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Post: MarketWatch Options Trader: The stock market’s trend is relentlessly bearish, especially after this week’s big daily declines

The stock market took a tumble Sept. 13 when a monthly government report showed inflation is widespread throughout the economy.

One might have thought that professional traders would have anticipated such a possibility, but the euphoria leading up to the announcement had been too much.

As a result, “everyone” tried to sell at once, and the S&P 500 Index

sank, registering the fifth-largest single-day point decline in history. (The fourth-biggest occurred earlier this year, and the top three were in March 2020 during the onset of the pandemic.)

This negative action left what’s called an island reversal on the SPX chart. There is also an island reversal on the chart from mid-August. These are unusual formations on a broad-based index chart, and they are usually negative. SPX has found support near 3,900 points so far. If that is violated, then 3,800 is the next support level, with the yearly lows at 3,637 providing support below that.

On a more positive note, a McMillan Volatility Band (MVB) buy signal was confirmed Sept. 9. It is marked with a green “B” on the accompanying SPX chart, above. Its target is the upper +4σ “modified Bollinger Band” (mBB), which is currently above 4,300. This MVB buy signal would be stopped out on a close below the -4σ Band, which is dropping rapidly at the current time.

Equity-only put-call ratios remain on sell signals, as they continue to rise. As long as these ratios are rising, that is negative for the stock market. It is interesting to note that the last stock market rally — at the beginning of September — did not register much, if any, decline in these ratios. That is, traders were still buying puts despite the rally.

Market breadth has had some huge days in both directions of late. Breadth figures were very strong at the beginning of this month, and both breadth oscillators thus generated buy signals. However, the huge down day Sept. 13 was a “90% down day,” that rolled the “stocks only” oscillator back over to a sell signal. Technically, the NYSE breadth oscillator is still on a buy signal as of Sept. 15, but one more day of solidly negative breadth would cancel that out.

New 52-week highs on the NYSE continue to be very few in number, and so this indicator remains on a sell signal. It has been bearish since early April, as very few stocks have been able to register new 52-week highs since then.

The indicator that has been more positive than most others is VIX
the CBOE 30-day Volatility Index. It registered two buy signals a week or so ago, but both have been stopped out since then.

The first was a “spike peak” buy signal Sept. 8, but that was stopped out Sept. 13, when VIX returned to “spiking” mode. Since VIX is still in spiking mode, a new “spike peak” buy signal will be issued soon. Specifically, it will occur when VIX closes at least 3.00 points below the highest price that it has reached while in “spiking” mode. So far, that high was 28.15 on Sept. 13. If VIX doesn’t register a higher price today, then a close at or below 25.15 would generate a new “spike peak” buy signal.

In addition, when VIX rose earlier this week and held on to its gains, it stopped out the trend of VIX buy signal. That happened when VIX closed above its still-rising 200-day moving average for two consecutive days. This is not a trend of VIX sell signal, however, for that would require that the 20-day moving average of VIX also cross above the 200-day moving average. The 20-day is moving higher, but is still more than a point below the 200-day.

The construct of volatility derivatives remains in a modestly positive state for stocks. There had been a slightly inversion of the term structure in the front end — in both VIX futures and in the CBOE Volatility Indices — but that was only temporary.

In summary, the trend of SPX is still downward, and that’s what defines a bear market (not the arbitrary 20% figure purported by the media). So, we are maintaining a “core” bearish position. We will trade other signals around that “core” position as they are confirmed.

New recommendation: Potential VIX ‘spike peak’ buy signal

As described above, yet another “spike peak” buy signal will be confirmed soon.  This indicator has had some small losses recently, but its long-term track record is stellar, so we are not going to “skip” a signal.

IF VIX closes below 25.15,

THEN Buy 1 SPY Oct (21st) at-the-money call

            And Sell 1 SPY Oct (21st) call with a striking price 15 points higher.

If established, then stop yourself out if VIX closes above 28.15.

New recommendation: SPY straddle buy

The S&P 500 is sitting very near support at 3,900. It could register another oversold bounce from there, or, conversely, if it breaks down below there, then a more severe market decline could take place. So, it seems that a straddle purchase near the 3,900 level is a reasonable options strategy. Typically, the most volatile market action takes place in September and October, so we will set the expiration date for this straddle purchase near the end of October:

Buy 1 SPY Oct (28th) at-the-money call

And Buy 1 SPY Oct (28th) at-the-money put

As follow-up action, if SPY trades 25 points above your strike, then roll the call strike up 25 points.  Similarly, if SPY trades 25 points below your strike, then roll the put strike down 25 points.

Follow-up action:

All stops are mental closing stops unless otherwise noted.

We are using a “standard” rolling procedure for our 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.

Long 10 expiring CRNT Sept (16th) 2.5 calls: Aviat Networks (AVNW) has bid a price of essentially $3.08 for CRNT, but CRNT is not interested in selling. We are not going to invest any more money in this position, so let these calls expire and do not replace them.

Long 3 MRO Oct (21st) 24 calls: We will hold this position as long as the put-call ratio for MRO remains on a buy signal.

Long 1 SPY Oct (21st) 396 put and Short 1 SPY Oct (21st) 366 put: This is our “core” bearish position. It was rolled down 30 points on each strike, since SPY traded at 396 this week (per our general rule of “rolling” stated above). There is no longer a stop for this position at this time.

Long 2 expiring SGEN Sept (16th) 170 calls and Short 2 SGEN Sept (16th) 185 calls: This spread was bought after rumors of a takeover by MRK were spreading. That did not materialize, so let these calls expire and do not replace them.

Long 6 CANO Oct (21st) 7 calls: Stop yourself out on a close below 5.50.

Long 2 BFB Oct (21st) 75 puts: We will hold these puts as long as the BFB put-call ratio is on a sell signal.

Long 1 SPY Oct (7th) 398 call and Short 1 SPY Oct (7th) 413 call: This was bought at the close on September 7th, since the VIX “spike peak” buy signal was finally confirmed at that time. Technically, this was stopped out a couple of days ago, but we did not specify a stop in the last report. So, we will set a tight one now:  stop yourself out if VIX closes above 27.80.

Long 0 SPY Oct (7th) 400 call and Short 0 SPY Oct (7th) 415 call: This spread was bought in line with the trend of VIX buy signal of September 8th. This spread was stopped out on September 14th, after VIX closed above 25.00 for two consecutive days.

Long 1 SPY Oct (28th) 406 call and Short 1 SPY Oct (28th) 421 call: This spread was bought in line with the McMillan Volatility Band (MVB) buy signal of September 9th. Stop yourself out if SPX closes below the -4σ, which is currently at 3830 and dropping rapidly – so it is not really “in play” at this time.

Long 6 HOLI Oct (21st) 20 calls: Hold without a stop for now.

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 best-selling 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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