Keep riding the stock market’s momentum — cautiously

This post was originally published on this site

The S&P 500 index SPX, -0.88% continues to plow ahead, having made new intraday and closing all-time highs on Feb. 15 and Feb. 16. The Nasdaq-100 NDX, -1.20%   QQQ, -1.22% did so on the same dates. The Dow Jones Industrial Average DJIA, -0.80% DIA, -0.81%  just made its new all-time on Feb. 17. The Russell 2000 RUT, -1.51%   IWM, -1.62% is a little weaker than those, having made its latest all-time highs a week ago, on Feb. 9 and Feb. 10.

In any case, these are all at or very near all-time highs, and their charts are trending higher: moving averages and “modified Bollinger Bands” are sloping upward. That is the main thing: the trend of the market is upward, and thus we are bullish as long as that is the case, but we are also on the lookout for signs of weakness, as evidenced by confirmed sell signals from our indicators.

The SPX chart has support at 3870 (the January highs), 3700 (the late January level from which this latest leg of the bull market rally was launched, and finally 3630 (the December lows). The chart could handle a breach of the 3870 level and still remain positive, but a breakdown below the other two — especially below 3630 — would change the picture from bullish to bearish.

The McMillan Volatility Band (MVB) sell signal from early January is still place and will continue to be in effect unless SPX rises above the +4σ Band, which is somewhat unlikely, as that Band is currently above 4000 and rising.

The realized volatility sell signal of Jan. 7 is still in place as well. It would be stopped out if the S&P’s 20-day historical volatility fell back below 9%. That, too, is unlikely since it is currently at 16%.

This is a very similar situation to January-February 2020, when both of these indicators gave sell signals in January and remained on those sell signals even though SPX moved to a new all-time highs in February. They were both still in effect when the market broke down in late February 2020. We are maintaining a small, bearish position based on these sell signals.

The equity-only put-call ratios are not giving much, if any, ground. They are in extremely overbought states, but they are not on sell signals. They won’t be on sell signals until they start to rise at a rapid pace. The standard ratio is now at its lowest levels since February 1999, and if it drops only a bit lower from here, would be at the lowest levels since 1997. The weighted ratio is not as low as that, but it still at very overbought levels.

Breadth has been fairly strong, and both breadth oscillators remain on buy signals. Since they are overbought (which is perfectly fine when SPX is making new all-time highs), they could withstand a couple of days of negative breadth without rolling over to sell signals.

Meanwhile, the cumulative Advance-Decline lines made new all-time highs as recently as Feb. 16 (“stocks only”) and Feb. 12 (NYSE). Cumulative volume breadth (CVB) was at a new all-time almost every day this month and as recently as Feb. 16. These cumulative indicators are not predictive, though, when they are making new all-time highs at the same time that SPX is. Their only use at this point would be to warn of a negative divergence, and that is not the case currently.

New highs have registered some astonishing figures in the past couple of weeks, while new lows remained almost non-existent. Thus this indicator remains positive.

Volatility has been the one area that has been in somewhat of a “warning” state, as VIX VIX, +9.02% basically refuses to fall below 20 (well, technically it did, by 3 cents, on Feb. 12). This reflects the heavy demand for SPX puts, and that in turn reflects concerns about the market — at least by the large traders who trade SPX options.

That aside, the SPX “spike peak” buy signal remains in effect, and the trend of VIX remains lower, as both VIX and its 20-day moving average are below the 200-day moving average.

On the accompanying VIX chart, there is a circle on the lower left that shows when a very strong VIX sell signal took place a year ago — when both VIX and its 20-day moving average crossed above the 200-day moving average. On the right, another circle shows the relatively close proximity of those three entities today. It would be bearish if both VIX and the 20-day crossed above the 200-day average.

The front-month VIX futures contract is now March. The construct of volatility derivatives is generally bullish but has taken on a new trait: the March futures are trading at an extremely high premium to VIX. They settled at 4.10 above VIX on Feb. 17 and were above 5.00 points late last week. The front end of the VIX futures term structure slopes upward from there. The CBOE Volatility Index term structure slopes upward, too. So those are bullish factors for the stock market.

As always, though, this would change if the front month (March) rose above the second month (April), or if VIX rose above VIX3M (the 90-day CBOE Volatility Index).

Overall, we remain bullish in line with the upward momentum of the SPX chart. However, we continue to roll call options up to higher strikes when they become sufficiently in the money and to raise trailing stops. We will take small bearish positions if confirmed sell signals arise and would increase the size of those positions if SPX broke down below support levels.

New recommendation: VIX/SPY put hedge

As noted above, the premium on the front-month March VIX futures is quite large. There is a hedged strategy we have used many times to profit from unusually large premiums or discounts in VIX futures. Since the VIX futures are trading with a large premium to VIX, we want to buy VIX puts, for they have an “edge” in that the prices of the March VIX futures and VIX itself will converge — but not necessarily until near the March 17 expiration of the March VIX futures. That is a long time to hold the VIX puts, and therefore we want a hedge.

The best hedge is to buy SPY puts, for VIX and SPY move in opposite directions. Thus, a purchase of puts on both VIX and SPY is a hedged position. We are going to buy in-the-money puts to reduce time value expense, and we are going to buy 3 VIX puts for each SPY put (that is a “neutral” position in terms of volatility, as long as the two options have approximately equal deltas).

Buy 3 $VIX Mar (17th) 30 puts

And buy 1 SPY Mar (17th) 400 put

This position cost about $3,200. In theory, this entire amount could be at risk, but in reality we will put a dollar stop on this position — closing it if it marks down $900 on any day’s close. Note that both puts expire on March 17.

New recommendation: Conditional SPX breadth sell signal

Using NYSE advance-decline data,

IF the number of declining issues outnumbers advancing issues on the NYSE over any one- or two-day period, by 1200 total issues,

THEN buy 1 SPY Mar (12th) at-the-money put

And sell 1 SPY Mar (12th) put with a striking price 25 points lower.

If this position is established, set a stop to close it out if SPX closes above 3950.

Follow-up action

All stops are mental closing stops unless otherwise noted.

• Long 500 CLIR common stock: The stop remains at 4.00.

• Long 5 expiring IVZ Feb (19th) 19 calls: Roll to the Mar (19th) 22 calls and raise the stop to 21.40.

• Long 2 AIG Mar (19th) 40 puts: We will hold as long as the put-call ratio is still on a sell signal, which it is at this time.

• Long 1 expiring SPY Feb (19th) 379 put and short 1 SPY Feb (19th) 359 put: This trade is based on the 20-day historical volatility sell signal. This trade will be stopped out if the S&P’s 20-day historical volatility falls back below 9%. We want to maintain a position here, so roll to the SPY Mar (19th) 390 – 360 put spread (i.e., long 1 SPY Mar 390 put and short 1 SPY Mar 360 put).

• Long 1 expiring SPY Feb (19th) 376 put and short 1 SPY Feb (19th) 356 put: This trade was established in line with the McMillan Volatility Band (MVB) sell signal of Jan. 15. It would be stopped out if SPX were to once again close above the +4σ Band. Of course, that would then set up another potential MVB sell signal down the road. For now, roll to the SPY Mar (19th) 390 – 360 put spread (i.e., long 1 SPY Mar 390 put and short 1 SPY Mar 360 put).

• Long 6 expiring DXC Feb (19th) 28 calls: DXC Technology DXC, -0.77% has rejected the proposed takeover bid by Atossa Therapeutics ATOS, -2.89%, claiming the company is worth more than what was being proposed. Atossa apparently isn’t interested in raising the bid, and we are out of time. Allow these calls to expire and do not replace them. There may be a higher bid here, but there is no evidence of it at this time.

• Long 3 expiring ODP Feb (19th) 46 calls: We are out of time here, too, so sell these calls if you can and do not replace them.

• Long 2 SPY Feb (26th) 378 calls and short 2 SPY Feb (26th) 398 calls: This spread was bought in line with the latest VIX “spike peak” buy signal. It would be stopped out if VIX returns to “spiking mode.” That is, if VIX rises by at least 3.00 points over any one-, two- or three-day period. Of course, that would set up the next signal, which should be taken as well. In any case, we want to roll this spread up and out. Sell the spread you own, and — using the same quantity — buy the SPY Mar (12th) 392 calls and sell the SPY Mar (12th) 402 calls.

• Long 800 shares of ZYNE common stock: Raise the stop to 5.00. Zynerba Pharmaceuticals stock ZYNE, +2.14% moved right in lockstep with all of the other cannabis stocks on Feb. 10 (up a lot) and Feb. 11 (down a lot). That is not why we own this stock, but now we’re in the stew with the rest of them. Hopefully, now that it’s back down some, the takeover rumors will take more precedence.

• Long 8 ZNGA Mar (19th) 11 calls: The closing stop remains at 10.25.

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 bestselling 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.