By Lawrence G. McMillan
The S&P 500's false upside breakouts should give stock buyers pause
Equity-only put-call ratios have continued to rise, and that is bearish for stocks.
The S&P 500 Index SPX has once again registered a false upside breakout. It probed to new all-time highs for two days, but then fell back into its old trading range. From there, selling accelerated, taking it down to the middle of that range.
There is resistance at the top of the range, in the 6,100-6,140 area, and there is strong support at the bottom of the range, in the 5,770-5,870 range. In addition, twice this month - on Feb. 3 and again on Feb. 25 - a sharp selloff was reversed, thereby installing short-term support levels at or just below 5,920.
That's two false upside breakouts and one false downside breakout so far. This market seems to not want to exit its trading range.
Since realized volatility is calculated using closing prices, it is falling despite some wide intraday ranges. That, in turn, is causing the "modified Bollinger bands" to contract somewhat. SPX has not traded outside either of the +/-4<SIGMA> bands since last August - a long stretch for this indicator.
Equity-only put-call ratios have continued to rise, and that is bearish for stocks. They are in overbought territory because they are near the lower regions of their charts.
Market breadth has been a problem for a while now. It was not expanding when SPX broke out to new all-time highs a week ago, and it has been dismal ever since. Both breadth oscillators are now on sell signals.
New lows on the New York Stock Exchange have taken over new highs, and that has stopped out the previous buy signal from this indicator. Moreover, it has returned the indicator to a neutral state. It would take either new highs or new lows numbering greater than 100 for two days in a row in order to generate a new signal here.
The Cboe Volatility Index VIX has been fairly subdued, but it did spike up when SPX sold off this past week. It is now in what we call "spiking mode." That is the precursor to a "spike peak" buy signal, which will occur when VIX closes at least 3.0 points below its most recent peak, which is 21.48 so far. When that buy signal occurs (and it will), then it will be held for 22 trading days unless stopped out by VIX climbing back above that most recent peak.
There is no trend of VIX signal in place at this time, because the 20-day moving average of VIX and the 200-day MA are essentially at the same price. If VIX moves higher from here, the 20-day MA will accelerate above the 200-day MA and generate a sell signal, but we'll see how this unfolds before trying to take a position.
The construct of volatility derivatives has remained bullish even with SPX registering another false upside breakout. The term structures of both the VIX futures and of the Cboe volatility indices continue to slope upward, and the VIX futures are trading at premiums to VIX. All bullish signs for stocks.
In summary, with SPX back in the trading range, we do not have a core position. Moreover, the indicators are mixed - which is to be expected in a trading-range environment. We will take new signals as they occur and will continue to roll deeply in-the-money options.
New recommendation: Potential VIX 'spike peak' buy signal
VIX has entered "spiking" mode. When it reaches its peak and backs off, a new "spike peak" buy signal will occur. Specifically, that will take place when VIX closes at least 3.0 points below its most recent peak. That peak, so far, is 21.48, which VIX reached on Feb. 25.
If VIX closes at least 3.00 points below its most recent peak:
Then Buy 1 SPY SPY (April 17) at-the-money call and Sell 1 SPY (April 17) call with a striking price 20 points higher.
If bought, we would stop out this position if VIX were to close above that most recent peak. Otherwise, by the rules of the trading system that we have built around these "spike peaks," we will hold for 22 trading days.
New recommendation: Dell earnings straddles
Dell Technologies (DELL) straddles appear to be favorably priced to purchase just prior to the earnings. Dell is reporting after the close on Feb. 27. Wait until late in the day and then buy the at-the-money straddle if it satisfies the criteria below.
Late in the day on Feb. 27, buy the DELL at-the-money Feb. 28 straddle for 13.50 or less.
On the next morning, the stock will open - probably on a gap. Use these guidelines for exiting the trade:
1) Let the stock gap and trade for an hour. If it has not exceeded the previous day's trading range by that time, then sell the straddle and take the loss.
2) Otherwise, continue to hold the straddle as the day progresses. If the stock trades back into its opening gap at any time during the day, then sell the straddle.
3) If neither of these conditions occur, then sell the (hopefully profitable) straddle just before the close of trading.
Is volatility going to explode?
The 20-day historical volatility of the VIX futures is now exceedingly low. This will not last, and one can expect sharp movements in the ensuing weeks - but the timing of any such moves is not clear. There have been claims that some traders are loading up on the VIX (March 18) 23 and 24 strike calls. This implies that market-makers would be extremely short volatility at that level and could accelerate a volatility push to the upside should the March VIX futures trade that high - up to 23 or 24.
As we know from past actions, if March futures were to get into that neighborhood, certain parties might attempt to buy enough futures to trigger that volatility explosion - similar to what happened in February 2018, although for slightly different reasons.
Currently VVIX, which measures the volatility of VIX (i.e., the volatility of volatility) is near 100%, but these options have a healthy implied volatility of about 160%, making them extremely overpriced. Still, their actual dollar price is not bad for a speculation. So, just in case these alarmists are correct, we are going to take a small speculative position here:
Buy 6 VIX (March 18) 24 calls in line with the market.
The entire premium is at risk, because a stop-loss order does not make sense here: VIX could explode at the last minute. Roll the options up if March VIX futures (the underlying security) trade at 29 or higher.
Follow-up action:
All stops are mental closing stops unless otherwise noted.
We are using a standard rolling procedure for our SPDR S&P 500 ETF Trust 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 options, roll if they become 8 points in-the-money.
Long 4 WBA (March 14) 11 calls: This is the "alternative" Dogs of the Dow position. Walgreens Boots Alliance (WBA) has been buoyed by positive earnings and takeover rumors but hurt by the threat of a Justice Department investigation. We are holding without a stop at this time.
Long 1 SPY (March 7) 611 call and short 1 SPY (March 7) 623 call: This position was originally based on the latest "spike peak" buy signal of Dec. 19. It was subsequently rolled to this spread when the most recent "spike peak" buy signal occurred, and the long call was rolled up last week on Feb. 20. We are now on the verge of a new "spike peak" buy signal, so we will start the clock over again for this spread, holding for 22 trading days unless stopped out by a VIX close above 21.48, the most recent peak.
Long 0 SPY (March 7) 607 call and short 0 SPY (March 7) 622 call: This position is based the "new highs vs. new lows" buy signal. This trade was stopped out as of Feb. 24, when new lows had outnumbered new highs for two days in a row. That returned this indicator to a neutral state.
Long 1 SPY (March 21) 607 call and Long 1 SPY (March 21) 595 put: We originally bought a straddle, and then later rolled the put down. Continue to roll any option that becomes at least 8 points in the money. Sell the put if SPX closes above 6,130 on any day going forward.
Long 2 ALL (March 21) 200 calls: We will hold these Allstate (ALL) calls as long as the put-call ratio buy signal is in place.
Long 10 WEAT (March 21) 5 calls: We will hold these Teucrium Wheat Fund WEAT calls as long as the put-call ratio buy signal is in place.
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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