The stock market is testing the bulls to see if they have what it takes

MW The stock market is testing the bulls to see if they have what it takes

By Lawrence G. McMillan

Maintain a core bullish position but keep your powder dry

The stock market, as measured by the S&P 500 index SPX, has had a couple of fairly large down days - the latest of which came after what was perceived as a poor consumer-price index number. Actually, the number itself wasn't so bad, but it caused worries that the Federal Reserve might not cut rates soon, or at all for the foreseeable future. Frankly, it seemed like a knee-jerk reaction to me, especially since most of the smart money has not been banking on rate cuts for quite some time.

The S&P 500 and other major U.S. markets rallied on Thursday, but if the S&P 500 closes below 5,050, that would be a much larger negative factor, because it would bring in technical selling. There is resistance in the 5,260 area, where the S&P 500 topped out on four separate days in recent weeks.

This is still a bullish S&P 500 chart, as long as the index holds above 5,050, so we will maintain our core bullish positions for now, albeit with out-of-the-money calls at this time.

Equity-only put-call ratios have accelerated to the upside, and so their sell signals (for stocks) are confirmed. When these sell signals are coming from the extreme lows of their charts - i.e., from extreme overbought conditions - as they are now, they often prove to be quite sustainable. They will remain on sell signals until they roll over and begin to trend downward.

Market breadth has remained generally poor, and the breadth oscillator sell signals that arose a week ago are still in place. So, breadth joins the put-call ratios as the first two sell signals after a long drive upward by stocks.

New highs on the New York Stock Exchange have continued to dominate new lows, until April 10. On that day, new lows had the upper hand, even though it was only by a small margin: 46 to 36. If new lows outnumber new highs, that would stop out the buy signal, which has been in place almost continuously since last November. If new highs dominate on Thursday, that resets the indicator, and it would still remain bullish.

The Cboe Volatility Index, or VIX VIX, has remained subdued for the most part, so it has not been swayed by the large down days in the market. Yes, VIX has risen slowly since bottoming out just below 13 in late March. But it has not gone into "spiking" mode (an advance of at least three points, over any three-day or shorter time horizon, using closing prices). When VIX is in spiking mode, the stock market often declines sharply, but eventually a "spike peak" buy signal occurs. In any case, spiking mode has not occurred recently.

The other potential bearish aspect of VIX has not appeared either - that would be if the trend of VIX were to turn upward. That would happen if both VIX and its 20-day moving average crossed above the 200-day MA. Currently VIX itself is slightly above the 200-day MA, but the 20-day remains below. Watch this indicator for a potential sell signal.

The construct of volatility derivatives remains mostly bullish for stocks. Even with the recent selling in the S&P 500, the term structures of VIX futures and of the Cboe volatility indices have continued to slope upwards. There have been little bumps in the term structure, especially immediately preceding the CPI release, but the upward slope is the prominent feature. The front-month April VIX futures have been trading at a discount to VIX, and that is a bit of a worry, but the rest of the futures are trading at a premium, and May continues trade higher than April, so those are positive signs.

In summary, we are continuing to hold a core bullish position because of the S&P 500 chart, but we are trading other confirmed signals around that core position.

Recapping recommendations

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 but will not continue to reprint the reasoning behind the trade.

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

New recommendation: SPY bear spread

We want to add a bearish position in line with the sell signals from the equity-only put-call ratios.

Buy 2 SPY SPY May 31 at-the-money puts and Sell 2 SPY May 31 puts with a striking price 30 points lower. We will hold this position as long as the equity-only put-call ratios remain on sell signals.

New Recommendation: AudioEye $(AEYE)$

Shares of AudioEye (AEYE) have broken out to the upside, trading at their highest prices since the fall of 2021. Moreover, stock and option volume have increased strongly.

Buy 3 AEYE May 17 12.5 calls in line with the market. Stop out if AEYE closes below $10.90.

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 0 XLP April 5 76 calls: These calls were stopped out when XLP XLP closed below $74.70 on April 3.

Long 2 expiring 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 to the May 3 520 calls. Roll the calls up every time they become at least eight points in-the-money.

Long 1 expiring 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 to the May 3 520 calls. Roll up every time the call is eight points in-the-money.

Long 3 TLT TLT May 19 95 puts: Roll down to the May 19 90 puts. We will hold as long as the put-call ratio sell signal is in place for Treasury bonds.

Long 1 expiring SPY April 12 520 call: This call was bought in line with the new highs versus new lows buy signal. It was rolled up several times. Stop out if NYSE new lows exceed new highs for two consecutive days. On April 10, new lows exceeded new highs, so there is a two-part follow-up for this trade:

1) If NYSE new lows outnumber new highs on April 11, then sell the calls to close the position.

2) If new lows do not outnumber new highs on April 11, then roll to the May3 520 calls. Roll up every time the call is eight points in-the-money.

Long 4 BKR April 19 30 calls: Bought when Baker Hughes $(BKR)$ closed above $30 on March 6. The put-call ratio has rolled over to a sell signal now, so sell the calls to close out the position. This was a profitable position.

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

Long 3 APA $(APA)$ May 17 32.5 calls: The put-call ratio has rolled over to a sell signal, so sell these calls. This will be for a small profit.

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 $(DKNG)$ May 17 46 calls: The stop remains at 43.40.

Long 2 SVXY SVXY April 19 113 calls: The front-month April VIX futures settled at a discount to VIX on April 5, so these calls should have been sold. Sell now if you have not already done so.

Long 4 RSI $(RSI)$ May 17 5 calls: Hold without a stop initially, in order to let the takeover rumors play out.

Long 2 MCD $(MCD)$ May 17 275 puts: We will hold this position as long as the weighted put-call ratio remains on a sell signal.

Long 1 SPY May 3 513 put: We will hold these puts as long as the breadth oscillators remain on sell signals.

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 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 best-selling book "Options As A Strategic Investment." www.optionstrategist.com

(c)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 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

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April 11, 2024 16:33 ET (20:33 GMT)

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