Home FSM Money Watch the warnings coming from the stock market's sell signals – MarketWatch

Watch the warnings coming from the stock market's sell signals – MarketWatch


The stock market suffered some damage through the week ending Jan. 29, but it has rebounded strongly this week. Part of that rebound is due to a seasonally bullish trend near the end of January, where institutional money managers put cash to work. But that seasonally bullish period ended with the close of trading Wednesday, so the market does not have that wind at its back any longer.
The S&P 500 index SPX, +1.58% bottomed out right at the 3700 level on Jan. 29, so that is support. We continue to view the 3630 level as more important support, however. If the 3630 level were broken on a closing basis, that would turn the S&P chart negative. SPX has rallied enough to close the small gap on its chart left from the Jan. 27 breakdown. So the next resistance area is the all-time highs at 3870 or so.
The McMillan Volatility Band (MVB) sell signal remains in place. It would only be stopped out by SPX closing above its +4σ Band. As you can see from the chart, the Bands are now moving away from the still-rising 20-day moving average because realized volatility has increased.
As long as we’re on the subject of realized volatility, that sell signal is still in place as well. It would be stopped out if the S&P’s 20-day historical volatility fell below 9%, but it is at 17% right now, so there is very little chance of that sell signal being stopped out soon. It might be worth noting that, in January 2020, there were MVB and realized volatility signals that persisted from January until the market finally broke in late February. No two market are ever exactly alike, but so far it is for SPX and these two indicators.
Equity-only put-call ratios are split in their outlook. That is quite unusual, but there is a possible reason for it. First, the standard ratio is breaking down to new lows. It hasn’t been this low since March 2000, and if it goes any lower, it will be down at the numbers last seen in 1999 – in other words, near the end of that previous tech boom euphoria.
Meanwhile, though, the weighted ratio is steadily moving higher. Technically that is a sell signal, although we would need more confirmation before acting on that.
Why are these trending in opposite directions? One rather simple explanation is that the call buyers that are out there are buying relatively low-priced calls in great quantity. That forces the standard ratio lower because it is measure in terms of option volume only. The weighted ratio includes the price of the options, and there is apparently more of a balance between the dollars being spent on calls and the dollars being spent on puts. Hence, the weighted ratio has been higher on a daily basis.
Breadth was negative enough to give sell signals about 10 days ago, but it has bounced back along with the market, and those sell signals have been canceled out. Even so, breadth is not the extremely positive indicator that it was in late 2020. The cumulative Advance-Decline lines are moving higher, too. The NYSE-based cumulative A-D line made a new all-time high on Wednesday. The “stocks only” based A-D line is just shy of a new all-time high.
What has been even stronger, though, is cumulative volume breadth (CVB). CVB has made a new all-time high on 17 of the last 21 trading days. Moreover, it is predictive, projecting that the S&P will trade at a new all-time high as well. I realize that’s not that far away, but it is still worth noting.
New highs have continued their dominance over new lows. Actually, that’s pretty easy when there are NO new lows, as there have been for the last two NYSE trading days. That’s right. Zero over two days. In any case, this indicator remains positive for stocks.
Volatility rose sharply when the market sold off a week ago, but it has coming plunging back down this week. As a result, a new VIX “spike peak” buy signal is in place, as of the Jan. 28 close. That will remain in place for 22 trading days, or until VIX returns to “spiking mode.”
VIX VIX, -0.70% was briefly above its declining 200-day moving average, but now it is back below its rising 20-day moving average. Even so, VIX is still at a relative high level. It hasn’t closed below 20 since before the market crashed in February 2020. Since VIX is based on the prices of SPX options, and since those are traded mostly by large, institutional accounts, one would have to conclude that “big money” (which may not be the same thing as “smart money”) is still nervous about where the stock market is going.
The construct of volatility derivatives remains modestly bullish: the term structure of the VIX futures slopes upward over the first three months and is then flat after that. The term structure of the CBOE Volatility Indices slopes upward through the 6-month Index. Moreover, the VIX futures are trading at a premium to VIX. That all adds up to a mostly positive outlook for stocks. An inversion of the term structure would be negative, and that occurred for about two days last week, but then reverted to the current bullish stance.
Some warning signs have appeared in the way of confirmed sell signals. Even a move to new all-time highs would not necessarily erase all of these sell signals. But for now we are trading signals from both sides. A move to new highs would be more bullish, of course, while a break below 3630 would be very bearish.
The similarities to 2020 are enough that one should stay extremely alert — tightening trailing stops and rolling options up if the market advances and taking confirmed sell signals in modest size when they appear.
Zynerba Pharmaceuticals ZYNE, +4.81%  jumped sharply on very strong stock and option volume. The cause was takeover rumors, sparked by the huge acquisition of GW Pharmaceuticals US:GWPH  by JAZZ Pharmaceuticals JAZZ, +1.52%  at $220 in cash and stock. GW Pharmaceuticals had been trading in the mid-140s prior to that.
Zynerba options are very overpriced right now, so we are going to buy the stock instead.
Buy 800 shares of ZYNE common stock.
ZYNE: $4.53 close on Feb. 3
If bought, stop yourself out on a close below $3.75.
If SPX breaks support at 3630, we want to add to bearish positions:
IF SPX closes below 3630,
THEN buy 2 SPY Feb (26th) at-the-money puts
And sell 2 SPY Feb (26th) puts with a striking price 40 points lower.
If this position is established, set a stop to close it out if SPX closes above 3750.
All stops are mental closing stops unless otherwise noted.
• Long 500 CLIR common stock: Raise the stop to 3.75.
• Long 5 IVZ Feb (19th) 19 calls: The stop remains at 19.80.
• 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 3 GILD Mar (19th) 62.5 calls: These were bought based on a put-call ratio buy signal. The put-call ratio has now rolled over to a sell signal, so exit this position now.
• Long 1 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 HV falls back below 9%.
• Long 1 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, continue to hold and we will update the situation weekly.
• Long 6 DXC Feb (19th) 28 calls: DXC Technology DXC, +1.85% has rejected the proposed takeover bid of Atossa Therapeutics ATOS, +6.98%  , claiming the company is worth more than what was being proposed. Atossa is apparently not interested in raising the bid. However, analysts are still positive on DXC, so we are going to hold for a while to see if something further develops.
• Long 0 QQQ Feb (5th) 324 puts and short 0 QQQ Feb (5th) 309 puts: This spread was bought at the close of trading on Jan. 20, in line with the seasonal “January Defect” system. It was closed out at the end of the 18th trading day of January – Jan. 28 — for a small profit.
• Long 3 ODP Feb (19th) 46 calls: Continue to hold as there are still more takeover rumors in this stock.
• Long 0 SPY Feb (19th) 374 puts and short 0 SPY Feb (19th) 344 puts: This position was established at the close of trading on Jan. 27, when the February VIX futures closed at a higher price than the March futures. It was stopped out on Feb. 1, when the February futures rose back above the March futures by more than 0.50.
• Long 0 SPY Feb (12th) 378 calls and short 0 SPY Feb (12th) 392 calls: This spread was bought at the close of trading on Jan. 28, when the January seasonal bullish period began. It was sold at the close of trading on Wednesday, when that seasonally bullish period ended. The overall trade was a small profit.
• Long 2 SPY Feb (26th) 378 calls and short 2 SPY Feb (26th) 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.
Send questions to: [email protected]
Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading adviser. 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 adviser and with the CFTC as a commodity trading adviser. 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.
Solid performance is expected in the chip maker's gaming and data center businesses when it reports earnings Wednesday.

Lawrence G. McMillan is a columnist for MarketWatch and editor of the “MarketWatch Options Trader” newsletter. He is president of McMillan Analysis, an investment and commodity-trading adviser.




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