The S&P 500 index SPX has managed to hold on to most of the gains it has achieved since its early April lows. SPX has risen into a resistance area between 5,700 and 5,800, which includes the declining 200-day moving average. If the index were to overcome resistance and close above 5,800, that would be very bullish. It may not be easy to do, though. Several levels have provided support on the way up: 5,440, 5,300, 5,100, and then of course the April lows in the 4,850-4,950 area.
As positive as the advance has been, if SPX were to turn down from a level at or below 5,800, that would reflect a pattern of lower highs and lower lows and would represent a bearish chart for the index. For example, the index rose to 5,700 early this week and has since fallen back. If it continues to move lower from here, then a new downtrend line would be set —connecting the February highs with the recent highs at 5,700.
A full McMillan volatility band (MVB) buy signal was generated when SPX rose above 5,575 at the end of April. The target for this signal is the +4ϭ band, which is currently near 6,000, while the -4ϭ band is at 4,950 and rising. The bands are beginning to contract now, since realized volatility is finally declining. See the Market Insight section for an expansion on the relationship between realized and implied volatility.
Equity-only put-call ratios remain strongly on buy signals for stocks. The ratios are declining rapidly now, and that is bullish. These ratios will remain bullish until they reverse upward, which doesn’t appear that it will happen in the near term.
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Market breadth remains positive as well. The breadth oscillators were some of our first buy signals a couple of weeks ago, and they remain on those buy signals. Despite a couple of days of negative breadth this week, the buy signals have not been stopped out. These oscillators are in overbought territory and have been for some time now. But it is a positive sign when they get overbought just as SPX is trying to establish a new leg up.
Another area that we watch is new highs versus new lows on the New York Stock Exchange. This indicator remains in a neutral state, as neither new lows nor new highs have been able to number 100 or more for two consecutive days. In fact, both have been relatively small in number for a couple of weeks now.
VIX VIX is slowly declining. As a result, the “spike peak” buy signal of April 9 has remained in place, and it’s been a good one. By the rules of the trading system that we built around these spike peaks, the position “expires” after 22 trading days. That is today. So, we are going to exit these positions today. In addition, the trend of VIX sell-signal that was issued in mid-February remains in place as well, since VIX continues to close well above its 200-day moving average.
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The construct of volatility derivatives has not come back into the bullish camp. The term structure of the VIX futures slopes downward in the front end and is flat after that. The term structure of the Cboe volatility indices is jumbled. When these term structures slope upwards, that is bullish for stocks, but they haven’t gotten back to that state yet. This is the longest inversion in the term structure since March 2020 (the pandemic crisis).
In summary, we are maintaining a low-delta “core” bearish position because the SPX chart still has bearish implications. However, we are trading other confirmed signals around that, and we will continue to roll deeply in-the-money options.
Realized volatility is high
This is a period where realized volatility is much higher than implied volatility. This occasionally happens, and if it does to a large enough extent, it is generally positive for the intermediate term.
For realized volatility, we use the 20-day historical volatility of SPX (HV20), and for implied volatility we use VIX. Recently, when VIX had dropped to 24, HV20 was still at 50. So, VIX minus HV20 is -26. The reason that realized volatility was still so high was due to the fact that we were experiencing 100-point moves with ease on both the upside and the downside. So the rapid rise in the market was causing volatility to fall, but it did not decrease HV20.
The accompanying chart shows the daily difference between VIX and HV20 (i.e., VIX minus HV20) going back to 2007. It has only dropped below -10 a few times. At the far right, you can see the current reading of -26.
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Eventually, the differential begins to subside. We rather arbitrarily used a rise back above -10 as a buy signal for stocks. It turns out that that has worked pretty well, except for 2008, where there was no buy signal that worked from this indicator. The chart below shows the buy signal and surrounding SPX movement for the most recent of the above signals — the one in 2020.
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The maximum differential, as seen from the first chart, was -53 on April 6, 2020. Just two weeks later, though, the difference between VIX and HV20 had shrunk to -10, and so the buy signal is marked on the chart at about the 2,800 level on SPX. The market rallied steadily from there over the next few months.
Going back to 1997, the other instances didn’t always show such a quick and positive response, although the ones in 2019 and 2018 did.
So this is a rare but seemingly useful statistic to watch. As of the close of trading on May 7, HV20 is 40 and VIX is 24, so the difference is still -16. The buy signal will probably be generated in the next week or two.
Buy signal: Carnival Corp.
A new weighted put-call ratio buy signal has been issued in Carnival Corp. CCL, and it has been confirmed by an upside breakout by the stock itself.
Buy 5 CCL (July 18) 20 calls in line with the market.
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Buy signal: Caesars Entertainment
A put-call ratio buy signal is in effect here. However, this stock CZR has not yet broken out over resistance at $29.
If CZR closes above $29, then Buy 5 CZR (June 20) 20 calls in line with the market.
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Follow-up actions:
We are using a “standard” rolling procedure for our SPY 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.
Also, for outright long options, roll if they become 8 points in-the-money.
Long 1 expiring SPY (May 9) 480 put: We originally bought a straddle, and then later rolled the put down repeatedly according to the above instructions until it landed in the put shown. Let it expire and do not replace it. Overall, this was a highly profitable position.
Long 2 APH (May 16) 65 calls: We will hold as long as the weighted put-call ratio for Amphenol Corp. APH remains on a buy signal. Roll up to the APH (June 20) 80 calls.
Long 8 IEF IEF (May 16) 94 puts: We will hold this position as long as the weighted put-call ratio for U.S. Treasury notes remains on a sell signal.
Long 1 SPY (June 20) 485 put and Short 1 SPY (June 20) 435 put: This is the “core” bearish position, bought near the close of April 3, when SPX was closing well below 5,480. It was rolled down once. Stop out of this position if SPX reverses and closes above 5,700.
Long SPY (May 16) 564 call and short 1 SPY (May 16) 594 call: This is the VIX “spike peak” buy signal. It was rolled up once. This position will be held for 22 trading days, and that occurs today. So sell this position now to take the profit.
Long 1 TSEM (July 18) 34 call and long 1 TSEM (July 18) 34 put: Plan to roll either option if it becomes at least 8 points in-the-money. For example, if Tower Semiconductor Ltd. TSEM trades up to $42, then roll to the TSEM (July 18) 42 call. Similarly, roll down if TSEM trades at $26. We will not carry this to expiration, as we will stop ourselves out if the straddle price falls below $4.
Long 1 SPY (May 16) 561 call and short 1 SPY (May 16) 581 call: This position is based on the breadth oscillator buy signal. It was recently rolled up 20 points on each side, when SPY traded at 561. We will hold without a stop, although we will update the status of the breadth oscillators in our weekly report. If they turn negative again, we will exit this position. Currently, despite a couple of negative breadth days this week, they remain on buy signals in overbought territory.
Long 1 SPY (Jun 20) 561 call and short 1 SPY (June 20) 591 call: This position is based on the equity-only put-call ratio buy signals. These buy signals are still in effect.
Long 1 SPY (Jun 20) 558 call and short 1 SPY (June 20) 583 call: This position is based on the MVB buy signal. The target is the upper +4σ band. The trade would be stopped out if SPX retreats and once again closes below the -4σ band.
Long 2 DLR (June 20) 160 calls: These were bought when Digital Realty Trust Inc. DLR closed above 162 on May 2. As usual, we will hold as long as the DLR weighted put-call ratio is on a buy signal.
