The Option Strategist By Lawrence G McMilla

The Option Strategist By Lawrence G McMillan
March 8, 2006

Stock Market


So much has happened in the past 10 trading days that one could justify a myriad of outlooks. However, we feel that the overriding theme is that major damage was done to wallets and psyches last week, and that kind of damage takes time to repair. Thus, while sharp, but short-lived oversold rallies can spring up to counter declines, we think that -- at a minimum -- there will be a retest of this week's lows. And, if that retest doesn't hold, lower prices will result before another retest takes shape. These thoughts, of course, are in line with the feature article this week. Cynics say that no one makes money in bear markets -- not even the bears -- because the reflex rallies are so violent and strong that they take the bears out of their short positions. There is some truth to that, as I'm sure that the 35-point $SPX rally we've seen off the Monday lows has forced some bears to cover. CNBC's incessant cheerleading is a further misleading indicator, that also makes it tough to stay short.

The $SPX chart is still quite negative. It dropped 85 points and has rallied back about 35, so the net loss is still a big one. There is resistance in the 1420-1430 area. If $SPX should climb above 1430, we would likely grade the chart is "bullish," but until then it's bearish.

The equity-only put-call ratios have steadfastly remained on sellsignals. The sharp decline caused them to rise quickly as put volume skyrocketed. But, even when the reflex rally occurred this week, put volume has remained heavy and so these ratios continue to rise. As long as they are rising, they're bearish. At this point, they aren't that high on their charts, so one can't really even call them "oversold."

Market breadth was abysmal during the decline. Look at the "stocks only" data for the day of the big decline -- February 27th. Only 59 optionable stocks advanced, while 3,211 declined! That's an unheard-of ratio. There has never been a day with that much one-sided market action in history. This clearly reflects the herd-like nature of today's money managers, many of whom are running hedge funds. Some say that this dismal breadth was the unwinding of the "Yen carry trade," as those who had borrowed cheap Yen over the years were heavily invested in the stock market, as well as commodities such as gold, and everything had to be sold when the Yen had to be bought back. However, just a few days later, when the reflex rally unfolded, advances swamped declines (2,898 advances vs. 191 declines in "stocks only" data). NYSE breadth eventually gave a buy signal, although "stocks only" has not.

Finally, volatility skyrocketed, as $VIX nearly doubled. But it has now retreated dramatically. A spike peak in $VIX is a buy signal, and therefore we grade $VIX as bullish after closing below 15 today.

Does this mean we should rush out and buy the market? No, for the first reflex rally often comes with buy signals from $VIX and from breadth. But the more intermediate-term indicators -- the equity-only put-call ratios and the $SPX chart -- don't roll over so easily, and so we wouldn't turn bullish until at least one of those turns positive as well.

Tags: Technical anaylysis, Put-call ratio, VIX, Breadth

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The Option Strategist by Lawrence G McMillan

The Option Strategist Weekly Updater
March 1, 2006
Stock Market

The landscape has changed dramatically in the last week: volatility has increased substantially and weeks, if not months, of gains in most stocks have been wiped out. The question now becomes when and where will this decline end? Since our technical indicators were instrumental in warning us of this decline, we are of course going to rely on them to aid us in answering that question.

We were looking for a selloff -- in fact, a "sharp, but short-lived correction," to quote our comments last week. But we didn't know it would be this sharp, of course. $SPX has broken most of the major support levels it had established in its inexorable, stair-step rise over the past several months. Specifically, $SPX wiped out 3 months worth of gains in one day -- trading at the same price it had on December 1st, 2006. For $SPX, the 1430 level is now resistance, much as it was during December and January (see Figure 1). Until that level is overcome, the $SPX chart should be interpreted with a bearish bias. On a more positive note, Thursday's retest of the lows seems to have held, and that is a constructive sign.

The equity-only put-call ratios were prescient in warning of a decline by rolling over to sell signals in late January. Yes, they were a bit premature, but they resolutely remained on those sell signals ever since -- and they show no sign of turning bullish yet. Figures 2 and 3 show that are continuing to rise rather strongly as (too late) lots of traders rush to buy puts now. Eventually, those put buyers will overdo things, and the ratios will roll over and turn downward. Only then will they turn bullish, but that does not appear to be something that will happen soon.

Market breadth (advances minus declines) had been running at very overbought levels for quite some time. That is no longer the case. Now, breadths has generated sell signals. We are looking for breadth to get oversold -- something it hasn't done for months -- before generating buy signals. That, too, is something that isn't going to happen overnight.

Finally, there is the indicator that was perhaps most instrumental in our expectation of a correction: the volatility index, $VIX. It had traded below 10, and history showed that a sharp correction normally takes place after that. Now, $VIX has spiked upward. A buy signal occurs when $VIX makes a spike peak on its chart (see Figure 4). We would turn short-term bullish if $VIX generates a buy signal.

In summary, the decline was sharper than nearly anyone had expected. It was exacerbated, of course, by the fact that the bulls (or pigs, if you prefer) just kept pumping money into the market for so long, without giving it a chance to correct. Eventually, a little trigger like the Chinese stock market caused all the lemmings to try to get out the exit at once, and, in doing so, they nearly brought the house down. There has been major damage done to many accounts and buying is no longer on many of their minds (I cringed at the money manager being interviewed on CNBC, who was remaining bullish, but when asked what he was buying, answered "Nothing. I was -- and am -- 100% invested"). That may be the case for many of these managers: they are more likely to be sellers on rallies than to be buyers.

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Tags: futures, options, technical analysis, crash, correction, put-call ratio, breadth, VIX

The Option Strategist by Lawrence G McMillan

The Option Strategist by Lawrence G McMillan
February 23, 2006

Stock Market

An entire week has passed since $SPX last broke out strongly on the upside to new 6-year highs. Since then, very little movement has taken place. $SPX is up a measly 1.08 points since then, and its closing range has been a minuscule 4 points over the five-day period. Once again, traders are barraged with the "cup half full" (bullish) theories that the market is working off its overbought condition by going sideways, versus the "cup half empty" (bearish) scenario that the market is living
on borrowed time because it hasn't been able to follow through on the upside. We noted similar comments a few weeks ago, and that short- term situation was resolved with a sharp downward move (followed by new highs). We are looking for similar action again.

The reason that we have a negative bias at this point is based on our technical indicators. First, the equity-only put-call ratios are negative. Despite recent new highs in $SPX and the tight range described above, both of these intermediate-term ratios have remained on sell signals throughout this period.

Second, market breadth has remained overbought while $SPX has been in this tight range. By itself, that is not bearish, since we know that the market can rally while overbought conditions exist. However, the fact that breadth indicators have remained overbought contradicts the bulls' contention that the sideways action is alleviating an overbought condition. It hasn't, in fact. More likely, one could conclude that the market is burning up a lot of energy (producing a lot of daily advancing issues) without going anywhere. That type of action often leads to a selloff when the buyers finally take a breather.

Third, the volatility indices remain in "sell" status, as $VXO closed below 10 for six days in a row, and $VIX closed below 10.30 for six days as well. Low $VIX readings are somewhat like high breadth readings -- they indicate the market is overbought. However, when $VIX is this low, it's usually a sign that $VIX is more than overbought. Rather, it's a sell signal.

In summary, we expect the market to have a sharp, but short-lived, correction to actually alleviate the overbought conditions that continue to persist. After that, we expect higher prices. Hence, we are not currently calling for a major top in the market, but we do feel that it certainly needs a minor shakeout before significantly higher prices are possible.

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Tags: VIX, Breadth, Call-Put ratio, S&P 500, market correction

Wolfe Wave applied to analysis of S&P500 on 28 Feb 2007

Wolfe Wave applied to analysis of S&P500 on 28 Feb 2007

Point 1 is a top.
Point 2 is a bottom of the decline after point 1.
Point 3 is the top of the first rally after point 2.
Point 3 is above point 1.
Point 4 is the bottom of the decline after point 3.
Point 4 is below point 1.
Point 4 is above point 2.
Point 5 is the top of the rally after point 4.
Point 5 is below the trendline from point 1 to point 3 before the more-than-50-point breakdown, implying that the market is very weak.  On 27 Feb, the S&P 500 plunges more than 50 points in a day.

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Tags: Wolfe Wave, technical analysis, day trading, short-term trading, S&P 500, breakdown, crash

Wolfe Wave - Bullish Pattern

Bullish Wolfe Wave Pattern

Point 1 is a bottom.
Point 2 is a top.
Point 3 is the bottom of the first decline.
Point 3 must be below point 1.
Point 4 is the top of the rally after point 3.
Point 4 must be above point 1.
Point 4 can be below point 2.
Point 5 is the bottom after point 4 and is likely to exceed the extended trend line of 1 to 3. This is the entry point for a ride to the EPA line (1 to 4).
Estimated Price at Arrival (EPA) is trend line of 1 to 4 at apex of extended trend line of 1 to 3 and extended trend line of 2 to 4.
Estimated Time of Arrival (ETA) is apex of extended trend line of 1 to 3 and 2 to 4.

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Tags: Wolfe Wave, technical analysis, charting, chart, price pattern, stock, futures, day trading, short-term trading