Struggling stock market is in a make-or-break situation

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MARKETWATCH OPTIONS TRADER

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The stock market, as measured by the S&P 500 Index, is struggling.

It’s been declining, for the most part, since the beginning of September. Volatility is increasing as well, which could have several negative ramifications. Yes, there was a strong rebound in the market from Sept. 20-23, but that rally failed very near the declining 20-day moving average (MA).

That sort of failure is what we typically see from an oversold rally in a bearish environment. So there is a lower high on the SPX chart, which defines a short-term downtrend line (declining red line on the accompanying chart). If the lows of Sept. 20 (at 4305 points) are taken out, then there will also be a lower low, and that would mean that the chart of SPX would “officially” be trending lower.

So that support at 4305 is important. As long as it holds, the bulls could still reverse the market to the upside. For the record, there is resistance at 4490 and then again at the all-time highs, 4545.

The decline on Sept. 20 was so steep that SPX closed below the -4σ “modified Bollinger Band” that day, and the next day a McMillan Volatility Band (MVB) buy signal was issued. That will remain in effect until SPX reaches either of the +/-4σ Bands. Closing below the -4σ Band would stop out the signal, and that would coincidentally occur just below the support level of 4305.

Equity-only put-call ratios remain on sell signals. The weighted ratio has been persistently rising for several weeks, while the standard ratio has only recently begun to rise. So these two ratios are back “in synch” with each other once again, and they will continue to remain bearish (for stocks) as long as they continue to rise.

Breadth continues to be an interesting market statistic. Breadth has actually been improving on a relative basis. During much of the past six months, breadth was lagging behind the surging S&P 500. That indicated that most stocks were not advancing — just the narrow sector of large-cap stocks that dominate SPX were.

Now, a bit of the reverse is occurring, as SPX is finally beginning to correct, while many individual stocks are not. In any case, the breadth oscillators are on buy signals at the current time. I would say they are ”clinging” to buy signals, but unless breadth turns more negative from here, their buy signals persist.

The cumulative breadth indicators have not improved, and thus the negative divergence that has been a warning sign since mid-June remains in place. So continue to closely watch your stops and avoid complacency in all facets of your trading — especially now that SPX is in a budding downtrend.

NYSE new 52-week highs have begun to slip below NYSE new 52-week lows. This is not yet a sell signal, though, because the number of new lows is so small on the NYSE. In terms of Nasdaq and “stocks only” data, the new lows have been more dominant, but our indicator uses NYSE data. In that data, a sell signal would occur if new lows exceed new highs on any given day, and new lows number more than 100 issues.

The realized volatility sell signal that was recently generated remains in place. That is, the 20-day historical volatility (HV20) of SPX has risen above 10%. As long as it stays above that level, the sell signal is in effect.

Implied volatility, on the other hand, has not capitulated to the bearish case yet, but it is suddenly getting close. A new VIX “spike peak” buy signal was generated on Sept. 21, and it has already been stopped out. The trade was a tiny loss, but we are not used to seeing these reliable buy signals stopped out so quickly. VIX is now in “spiking mode” once again, and the next VIX “spike peak” buy signal will set up soon. See the recommendation below for more specific information.

More disturbing, though, is the fact that the 20-day moving average of VIX is quickly approaching the 200-day MA. See the accompanying chart. If the 20-day crosses above the 200-day and VIX is also above the 200-day, that is an intermediate-term sell signal. We have not had one of these since late February 2020. If that sell signal takes place, it would remain in effect as long as both VIX and its 20-day MA are above the 200-day MA.

The construct of volatility derivatives has, so far, been remaining bullish on stocks. While the VIX futures have lost a great deal of their premium over VIX, their term structure has continued to slope upward. The same is true of the term structure of the CBOE Volatility Indices, which the occasional exception of the 9-day (VIX9D) rising sharply a couple of times.

What we are watching in this area, though, is the relationship between the front-month October VIX futures and the November VIX futures. If October were to cross above November and settle there, that would be a negative indicator for stocks.

On the big decline this week (on Sept. 28), November consistently traded above October by 70 cents or more, so this indicator remained bullish. But this is an area that bears watching, for when the front month crosses above the second month, it has been an immediate warning sign of a sharp market decline in the past.

In summary, the picture is getting more bearish, but the signals are still mixed.  Unless SPX breaks below 4305, it would mean nothing.  However, a breakdown below 4305, accompanied by another increase in VIX, would be a very negative combination for the stock market.

Regardless, we will trade confirmed signals as they occur, from our various indicators.

New recommendation: bearish VIX crossover

IF the 20-day moving average of VIX closes above the 200-day moving average

And

IF VIX closes above the 200-day moving average on that same day,

THEN

            Buy 1 SPY Oct (29th) at-the-money put

            And sell 1 SPY Oct (29th) put with a striking price 25 points lower.

Furthermore, Oct VIX futures settle above Nov VIX futures on any given day, add another spread of a similar nature:

            Buy 1 (more) SPY Oct (29th) at-the-money put

            And sell 1 (more) SPY Oct (29th) put with a striking price 25 points lower.

New recommendation: VIX ‘spike peak’ buy signal

VIX spiked on Sept. 28 and stopped out the new “spike peak” buy signal, which had been confirmed on Sept. 21. So, now, we are waiting for VIX to close at least 3 points below the highest price that it has reached since entering “spiking” mode. That mode began on Sept. 28, and the highest VIX price reached so far is 24.82 (although it could trade higher at any time).

IF VIX closes at least 3.00 points below its highest price reached since Sept. 28 (including Sept. 28), then

Buy 1 SPY Oct (29th) at-the-money call

And sell 1 SPY Oct (29th) call with a striking price 12 points higher.

This spread will be held for 22 days or until VIX re-enters “spiking mode” (a gain of at least 3 VIX points over any 1-, 2-, or 3-day period, using closing prices). If it does re-enter “spiking mode,” that would then set up yet another “spike peak” buy signal as soon as the next spike is completed.

New recommendation: Meredith Corp.

Meredith Corp. is rumored to be in advanced talks with Interactive Corp. Rumors are for a bid of $61 or higher. MDP traded at a 2-year high, on very strong stock volume. If the calls are bought, we will hold without a stop initially.

Buy 3 MDP Oct (15th) 55 calls at a price of 2.75 or less

MDP: 55.58                            Oct (15th) 55 call: 2.00 bid, offered at 2.95

Follow-up action

All stops are mental closing stops unless otherwise noted.

Long 1 RAPT Oct (15th) 35 call: continue to hold without a stop.

Long 1 SPY Oct (15th) 440 put and Short 1 Oct (15th) 415 put: this spread was bought in line with the equity-only put-call ratio sell signals. Those put-call ratio signals are still on sell signals, so we are continuing to hold this spread.

Long 3 LDOS Oct (15th) 100 calls: these calls were bought in line with a weighted put-call ratio buy signal for LDOS, which is still in effect. Continue to hold as long as the put-call ratio buy signal is in place.

Long 3 PCAR Oct (15th) 82.5 calls: these calls were bought in line with a weighted put-call ratio buy signal for PCAR, which is still in effect. Continue to hold as long as the put-call ratio buy signal is in place.

Long 0 IWM Oct (15th) 224 puts and Short 0 IWM Oct (15th) 209 puts: were stopped out on September 23rd, per instructions in last week’s report.

Long 2 ETN Oct (15th) 165 puts: these puts were bought in line with a weighted put-call ratio sell signal for ETN, which is still in effect. ETN has fallen sharply, so roll the Oct (15th) 165 puts down to the Oct (15th) 155 puts. Be sure to sell your Oct 165 puts for at least parity (parity for an in-the-money put = strike minus stock price = 165 minus stock price, in this case). Continue to hold as long as the put-call ratio sell signal is in place.

Long 3 CTXS Oct (22nd) 112 calls: the closing stop remains at 107.

Long 0 SPY Oct (15th) 434 puts and Short 0 SPY Oct (15th) 409 puts: these put spreads were stopped out when SPX closed above 4430 on September 23rd.

Long 0 SPY Oct (22nd) 434 calls and Short 0 SPY Oct (22nd) 447 call: this spread was bought in line with the most recent VIX “spike peak” buy signal. That buy signal was stopped out on September 28th, when VIX went back into “spiking mode.”  The spread was closed and a new one will be bought on the next VIX “spike peak” buy signal.

Long 1 SPY Oct (29th) 443 calls and Short 1 SPY Oct (29th) 456 call: this spread was bought on Sept 23rd, when SPX closed above 4430. This is the McMillan Volatility Band (MVB) buy signal. It will remain in effect until SPX trades at either of the +/-4σ bands. Touching the +4σ Band would complete the signal, and the spread should be closed. Closing below the -4σ Band would stop out the trade but would eventually set up another buy signal.

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.

Disclaimer:

©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.

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