SPX Through 9-25-09

Wednesday’s downside market reversal, coming as it did on the heels of a post-FOMC stock market rally, has caused the bears to become empowered and has seemingly converted quite a few people to the bearish camp in a blink. Little did we know that technical analysis was so in favor!

So, has “the” correction begun? Anything is possible, of course, but there is still plenty of upward price momentum in $SPX. It remains above the trend line that connects the March and July lows. There is support at 1040-1045, the area from which $SPX broke out in July. The rising 20-day moving average is at 1040 as well. So a close below 1040 would be negative, but the major trend line is what truly demarcates this bullish phase, and it is currently near 1000. The equity-only put-call ratios continue to rise. Technically, they are thus on sell signals.

Market breadth has been very strong, keeping the breadth indicators in overbought territory. Today’s negative action, however, has pushed the oscillator down to the brink of sell signals. Previous breadth sell signals during this rally have not been particularly meaningful, as all corrections have been short-lived.

VIX Through 9-25-09

Volatility indices ($VIX and $VXO) both made yearly lows Wednesday morning, before the market reversed downward. The $VIX chart remains in a downtrend and is thus bullish for the broad stock market. A close above 27 by $VIX would break the downtrend, but the four similar previous such occurrences this year have not resulted in a rising trend in $VIX — and that is the only way that $VIX would turn negative.

In summary, a seemingly large number of people have quickly turned bearish with Wednesday’s negative market reversal. However, unless we see some signs of intermediate-term sell signals — most noticeably a break of support in $SPX and a confirmed rising trend in $VIX — we will not be joining the bearish throng.

S&P 500 Through 17th July 2009

SPX continues to remain within the confines of its 880-950 trading range on a closing basis. A clear breakout in either direction can and should be “played,” but so far the stock market — [in] it is best contrarian form — has created the image of false upside breakouts (in early June) and false downside breakouts (in early July). The fact that today $SPX closed above prior resistance at 930 likely means that it is headed for a test of the 950 level. However, a breakout is by no means guaranteed.

Market breadth has been the most accurate indicator in recent weeks. The breadth oscillators that we use are able to swing quickly between buy and sell signals — something that seems to be necessary in this environment. Buy signals were issued late last week and early this week. But now these same breadth oscillators are very overbought. So it is going to be necessary to keep a close eye on these breadth oscillators.

Equity Only Put-Call Ratio 17 July 2009

Weighted Equity Only Put Call Ratio 17 July 2009

VIX through 17 July 2009

So, what does this all add up to? A market that’s still in a trading range, that’s what. A clear breakout over 950 would be bullish, of course, but it frankly seems too early to say that will occur. Right now, the market is too overbought to break out, in my opinion.

So, we’ll watch for the next breadth sell signal, or for the breakout over 950. One or the other should occur soon.

but basically, just look for generally uptrending names, and then short some puts into mini dips

My guess is that the mini dip where he sold some puts was at the point marked 1. My guess is that he sold 105 puts. Just to keep the trades concrete, say he started out short 10 July 105 puts. I don’t know and he won’t say.

The “T” on the chart labels the day that ICE fell through the 105 strike like a hot knife through butter. AW was in trouble.

So I ended up covering by turning the put short into a butterfly, going long the 100 strike. That was the mediocre.

Long twice as many 100 puts as he was short 105 sounds good to me. Of course, if this is a butterfly, then he was also short, maybe, the 95 puts. So now our hypothesis is that his position is:

-10 105 P,
+20 100 P and
-10 95 P

And he has turned his profit distribution from this:

To this:

Look at the purple line, since that is where the position is when it is put on. He is working his way to breakeven if ICE keeps falling, but no better than break even. Hence “mediocre”.

Stock kept going lower, so then had my one good idea. Just converted it to long downside gamma by shorting more 105 puts so that I was now short the 105-100 put spread 1:1, and then bought an equal number of 95 puts and a little stock.

So the hypothetical position now looks like:

-20 105 P
+20 100 P
+20 95 P

The position gets to break even at 86. Which is where it closed Friday.

That part worked out well yesterday as the stock imploded. The only thing holding me back was….well, me. I got short and shorter thru 95 and was patient all the way until….the 91’s. Which sounded great at the time, not knowing it would go to the 84’s. By which time I bought more stock and kept the long gamma game going by purchasing some July 85 puts.

Roll it all up and a lot of trouble to pretty much break even, although even sounds good compared to the initial ugliness of my put short. I’m now just long some gamma. For the moment, will probably sell some “wings” (OTM puts and calls) and call it a day.

A good recovery.

SPX Through 10 July 2009

Put Call Ratio 10 July 2009 with OEX

The equity-only put-call ratios continue to rise and are thus still on sell signals. Since they started from such a low point on their charts, they have a long way to roam on the upside before we would consider them “oversold.”

Weighted Put Call Ratio with OEX

Market breadth turned decidedly negative in the last week, as the market sold off, but have now reached oversold status. However, “oversold” does not mean “buy.” So until these generate true buy signals — which they would do with one more day of advances leading declines — we consider them as still being on sell signals.

VIX with Trend Line 7-10-09

In summary, the bulls may attempt a rally here, but we would not expect it to be particularly robust — probably just enough to work off the oversold condition in the breadth oscillators. Thereafter, unless the indicators quickly change, we expect a downside breakout to occur.

As noted in the recent tweet, we had a strong downside momentum day on Monday, with Demand closing at 15 and Supply at 214. The general pattern following such downside momentum days is a bounce one day later followed by subsequent weakness, although this pattern is affected by larger-term market regimes.

Given the significant expansion in the number of stocks registering fresh 20-day lows, I went back to October, 2002 (when I first began archiving the 20-day high/low data) and examined what happens in the S&P 500 Index (SPY) after 20-day new lows make a 20-day new high. The next day, SPY averages a gain of .18% (91 occasions up, 59 down), versus no change for the rest of the sample (818 up, 712 down). Five days after a surge in 20-day lows, SPY averages a gain of .47% (88 up, 62 down), versus .02% for the remainder of the sample (836 up, 694 down).

It’s thus not unusual to get a bounce following significant market weakness. I will be watching to see how we trade relative to yesterday’s pivot level, as well as the usual sentiment gauges of NYSE TICK and volume transacted at bid/offer, to gauge the likelihood of sustaining a bounce on the day today. Alternatively, inability to sustain buying sentiment below the pivot would sustain the downtrend.

10:17 AM CT – I added the above chart of the NYSE TICK with a green 20-minute moving average to show how sentiment has weakened during the trading day, with more stocks transacting on downticks than upticks. Noticing that shift was key to anticipating the move below the overnight low. Should we continue with bearish sentiment, the next target would be S1. The fact that it’s taken us a while to even approach S1 suggests to me, however, that we could see more of a range environment, trading back into the overnight range, in advance of the Fed announcement and Wednesday’s numbers. I’m watching TICK closely to handicap that scenario (but not become wedded to it!)

$SPX failed to capitalize on its upside breakout above 950 last week. Ever since, the index has been on the defensive. To make matters worse for the bulls, nearly all of our technical indicators have generated sell signals. Recently, the $SPX breakdown below 930 confirms that last week’s upside breakout was a false one and raises the possibility that the lower end of the trading range, near 880, will now be tested.

SPX Price Chart 6-19-2009

The $SPX chart is neutral, with strong support at 880 and strong resistance at 950. There are some who claim that the chart has turned negative with this week’s decline, but that isn’t the way we are viewing it. Rather, the false upside breakout has merely returned $SPX’s classification to “trading range” from “bullish.” However, if 880 is violated on the downside, that will clearly be bearish. Meanwhile, adroit traders can attempt to trade within the range — buy near the lows and sell near the highs.

Put Call Ratio 6-19-2009

Weighted Put Call Ratio 6-19-2009

Market breadth has worsened. The heavily overbought conditions that existed in the breadth indicators after an unprecedented amount of time in overbought status (almost 2-1/2 months) have been alleviated. But these breadth indicators have now generated sell signals.

VIX 6-19-2009

In summary, the indicators are painting a more dire picture than is the chart of $SPX itself, and we always place a great deal of importance on prices because they are the final arbiter. In either case, bullish positions are no longer warranted.

Here we see the S&P 500 e-mini (ES) futures prior to the 7:30 AM CT release of consumer inflation numbers (bottom chart). What you can see is that we broke below the early June range (purple horizontal line); note how that range support turned into upside resistance early yesterday as we moved further into May’s trading range. This transition from a range trade to a short-term downtrend was anticipated by the non-confirmations among the indicators I track and has also been reflected in recent indicator readings, which I put out via Twitter (follow here) prior to each market open: more new 20-day lows than highs; Supply exceeding Demand; less than 50% of stocks trading above their 20-day moving averages, etc.

We should stay below the early June range to sustain the downtrend. I’ll be tracking intraday sentiment and intermarket themes (strong dollar, weak commodities) via the tweets to see if we can sustain the downside.

8:23 AM CT – In the top Market Delta chart, we see that we’re building value at the low end of yesterday’s trading range, as in-line inflation numbers at 7:30 AM CT could not sustain a move to the upper end of the overnight range. With acceptance of lower value, we keep the short-term downtrend intact, with short-term resistance at 908/909.
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The remarkable thing about the past four weeks is just how tight the range is.  If the S&P can muster a print at 923 or so by Friday, then we’ll have four straight weeks where every week’s high is within 0.75% and every week’s low is within 0.75%.

The last time we saw this kind of four-week cluster was during the end of December 2006 through the first week of January 2007 (it’s not surprising that many of these occurrences happen around holidays when volatility is dampened).

Using the S&P 500 since the late 1920’s, we usually saw a quick move to the downside out of these consolidations – the next week was positive only 32% of the time.  But after that, the returns turn considerably more positive.

That’s something we very often see with volatility contractions…the first move is usually a fakeout before a more sustained move in the other direction.  We’ll look at that more in depth on the main site tomorrow.

Today, before the market open, the SP500 is up 16 points to 935.

The last time we saw this kind of four-week cluster was during the end of December 2006 through the first week of January 2007 (it’s not surprising that many of these occurrences happen around holidays when volatility is dampened).

Using the S&P 500 since the late 1920’s, we usually saw a quick move to the downside out of these consolidations – the next week was positive only 32% of the time. But after that, the returns turn considerably more positive.

That’s something we very often see with volatility contractions…the first move is usually a fakeout before a more sustained move in the other direction.

Volatility collapsed Friday afternoon as well.

The broad market, as depicted by $SPX, remains in a trading range. On the upside, resistance is evident at the 930-940 area, and it is comprised of several items. These present a formidable barrier to further short-term advances — at least until the current overbought conditions abate and new buy signals arise. On the downside, there is support at 880.


SPX Showing Support and Resistance

The equity-only put-call ratios have flirted with sell signals,

but only the standard ratio has a confirmed sell signal — and even it’s a bit shaky (see Figure 2). Meanwhile, the weighted ratio has moved lower and established new lows. Thus, it remains on its previous buy signal and has not generated a confirmed sell signal.

Standard Put Call Ratio

Weighted Put Call Ratio

Market breadth had finally worked off its overbought condition and generated sell signals last week. However, breadth expanded greatly on Monday’s rally, so those sell signals were briefly canceled out before reinstating themselves today. The rally is mature now, so there is a greater chance that the current sell signal will precede a broader market decline.

Volatility indices ($VIX and $VXO) continue to decline, in general, and that means they remain on buy signals. Much has been made on CNBC of the rise in $VIX since yesterday morning’s lows, but as you can see from the chart in Figure 4, $VIX is still clearly in a downtrend. $VIX would have to rise above 34, in our opinion, to break the bullish downtrend and potentially generate a sell signal for the broad market.

VIX

So we can buy at 880 and sell at 940.