Opinion: The S&P 500 is trying to start a rally, but that won’t end the bear market

The S&P 500 index traded at new yearly lows late last week. This keeps the pattern of lower highs and lower lows intact, meaning it is still a bear market. After the three-day weekend, however, prices have risen, largely due to massive oversold conditions, and the S&P is trying to find a trading floor to initiate an oversold rally.

Bear markets are littered with oversold rallies, and the last one in late May was kind of a dud. The next one however has a chance to be a bit better, as it looks like additional oversold buy signals could be confirmed relatively soon.

This oversold rally will not end the bear market (although there will be one eventually), but oversold rallies usually break above the falling 20-day moving average, which is currently at 3960. There are also two spreads on the S&P SPX,
chart, the second of which would be filled by the index trading at 4017. So this is kind of a target for the next oversold rally.

Laurent McMillan

The sharp decline on June 16 pushed SPX low enough to close below its -4σ “modified Bollinger Band” (mBB). This was the precursor to a “classic” mBB buy signal, which occurred on Tuesday, when SPX closed above the -3σ mBB.

For this to be a full-fledged McMillan Volatility Band (MVB) buy signal, however, additional confirmation is required: SPX must close above 3780, the June 21 high. If that happens, it will be MVB’s first buy signal since late January. The objective of an MVB buy signal is to touch the +4σ band. This MVB buy signal from the previous January reached its target at the end of March, so it may take some time.

The stock-only sell and buy ratios rose last week, challenging the ratio’s trend. They are now starting to fall again, but they need to go below the early June lows to get back to confirmed buy signals, in my opinion. There is a small horizontal red line on each of the put-call charts indicating this. The thing is, selling volume remains relatively heavy despite the market’s recent attempt to rally, but if these ratios drop to new relatively low lows (i.e. below early June lows), this will solidify a buy signal.

Laurent McMillan

Laurent McMillan

The width of the market remained weak, so the width oscillators remained on sell signals, albeit in deeply oversold territory. However, they are about a day away from the magnitude of the rollover to buy signals, so this is an indicator worth paying close attention to at this point.

For example, if there are at least 800 more advances than declines on the NYSE on Thursday, then the NYSE width oscillator will have moved to a confirmed buy signal.

New 52-week highs are still virtually non-existent, in all of our datasets. In seven of the last eight trading days, there have been only new single-digit highs on the NYSE. As a result, this indicator remains on a sell signal and is also deeply oversold.

rose during last week’s broad market decline and gave a “peak peak” buy signal on June 15, and there was a second “peak peak” buy signal overlapping the June 17. We only trade the first signal, although both are marked on the attached VIX chart. So this is the only confirmed trading signal we have in place at this time.

This positive short-term signal from the VIX is counteracted by the fact that the medium-term trend of the VIX remains up, which is bearish for stocks. This uptrend would only be broken if the VIX closes below its 200-day moving average, which is currently rising and sits just below 24. This medium-term downtrend for the VIX has been in place since the beginning of last December (circled on the VIX chart).

Laurent McMillan

The construction of volatility derivatives improved slightly. The term structure of VIX futures rises again in the first few months, before falling further down the curve. The term structure of the CBOE volatility indices has a similar shape. So it’s at least not bearish for stocks, although I wouldn’t say it’s outright bullish either.

Our “heart” position is still bearish, due to the downtrend of the SPX and the uptrend of the VIX. However, we will be trading confirmed oversold buy signals around this “middle” position, and we are starting to see the possibility of these occurring soon.

New Recommendation: MVB Potential Buy Signal

As noted in the comment above, a “classic” mBB buy signal has already occurred, so all that is needed to confirm a McMillan Volatility Band (MVB) buy signal is for SPX to close above the high of the day when the “classic” signal took place:

IF SPX closes above 3780,

THEN buy 1 SPY August (19e) call for parity

and sell 1 SPY Aug (19e) call with a strike price 20 points higher.

If this buy signal occurs, its target will be for SPX to touch the +4σ band. The signal would be stopped if SPX were to close below the -4σ band.

New recommendation: potential buy signal in breadth

As also noted in the market commentary above, the width oscillators are improving and could confirm a buy signal with a strong positive width day.

Starting with Thursday’s trade, keep a running total of daily advances minus declines on the NYSE. If this total reaches +800 or more at the close of any trading day, then a NYSE Width Oscillator Buy signal will have occurred, and it is highly likely that a “stocks only” width oscillator also occurred. If this cumulative total criterion of +800 or more is met, then:

Buy 1 SPY July (22n/a) call for parity

And sell 1 SPY July (22n/a) call with 15 points higher striking price

This signal would be stopped if the width oscillators return to sell signals, and we will update you on their status weekly.

Follow-up measures

All stops are mental closing stops unless otherwise stated.

We will implement a “standard” rolling procedure for our SPY spreads: in any bullish or bearish vertical spread, if the underlying hits the short strike, then roll the entire spread. It would be rolling at the top in the case of a call bull spread, or roll down in the case of a bear put spread. Stay in the same exhale and keep the same distance between strikes unless instructed otherwise.

Long 2 SPY July (15e) 366 puts and shorts 2 SPY July (15e) 346 put options: We initially bought this spread in line with the VIX trend sell signal. It was rolled twice. We will exit this position if VIX drops below its 200-day moving average, which is currently just below 24.

Long 1 SPY July (1st) 417 calls and short 1 SPY July (1st) 432 calls: This spread was originally bought on May 26, based on a combination of new stock-only ratio buy signals and width buy signals. It was then rolled up on June 2, when SPY SPY,
traded at the spread’s high strike. Half of the position was sold when the width oscillators pulled back to sell signals. We will close the other half when the stock-only buy and sell ratios change to a clear sell signal.

Long 5 KOD July (15)e) 10 calls: We will hold without stopping, initially.

Long 2 SPY July (15e) 366 put options: We initially bought a straddle then sold the calls when SPX closed below 4070. The remaining puts were reduced last week. Stop if SPY closes above 384.

Long 1 SPY July (22n/a) 367 call and short 1 SPY July (22n/a) 382 call. This gap was bought in line with the last VIX “peak” buy signal on June 15th. This signal would be stopped if VIX closes above 35.05 on any day.

Long July 3 AMLX (15e) 15 calls: Raise the closing stop to 12.50.

Send your questions to: lmcmillan@optionstrategist.com.

Lawrence G. McMillan is President of McMillan Analysis, a registered commodity trading and investment adviser. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and fund 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 its accuracy and completeness are not guaranteed. Officers or directors of McMillan Analysis Corporation, or accounts managed by such persons, may hold positions in the securities recommended in the advisory.

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