MW Stock traders are seeing more reasons to be cautious about the market.
By Lawrence G. McMillan
Positive seasonal conditions prevail - though small caps have yet to rally
The S&P 500 SPX rose this week on a CPI report that was in line with estimates, which analysts believe paves the way for a U.S. Federal Reserve rate cut next week. Regardless, there is support for SPX at 6,010, and then there is major support at 5,870.
There is no formal overhead resistance, but we have been using the +4<SIGMA> "modified Bollinger Band" as a potential target for this move. That band is currently at 6,107. It has contracted a bit, since realized (historical) volatility has declined. In fact, the 20-day historical volatility of SPX (HV20) is now down to 8%. That represents an overbought condition, and a sell signal will be issued when it rises back up to 10% and above. That may take some time to reach.
The McMillan volatility band $(MVB.AU)$ buy signal from mid-August is still in place. It has the same target: the +4<SIGMA> "modified Bollinger Band."
Equity-only put-call ratios have begun to trend upward over the past day or two. This is potentially the beginning of a sell signal. The computer programs we use to analyze these charts are saying that, yes, this is indeed a sell signal. However, there is a certain amount of "reversion to the mean" logic in this analysis, and since the ratios are still extremely low, it seems probable that they would revert to higher levels. I'm not 100% convinced of that, so the sell signals are marked with question marks until we see more of an upward trend developing in these ratios.
Market breadth has been poor on many trading days recently, and two key breadth oscillators have generated confirmed sell signals (which required a two-day confirmation). This is our only confirmed sell signal at this time. These breadth signals can be subject to whipsaws, and the sell signals would be stopped out if breadth recovered to a significantly positive state.
New highs on the NYSE have continued to outnumber new lows. There has been some slippage in the number of new highs, but it has not been large enough to cancel out this buy signal, which has been in place since last August. This buy signal would be stopped out if new lows were to outnumber new highs for two consecutive days on the NYSE.
VIX VIX continues to hover at low levels. That means that the trend of VIX buy signal remains in place. On the accompanying VIX chart, there are several boxes, inside of each is a "B" (buy) or "S" (sell). Those are the trend of VIX signals, as they pertain to stocks. One can see that there was a buy signal in November 2023 and another one in May 2024. The stock market rose after both of those signals were generated, even though VIX itself was moving sideways. So, that is the situation once again. This trend of VIX buy signal would be stopped out if VIX were to rise above its 200-day moving average $(MA)$.
Meanwhile, the VIX "spike peak" buy signal of early November has expired. That is, we only hold those positions for 22 trading days after the signal occurs, and that time limit has been met. It was a positive trade, buying the market the day after the election.
The construct of volatility derivatives continues to paint a bullish picture for stocks. The term structures of the VIX futures and of the Cboe volatility indices continue to slope upwards, and the VIX futures are trading at large premiums to VIX.
Positive seasonals are still in effect, even though small-caps are not having their usual outperformance yet. This is reflected in the poor breadth statistics. The post-Thanksgiving rally has occurred, and now we are in the "January effect" part of the seasonal. The final part will be at the end of the year (the Santa Claus rally).
In summary, we are maintaining our core bullish position as long as SPX remains above 5,870. We will trade other confirmed signals around that core. Finally, we continue to roll deeply in-the-money options in order to take partial profits and reduce reversal risk.
New recommendation: Breadth-oscillator sell signal
As noted above, the market-breadth oscillators have generated confirmed sell signals. So, we want to take a position based on that signal.
Buy 1 SPY SPY (Jan. 3) at-the-money put
We will hold this put as long as the oscillator sell signal is in effect. We will update the signal on a weekly basis.
New recommendation: Draftkings $(DKNG)$ sell signal
There is a new sell signal, based on the weighted put-call ratio, in DKNG (DKNG).
Buy 4 DKNG (Jan. 17) 42 puts in line with the market.
We will hold these puts as long as the weighted put-call ratio for DKNG remains on a sell signal. From the accompanying chart, one can see that two of the three previous sell signals from this level preceded a drop in the stock price.
New recommendation: LKQ Corp. $(LKQ)$ buy signal
This is a repeat from each of the last two weeks, since the condition has not yet been satisfied. There is a recent weighted put-call ratio buy signal in LKQ (LKQ). However, we want to see the stock be able to rise above resistance at $40, so we are making this a conditional recommendation.
If LKQ closes above $40, then buy 3 LKQ (Feb. 21) 40 calls in line with the market. If the calls are bought, we will hold as long as the weighted put-call ratio remains on a buy signal.
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.
For outright long calls, roll up if they become 8 points in-the-money.
Long 1 SPY (Dec. 27) 607 call: This position is based on the new highs vs. new lows buy signal. It was entered via a bull spread bought at the close of trading on Aug. 15. It was then rolled several times. It would be stopped out if, on the NYSE, new lows outnumber new highs for two consecutive days.
Long 1 SPY (Dec. 27) 607 call: This is our "core" bullish position. Stop out of the position if SPX closes below 5870 for two consecutive days.
Long 4 WBA $(WBA)$ (Dec. 27) 9 calls: This is the "alternative" Dogs of the Dow position. Hold without a stop at this time. A takeover rumor arose this week, following a Wall Street Journal report that WBA is in talks to sell itself to private equity firm Sycamore Partners.
Long 2 APH $(APH)$ (Jan. 17) 62.5 calls: Sell these calls now, since the weighted put-call ratio remains has rolled over to a sell signal.
Long 0 SPY (Dec. 20) 595 call and Short 0 SPY (Dec. 20) 615 call: This position was based on the most recent VIX "spike peak" buy signal. It was exited at the close of trading on Dec. 9.
Long 3 MSTY MSTY (Dec. 20) 31 calls: stop yourself out on a close below $30 by MSTY.
Long 2 IWM IWM (Jan. 17) 241 calls and short 2 IWM (Jan. 17) 254: This is the post-Thanksgiving seasonal trade. We will plan to hold this trade through the second trading day of 2025, so the entire amount of the money in this trade is at risk. If IWM trades at 254, then sell the spread and replace it by buying the IWM (Jan. 17) call at that higher strike, holding it as an outright long.
Long 4 IEF IEF (Jan. 17) 94 calls: We will hold as long as the weighted put-call ratio for T-Notes is on a buy signal.
Long 10 POET $(POET)$ (Jan. 17) 5 calls: Sell the calls if POET closes below $4.25.
Long 1 SPY (Jan. 17) 607 call and short 1 SPY (Jan. 17) 622 call: Stop out if VIX closes above its 200-day moving average for two consecutive days.
Long 3 ACGL $(ACGL)$ (Jan. 17) 100 calls: We will hold as long as the put-call ratio buy signal is 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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December 14, 2024 10:29 ET (15:29 GMT)
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