Continue to ride the stock market’s bullish momentum

The S&P 500 index broke out to new all-time highs on April 1, and then backed it up with an even stronger upside move on the next trading day. This move was accompanied by decent internal strength, too, although as you will see, there are some potential problems developing.

There should now be support for the S&P SPX, +0.42% at the most recent highs – around 3985. A move back below that level right now would be disappointing but wouldn’t break the uptrend in the chart. There is further support at 3850-3870, and a breakdown below there would change the chart from bullish to at least neutral – and possibly bearish. SPX bounced off that support area on March 25 and hasn’t looked back since.

One new development is that the S&P has now risen above its +4σ “modified Bollinger Band” (mBB) – the circle on the upper right of the accompanying SPX chart.

This sets up a “classic” mBB sell signal but isn’t necessarily a complete McMillan Volatility Band (MVB) sell signal. In the “classic” mBB signal – as we define it – a sell signal would occur when SPX closes back below the +3σ Band. That would occur today if the S&P closes below 4063.

However, we will not act on that “classic” sell signal until it is confirmed by a further move downward. That is the modification that we made to the original system and is what we call an MVB sell signal. It is designed to eliminate most of the losing, whipsaw trades, while still participating in the longer-lasting ones. Essentially, for the MVB sell signal, SPX would not only have to generate the “classic” sell signal, but would also have to close below the low of the day on which the “classic” sell signal was generated.

A very positive development has been the fact that the equity-only put-call ratios have turned downward, thus generating buy signals. The weighted ratio is the most prominent, in that it has fallen rapidly, and its sell signal came from a reasonably “normal” area on its chart (the heights reached in March 2020 weren’t “normal”). The standard ratio has turned downward, too, but it is still in an area that is considered extremely overbought – an area that hasn’t been visited since the late 1990s.

Breadth has been positive on this rally, and both breadth oscillators remain on buy signals. However, we would like to see them expand even more if the rally persists.

One potentially negative thing, though, is a developing negative divergence between the cumulative breadth indicators and SPX. That is, SPX has moved out to new all-time highs, but the cumulative breadth indicators have not. They last reached new all-time highs since March 15.

When a negative divergence exists, it cannot be timed – some reach fruition quickly (in late February 2020, when the market broke down, there had been a negative divergence in place since Jan. 17, 2020) but some take a much longer time to develop.

I have found that the proper use of negative divergence is to be vigilant and to take every confirmed sell signal that comes along. Don’t get complacent and ignore your indicators.

New 52-week highs continue to dominate new 52-week lows, so that indicator remains a positive for stocks.

Volatility indicators and constructs remain very bullish for the stock market. In the accompanying VIX VIX, -1.22% chart, one can see – on the lower right – that VIX broke down at essentially the same time that SPX broke out on the upside. The VIX breakdown is another bullish indicator for stocks, for it confirms that VIX remains in a downtrend.

Technically, the VIX “spike peak” buy signal of March 5 has “expired.” That means that the trading system we built around the phenomenon of “spike peaks” calls for an exit of the profitable trade after 22 trading days. However, depending on the overall outlook, we sometimes roll the position up, as we are doing in this case.

In addition, the trend of VIX is defined not only by the recent breakdown to VIX prices not seen in a year, but also by the fact that both VIX and its 20-day moving average are below the declining 200-day moving average.

The construct of volatility derivatives remains positive for stocks too. The term structures of the VIX futures and of the CBOE Volatility Indices slope upward. Furthermore, there is a relatively large premium on the VIX futures.

In summary, these indicators are mostly positive and thus a long “core” position should be maintained. Currently, there are no confirmed sell signals, although the MVB sell signal is a possibility (but not a certainty). As sell signals appear, we will take positions because of the developing negative divergence.

New recommendation: Buy SPX upside breakout

The recent move to new all-time highs warrants an additional long position in SPY SPY, +0.47%. We will use a fairly tight stop on this trade, though.

Buy 2 SPY Apr (30th) at-the-money calls

and sell 2 SPY Apr (30th) calls with a striking price 10 points higher.

Stop yourself out on a SPY close below 397.

New recommendation: Leaf Holdings

On April 5, Leaf Holdings LEAF, +0.11% received an all-cash buyout offer of $8.50 from Graham Holdings. However, the stock is now trading higher than that, as several large holders and other analysts say the bid is too low. We are going to take a position, looking for a higher bid from another party.

Buy 2 LEAF May (21st) 9 calls

At a price of 0.60 or less.

LEAF: 9.06 May (21st) 9 calls: offered at 0.85

Follow-up action

All stops are mental closing stops unless otherwise noted.

Long 500 CLIR common stock: Raise the stop to 4.50.

Long 2 SPY April (23rd) 399 calls: This position was originally a SPY call bull spread, taken in line with the VIX “spike peak” buy signal of March 5. It was rolled up last week. Raise the trailing stop to 395, basis SPY.

Long 2 MX Apr (16th) 20 calls: Magnachip Smiconductor MX, -0.23% accepted a deal to be taken private by private equity at $29, from private equity. We sold a third on that news. This week, the stock rose sharply on April 5, as it appears that the deal is solidifying, although there was no specific news. Raise the trailing stop to 24.50.

Long 2 SPY April (16th) 407 calls: SPY traded at 407 on April 6, so we sold the original the spread and replaced it with an equal number of plain long SPY April (23rd) 407 calls. Stop yourself out of this position if SPY closes below 395.

Long 1 COHR Apr (16th) 265 call: Hold without a stop while the bidding war plays out.

Long 0 FLY Apr (16th) 12.5 calls: Per last week’s instructions, these calls were sold at a profit after Fly Leasing FLY, -0.53% accepted an all-cash takeover bid.

Long 2 CXP Apr (16th) 15 calls: Hold without a stop while the takeover bid works its way forward. The bid is $19.50, but there are rumors that the stock will trade higher.

Long 4 BOX April (16th) 22 calls: Hold without a stop, while the activist investor process is worked out.

Long 2 VIX April (21st) 20 puts: These were bought when VIX closed below 18.86 on April 1. The VIX April futures settled at 20.08 that day, so the “at-the-money” strike was 20. Stop yourself out on a VIX close above 22.

Long 1 AMAT Apr (16th) 135 call: Stop yourself out on a close below 129.

All stops are mental closing stops unless otherwise noted.

Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading adviser. 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 adviser and with the CFTC as a commodity trading adviser. 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.

source:marketwatch.com