to triple in one day, SVXY would fall to zero. That's why we buy calls - the risk is fixed.

New recommendation: Rush Street Interactive $(RSI)$

Option volume in Rush Street Interactive (RSI) rose sharply recently following a Bloomberg report that the company was exploring strategic options including a potential sale. The report further stated that potential buyers, including DraftKings $(DKNG)$, have been contacted by RSI. Stock volume patterns are very strong and improving rapidly. There is support at $6. The options are also gaining implied volatility.

Buy 4 RSI May (17th) 5 calls in line with the market.

We will hold without a stop initially in order to let the takeover rumors play out.

Follow-up action:

All stops are mental closing stops unless otherwise noted.

We are using a "standard" rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll up in the case of a call bull spread or roll down in the case of a bear put spread. Stay in the same expiration and keep the distance between the strikes the same unless otherwise instructed.

Long 4 XLP XLP (April 5) 76 calls: The trailing stop remains at 74.70.

Long 2 SPY SPY (April 12) 520 calls: This position was initially a long straddle. It was rolled up, and the puts were sold. This is, in essence, our "core" bullish position. Roll the calls up every time they become at least eight points in-the-money.

Long 1 SPY (April 12) 520 call: This was also originally a long straddle. The put was sold, and the call was rolled up several times. Roll up every time the call is eight points in-the-money.

Long 3 TLT TLT (May 19) 95 puts: We will hold as long as the put-call ratio sell signal is in place for T-Bonds.

Long 1 SPY (April 12) 520 call: This call was bought in line with the new highs vs. new lows buy signal. It was rolled up several times. Stop out if NYSE new lows exceed new highs for two consecutive days. Roll up every time the call is eight points in-the-money.

Long 4 BKR (April 19) 30 calls: Bought when BKR $(BKR)$ closed above $30 on March 6. Continue to hold as long as the weighted put-call ratio remains on a buy signal.

Long 6 QBTS $(QBTS)$ (April 19)1.0 calls: The stop remains at 1.75.

Long 3 APA $(APA)$ (May 17) 32.5 calls: We will continue to hold these calls as long as the weighted put-call ratio for APA remains on a buy signal.

Long 4 CSX (May 17) 37.50 puts: Bought when CSX $(CSX)$ closed below $37.50 on March 14. We will hold these puts as long as the weighted put-call ratio for CSX remains on a sell signal.

Long 2 DKNG (May 17) 46 calls: Raise the stop to 43.40.

All stops are mental closing stops unless otherwise noted.

Send questions to: lmcmillan@optionstrategist.com.

Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. 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 best-selling book, Options As A Strategic Investment. www.optionstrategist.com

(c)McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.

-Lawrence G. McMillan

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

March 28, 2024 17:31 ET (21:31 GMT)

Copyright (c) 2024 Dow Jones & Company, Inc.