Why stocks are getting that same look they had just before the 2022 bear market

MW Why stocks are getting that same look they had just before the 2022 bear market

By Lawrence G. McMillan

Key market indicators are breaking down, suggesting weakness ahead for stocks

The S&P 500 Index $(SPX.UK)$ SPX has stalled out and some of its internal indicators are starting to weaken. Specifically, SPX has found resistance near 5,860 six times in recent days. That is now a resistance area.

The area between 5,670 and 5,770 should provide support, as that is the trading range from late September into early October. A close below 5,670 would be a substantial negative and would cause us to remove our core bullish position.

SPX has not quite reached the +4<SIGMA> "modified Bollinger Band" (mBB), so the McMillan Volatility Band $(MVB.AU)$ buy signal from mid-August (green "B" on the above SPX chart) remains in place. That position has been rolled up multiple times, so there is not much downside risk, but formally its target is that +4<SIGMA> band.

Equity-only put-call ratios have so far remained in the bullish camp. Despite the stagnation by SPX, put volume has not increased. So the ratios remain on buy signals - but they are in overbought territory. The standard ratio has dropped to the lowest levels since late 2021 - just before the 2022 bear market began. The weighted ratio is at new relative lows but is not below the 2024 lows. These ratios would generate buy signals if they roll over and begin to trend higher.

Market breadth has deteriorated badly. As a result, both breadth oscillators are now on sell signals. We require a two-day confirmation of any breadth signals, and that confirmation was attained at the close of trading on Oct. 22.

New highs on the NYSE have continued to outpace new lows, although the difference between the two is shrinking. Wednesday's trading showed 68 new highs and 40 new lows. If new lows were to outnumber new highs for two consecutive days, it would stop out this bullish signal, which arose back in mid-August.

VIX VIX continues to display a mixed picture. On the one hand, there is a "spike peak" buy signal in place. That will remain in place unless VIX closes above 23.14. On the other hand, there is a trend of VIX sell signal in place. That would be terminated if VIX were to close below its rising 200-day moving average $(MA)$, which is currently just below 15.50. At the end of trading on Wednesday, the VIX stood at 19.24 - about midway between these two significant points.

The construct of volatility derivatives remains mostly bullish for stocks. That is, the term structures of the CBOE volatility indices and the VIX futures slope upward, but only after the post-election rise in implied volatility. The SPX options that expire immediately after the U.S. elections on Nov. 5 are quite expensive - similar to how options on a particular stock might be expensive right after an anticipated earnings reporting date. In other words, traders expect the "event" to be volatile, where the event in this case is the election. A seasonally bullish pattern also might come into play.

In summary, we are maintaining a core bullish position as long as SPX continues to close above 5,670. This position would be terminated on a two-day close below 5,670. Regardless, we will take new positions as signals are confirmed. Continue to roll deeply in-the-money positions to take partial profits and reduce risk.

New recommendation: Breadth oscillator sell-signal

As noted in the commentary above, there is a new breadth oscillator sell signal. So, we are going to take a position because of it.

Buy 1 SPY SPY (Nov. 15) at-the-money put and sell 1 SPY (Nov. 15) put with a striking price 30 points lower. This position will remain in place as long as the breadth oscillators are on sell signals.

Market insight: October seasonal trade

We have noted this seasonal pattern many times in prior years. Simply, if there is a selloff in the broad market of at least 3.2% at any time during October, then the end of the month presents a strong buying opportunity.

So far this October, the high for SPX has been 5,878. A 3.2% decline from there would be 5,688. A couple of days ago, it didn't appear that SPX would decline that much, but after Wednesday's session (an intraday loss of 89 points), there is a chance that this trade could be in play later this month.

If SPX hits 5,688 or lower on or before the close of trading on Friday, Oct. 25, then buy 2 SPY (Nov. 8) at-the-money calls. If the position is taken, then roll the calls up if they become at least six points in-the-money. Otherwise, sell them at the close of trading on Monday, Nov. 4. Note that these calls are rather expensive because of the "election bump" in implied volatility, but we will be exiting them the day before the election, so they will still be relatively expensive then.

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 1 SPY (Nov. 1) 560 put: This position is based on the trend of VIX sell signal and would be stopped out if VIX closes below its 200-day MA for two consecutive days.

Long 1 SPY (Nov. 15) 584 call and short 1 SPY (Nov. 15) 604 call: This position was entered via a bull spread bought at the close of trading on Aug. 15. It was then rolled up twice. It would be stopped out if, on the NYSE, new lows outnumber new highs for two consecutive days.

Long 1 SPY (Nov. 1) 585 call: This was initially a long straddle, intended to capture a large move in either direction. After several rolls, it is now a long call only. Continue to roll the call up every time it becomes eight points in-the-money.

Long 10 WEAT (Nov. 15) 5 calls: These were bought because of the put-call ratio buy signal in wheat futures. That put-call ratio has now rolled over to a sell signal, so sell these WEAT WEAT calls to close the position.

Long 6 APA (Nov. 1) 25 calls: This was an MVB buy signal. Sell the calls if APA $(APA)$ trades at 29 at any time. Stop yourself out if APA closes below 23. APA is reporting earnings on Nov. 6.

Long 1 ABNB $(ABNB)$ (Nov. 15) 135 call: Raise the closing stop to $130.

Long 1 SPY (Nov. 15) 584 call and short 1 SPY (Nov. 15) 604 call: This is our core bullish position. Stop out of the position if SPX closes below 5,670 for two consecutive trading days.

Long 2 PLD (Nov. 15) 125 puts: We will continue to hold these puts as long as the put-call ratio remains on a sell signal. If PLD $(PLD)$ trades at $115 or lower, roll down to the PLD (Nov. 15) 115 puts.

Long 4 LX (Nov. 15) 2.5 calls: Stop out on a close below 2.85 by LX $(LX)$.

Long 1 SPY (Nov. 15) 584 call and Short 1 SPY (Nov. 15) 601 call: This position is based on the VIX "spike peak" buy signal of Oct. 14. It would be stopped out if VIX were to close above 23.14. Otherwise, it will be held for 22 trading days.

Long 2 CLX (Nov. 15) 160 puts: This position will remain in place as long as the weighted put-call ratio of CLX $(CLX)$ remains on a sell signal.

Long 4 expiring WBA (Oct. 25) 9.5 calls: This is the "alternative" Dogs of the Dow position. Roll to the WBA $(WBA)$ (Nov. 29) 9.5 calls.

Long 2 APH (Jan. 17) 62.5 calls: We will hold these calls as long as the weighted put-call ratio for APH $(APH)$ remains on a buy signal.

Long 1 BLDR (Nov. 15) 200 put: BLDR $(BLDR)$ shares dropped sharply this week, so roll down to the BLDR (Nov. 15) 180 put. We will hold this put as long as the put-call ratio sell signal remains in effect.

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 "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

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October 24, 2024 07:20 ET (11:20 GMT)

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