Also, how to trade the VIX “spike peak” buy signal and Gilead Sciences
The stock market, as measured by the S&P 500 index SPX, +1.48%, continues to plow ahead to new all-time highs. Other major indexes — the Dow Jones Industrial Average DJIA, +0.69%, the Nasdaq-100 NDX, +2.51% and the Russell 2000 RUT, +1.89% — are doing same.
The S&P had a scare on Monday, when it sold off over 90 points intraday, mostly as a reaction to the fact that it had been so overbought to close out 2020. However, it bounced from the 3662 level and closed above its rising 20-day moving average that day. It has not closed below that moving average since early November.
Thus, the momentum of the S&P chart remains positive. Because this is the most important indicator, traders should remain long the market, raising trailing stops as needed.
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That pullback on Monday to the 3662 level was just above the broader support area at 3630-3650. Hence that entire area now is important support, merely because SPX has bounced off of there so many times. That also means that a violation of that level would be bearish. There is also a support level at 3550. On the accompanying chart, those two support areas are denoted by red horizonal lines.
That’s really all you need to know right now, keeping things quite simple: stay long the market as long as SPX is above those support lines.
Some other indicators have generated sell signals, or at least have come close to doing so. But such sell signals must be viewed with a certain amount of skepticism until confirmed by an accompanying breakdown in the price of SPX.
Equity-only put-call ratios are good example. The ratios have been (and still are) very overbought, meaning that call buying has been heavy and dominant. Since these are contrary indicators, that eventually leads to sell signals when the call buying wanes. These ratios have begun to climb (slowly) in the past week, as noted by the two put-call ratio charts.
Technically these are on sell signals. However, they aren’t rising because there has been a shift in sentiment, but rather because they were so low on their charts that they are “reverting to the mean” to some extent.
So we are viewing these sell signals with skepticism unless SPX breaks down below a support level. We would expect these put-call ratios to be rising rapidly in a truly bearish scenario for stocks.
Market breadth had been one of the stronger areas of technical support for the market. But in the past couple of weeks, breadth has wavered. Both breadth oscillators generated two short-lived sell signals which have both been stopped out. This is our shortest-term indicator, and it is not unusual to see whipsaws in the signals such as this.
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At this moment, both breadth oscillators are back on buy signals. Moreover, the cumulative Advance-Decline lines and cumulative volume breadth (CVB) both made new all-time highs on both Tuesday and Wednesday.
New highs are continuing to dominate new lows in a way never quite seen before On Wednesday, the differential between new highs and new lows was the largest in the history of our database, in terms of all three data sets — NYSE, NASDAQ, and “optionable stocks.” This indicator remains extremely bullish for the stock market.
Volatility has joined the bullish chorus as well, with a new VIX “spike peak” buy signal as of the close of trading on Tuesday. There was a school of thought that VIX might break down once the Georgia Senate elections were over, but that hasn’t played out. VIX VIX, -10.77% remains rather elevated — above 22 — merely because many traders are still feeling the need to pay up for SPX puts (the main driver of the price of VIX). That doesn’t mean these traders are bearish (they are probably buying stocks at the same time they are buying SPX puts — that is, the puts are for protection).
In any case, VIX remains on its second “spike peak” buy signal in that last couple of weeks.
Finally, the construct of volatility derivatives remains bullish where it counts – in the front end of the VIX futures term structure. As long as January VIX futures continue to trade at a lower price than February VIX futures, that is bullish for the stock market. That construct remained in place even during Monday’s 90-point selloff.
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The Santa Claus rally period ended with a gain of just under 1%, and so a potential sell signal was averted there (if the period had ended with a loss, that would have been a sell signal). The next seasonal trade that we are eyeing is not until the end of January.
In summary, remain bullish as long as the SPX chart holds above support. Roll long calls up to higher strikes and/or raise trailing stops but stay long. Do not become complacent, however, for eventually there will be sell signals that are confirmed, and they should be acted on.
We are going to use this strategy: while remaining long, if sell signals do occur, we will take them in small size. Later, if SPX breaks support, we would then add to the bearish positions.
New recommendation: Gilead Sciences
This recommendation is based on a put-call ratio buy signal in Gilead Sciences GILD, +0.92%. The buy signal itself took place a couple of weeks ago, after there had been overly heavy put buying in Gilead Sciences (remember, put-call ratio signals are contrary signals, so heavy put buying implies that one should be long the stock – modulo certain other criteria). In any case, we wanted to see the stock price recover somewhat, and now it has.
Buy 3 GILD Mar (19th) 62.5 calls
At a price of 3.70 or less.
GILD: 63.09 Mar (19th) 62.5 call: offered at 3.60
We will hold as long as the put-call ratio is on a buy signal for GILD.
New recommendation: VIX “spike peak” buy signal
Another VIX “spike peak” buy signal occurred on Tuesday. Since we had previously been long a similar position based on the VIX “spike peak” buy signal of Dec. 21, perhaps you are still long that spread. If you are not long a SPY spread based on the VIX “spike peak” buy signal, then take this recommendation. But if you are still long from before, do not double up – hold only one long SPY bull spread based on the VIX “spike peak” buy signals.
Buy 2 SPY Feb (5th) at-the-money calls
And sell 2 SPY Feb (5th) calls with a striking price 13 points higher.
New recommendation: Conditional term structure sell signal
IF Jan VIX futures settle at a higher price than Feb VIX futures on any given day,
THEN
Buy 2 SPY Jan (29th) at-the-money puts
And sell 2 SPY Jan (29th) puts with a striking price 25 points lower.
If this position is established, then stop yourself out if the term structure reverts back to its normal state, with Feb closing higher than Jan.
Follow-up action
All stops are mental closing stops unless otherwise noted.
• Long 500 CLIR common stock: The closing stop remains at 2.74.
• Long 5 IVZ Jan (15th) 16 calls: The stop remains at 16.75.
• Long 500 shares of SURF common: The stop remains at 8.50.
• Long 2 expiring SPY Jan (8th) 371 calls and short 1 SPY Jan (8th) 381 calls: This position was originally taken when SPX closed above 3588 on Nov. 16. Since the SPX chart is still bullish, we want to stay with this position. Roll to the same number of SPY Jan (29th) 367 – 380 bull spreads. That is, sell the position you currently have and replace it by buying 2 SPY Jan (29th) 367 calls and sell 2 SPY Jan (20th) 380 calls. We will continue to hold without a stop since we have already rolled up a couple of times.
• Long 0 IWM Jan (8th) 194 calls: We bought these for the post-Thanksgiving seasonal trade, and they were rolled up twice. We exited the trade at the close of trading on Tuesday, which is the end of the seasonally bullish period. For the record, the Russell 2000 index IWM, +1.78% gained 7% over that period.
• Long 3 CATM Jan (15th) 35 calls: Cardtronics CATM, -0.17% continues to edge higher, as rumors circulate that a higher bid is forthcoming. Continue to hold.
• Long 1 BMRN Jan (15th) 90 call: The stop remains at 82.
• Long 2 AIG Mar (19th) 40 puts: We will hold as long as the put-call ratio is still on a signal, which it is at this time.
• Long 0 SPY Jan (29th) 368 calls and short 0 SPY Jan (29th) 383 calls: This position was based on the VIX “spike peak” buy signal of Dec. 21. This spread was stopped out on Monday, when VIX closed 4.22 higher than the day before. The next day, however, another spike peak buy signal occurred. We are trading that new signal (see recommendation in the main newsletter above). If you did not yet sell this spread, I would not double up. Just hold one position based on the VIX “spike peak” buy signal.
Send questions to: [email protected].
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.
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