MarketWatch Options Trader: As the S&P 500 falters, this is what it will take to revive the bull market

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Over the past two weeks, the S&P 500 index
SPX,
+0.07%

has been attempting to break out to the upside. The previous highs at 4238 were registered in early May, and while SPX did close or trade above 4238 for five straight days, there was no follow-through. Now the nervousness brought about by the Federal Reserve meeting has caused the index to fall back below that level.

I wouldn’t classify this as a “false breakout” yet, but it’s pretty close to being one.

SPX has been trading in a tight range since May 24, and it seems to have been pulled back into that range. A close below 4190 would be a close below the bottom of that range, and that would be the completion of a “false breakout,” in my opinion.

A failure at that level would bring about the specter of a retracement all the way to the bottom of the larger trading range – to the May lows at 4060. A failure of that level would be much more dire and might be the issuance of a new bear market.

But before getting carried away with dire predictions, it should be noted that the bears have had many, many chances to take control – especially since last December – and have failed to do so every time. It is still the case that the return to new all-time highs, via a breakout over what is now a rather condensed resistance area from 4238 up to the recent new highs at 4257, would return clear control to the bulls.


Lawrence McMillan

The limited movement that has been seen by SPX since May 24 has had the effect of drastically dropping the realized, or historical volatility (HV). The S&P’s 20-day HV is now down to 7% (a rise back above 11% would be a sell signal, but that’s not imminent).

In turn, this drop in realized volatility has caused the “modified Bollinger Bands” (mBB) to tighten about the S&P’s still-rising 20-day Moving Average. The McMillan Volatility Band (MVB) sell signal of early May is still in effect. It will either be stopped out by rising above the +4σ Band, or it will reach its target by touching the -4σ Band. Both of those are now more likely, since the Bands are constricting.

Equity-only put-call ratios remain on buy signals. They turned downward, issuing those buy signals, in late May. Call buying has remained relatively heavy since then, forcing those ratios lower. As long as they are declining, that is a bullish sign for stocks.


Lawrence McMillan


Lawrence McMillan

Breadth has been something of a problem. While our breadth oscillators did issue buy signal on May 13, they never really expanded as SPX was making those new all-time highs recently. That is not a good sign, and now breadth has been negative for the last three trading days. This is enough to roll the “stocks only” breadth oscillator over to a sell signal.

The NYSE breadth oscillator is not yet in agreement, but one more day of negative breadth today would force that onto a sell signal as well.

Meanwhile, the cumulative breadth indicators had been making new all-time highs along with SPX, but as readers of mine should know, I do not consider that predictive. It only means that a negative divergence is not in place. Even so, not every market top has a negative divergence. So, for now, breadth has become something of a problem.

The measure of new 52-week highs vs. new 52-week lows, however, is not a problem as far as the bulls are concerned. New highs continue to dominate new lows across all three data sets. So, this indicator remains bullish.

Volatility and volatility derivatives have remained in the bullish camp for most of the last year, and they are still there. VIX
VIX,
-4.68%

has not returned to “spiking” mode (a gain of 3.00 or more points, using closing prices, over any three-day time frame). Thus, the “spike peak” buy signal of May 21 remains intact. Meanwhile, the trend of the VIX chart is still lower, as VIX is well below its declining 200-day moving average, and so is the 20-day MA.

The construct of volatility derivatives remains bullish for stocks. That is, the VIX futures (of which July is now the front month) are all trading at fairly large premiums to VIX, and their term structure slopes upward. Likewise, the term structure of the CBOE Volatility Indices slopes upward, too. Those are all bullish signs for stocks.


Lawrence McMillan

In summary, the indicators are still mostly positive, so as long as the S&P 500 can remain above 4190, we are still bullish. As confirmed sell signals may arise, we will trade them around the essentially “core” bullish position.

New recommendation: SPX upside breakout

Should SPX recover and make new all-time highs, we want to take a corresponding long position.

IF SPX closes above 4260,

THEN buy 2 SPY July (16th) at-the-money calls.

SPX: 4223

NOTE: We are not use a call bull spread for this recommendation, since VIX is low enough (and will likely be lower if SPX makes new all-time highs) that the spread is not necessary. Call bull spreads, as opposed to outright long call positions, are only called for when volatility is high (i.e., when the options are “over-priced”). That is not the case any longer.

New Recommendation: Rapt Therapeutics

This past week, there has been unusual option volume in a number of areas, but not so much in takeover rumors. There was heavy volume in a couple of the new SPAC mergers – Churchill Capital Corp. V
CCV,
-0.54%

and GS Acquisition Holdings Corp.
GSAH,
+2.05%

Those are typically overdone in the first few days after the mergers are announced. There was also heavy option volume in Petco Health & Wellness Co.
WOOF,
+0.95%
,
but that seem to be related to the social media message boards – a dubious reason for buying a stock.

However, in Rapt Therapeutics
RAPT,
+1.34%
,
there was a major drug announcement in the form of the results of a positive trial for a drug for eczema. Apparently, there is major potential for such a drug. The stock exploded from 19 to 42 in one day but has now pulled back to 31. This is a highly aggressive recommendation, but at least with a call option purchase, you know what your risk is – the cost of the call.

Buy 1 RAPT July (16th) 30 call

At a price of 5.00 or less.

RAPT: 31.90 July (16th) 30 call: 4.50 bid, offered at 5.00

If the call is bought, stop yourself out on a close below 26 by RAPT, for that would close that gap from last December and would not be in line with a bullish outlook.


Lawrence McMillan

Follow-up action

All stops are mental closing stops unless otherwise noted.

Long 2 SPY July (2nd) 410 puts: This trade was originally taken because of the MVB sell signal that occurred on May 12. It would be stopped out by SPX once again closing above the +4σ Band, which is at 4280 and moving sideways. The signal would reach its profit target if SPX trades at the -4σ Band, which is currently at 4135 and rising.

Long 3 expiring DUK June (18th) 100 calls: There has not been any news on the activist investor in Duke Energy
DUK,
+1.08%

except for the fact that option volume picks up whenever the stock rallies slightly. We are going to roll to July (16th) 100 calls.

Long 2 expiring SPY June (18th) 415 calls and short 2 SPY June (18th) 428 calls: This spread was bought when the most recent VIX “spike peak” buy signal was confirmed on May 21. Since the signal is still intact (barely), sell this spread and replace it by buying 2 SPY July (9th) at-the-money calls. We are no longer using a spread here. The calls would be stopped out if VIX were to return to spiking mode – that is, if it rose at least 3.00 points over any three-day or shorter period (using closing prices). Today, that would be a close over 19.39. Meanwhile, if the position is stopped out, a new “spike peak” buy signal will set up shortly.

Long 1 expiring KSU Jun (18th) 300 call: This takeover bid has not worked out well. Sell these calls and do not replace them.

Long 1 SPY July (16th) 420 call and long 1 SPY July (16th) 420 put: This long straddle is in anticipation of SPX making a volatile move away from the 420 level. If SPX trades at 437, roll up the calls from the 420 strike to the 437 strike (or the closest strike to that). Conversely, if SPX trades at 403, roll down the puts to the 403 strike.

Long 4 CERN June (18th) 80 calls: The takeover rumors were rampant again this past week – on June 14. Roll to the July (16th) 80 calls.

Long 4 CSOD July (16th) 47.5 calls: Our recommendation was to buy these calls if Cornerstone OnDemand
CSOD,
+1.24%

closed above 47, which it did on June 4. Raise the trailing, closing stop to 48.00.

Long 4 DBX July (16th) 28 calls: Our recommendation was to buy these calls if Dropbox
DBX,
-0.68%

closed above 28.50, which it did on June 7. This is also an “activist investor” situation. Raise the trailing, closing stop to 27.80.

Long 6 CVA July (16th) 17.5 calls: Hold without a stop, while the rumor of the company pursuing strategic alternatives has a chance to work out.

Long 4 SDC July (16th) 9 calls: Option volume remains modestly heavy as takeover rumors continue to circulate. Hold without a stop.

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 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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