Don't trust this rally in the S&P 500 –it's unlikely to be a new leg of a bull market – MarketWatch


The S&P 500 index has finally launched a strong, oversold rally. There is always the chance that this is the beginning of a new leg in a bull market for stocks, but that seems unlikely. In any case, we will follow the indicators without trying to make a “guess.” 
Oversold rallies typically carry to a level slightly above the declining 20-day moving average. In the case of the S&P SPX, +1.84%, that MA is at about 4040 and has already been surpassed. SPX rallied into resistance at 4150 and seems to have stalled there for now. The next resistance level is at 4300 – the double tops from early April.
As for support, there were several days in May that bottomed out in the 3800-3900 area, so that is major support at this time.
The last, strong oversold rally was in the latter half of March, and it carried all the way up to the +4σ “modified Bollinger Band” (mBB) before failing. Currently that +4σ Band is at 4370 and declining. So the S&P trend is still downward (note the blue lines on the accompanying chart), as the pattern of lower highs and lower lows was reinforced as recently as last week. A decisive move above 4300 might be able to change that.
Equity-only put-call ratios remain on buy signals, as they are declining. Those declines started at very high (i.e., very oversold) levels on their charts. That is, there was a lot of pessimism in the market, which had resulted in put buyers driving these ratios to heights near those of March 2020. Normally, buy signals from such elevated levels are strong buy signals. These buy signals will remain in place until the ratios roll over and begin to rise.
From the accompanying charts, one can see that the weighted ratio is dropping much more quickly than the standard ratio, but both are declining.
Breadth oscillators registered buy signals on May 19 and May 20. Those breadth oscillators then exploded upward as breadth was extremely positive for several days. That resulted in both breadth oscillators moving into deeply overbought territory, but “overbought does not mean sell.” 
Over the past two days, though, breadth has weakened, and one more strong day of negative breadth will roll these breadth oscillators over to sell signals. So if the bulls are to convince us that this is more than just an oversold rally, it would behoove them to see breadth improve immediately.
New 52-week highs have finally risen above new 52-week lows on the NYSE, but not by enough to generate a buy signal. That is, we need to see new highs total at least 100 in number for two consecutive days, and for new highs to exceed new lows on both of those days before declaring a buy signal. That has not happened (yet).
We are getting some mixed signals from volatility. First, the VIX “spike peak” buy signal of May 12 (green “B” on the VIX chart) is still in place. In fact, there was a second, overlapping buy signal a few days later (light green “B” on the chart), but we are only concerned with the initial signal. That has been a strong, positive signal so far. It will remain in place for 22 trading days, or until stopped out by VIX VIX, -3.78% returning to “spiking mode.”
Conflicting with that, over a longer-term outlook, is the fact that the VIX trend is still higher. That is, both VIX and its 20-day moving average are above the 200-day MA. VIX would have to fall to a level below 23 in order to return this bearish indicator to a neutral state.
Of a more general bearish nature is the fact that VIX is remaining high. Note that it has not fallen below 26 on this latest rally. VIX has remained somewhat elevated ever since the pandemic “crash” of March-April 2020, and to some that is a general warning sign to remain alert – that there are still problems for the stock market in general.
The construct of volatility derivatives remains somewhat bullish, in that the term structure of the VIX futures slopes upward out through October. The term structure of the CBOE Volatility Indices slopes upward, too.
In summary, we are retaining a “core” bearish position as long as the trends of SPX (down) and VIX (up) are intact. Along with that, though, we are trading the various oversold buy signals generated by the internal indicators – all of which have relatively tight stops in case the oversold rally abruptly ends.
Option volume in Kodiak Sciences KOD, +4.25% increased sharply on Wednesday following unconfirmed chatter regarding potential activist investor interest. The company is also presenting at a healthcare conference next week. Back in February, the stock had fallen dramatically after a major drug test did not meet its primary endpoints.
Buy 5 KOD July (15th) 7.5 calls
At a price of 1.00 or less.
KOD: 7.53 July (15th) 7.5 calls: 0.70 bid, offered at 1.20
We will hold without a stop, initially.
We continue to keep this recommendation open. In a weekly newsletter, it is difficult to lay out all the possibilities, especially in an extremely volatile market such as this one. But this recommendation’s conditions are easy to track, so we will go with a potential buy signal from the New Highs vs. New Lows indicator:
IF NYSE new highs outnumber NYSE new lows for two consecutive days,
And IF new highs are at least 100 in number of both of those days,
            Buy 1 SPY SPY, +1.90% Jul (1st) at-the-money call
            And Sell 1 SPY Jul (1st) call with a striking price 15 points higher.
If the trade is established, then stop yourself out if New Lows outnumber New Highs for two consecutive days.
All stops are mental closing stops unless otherwise noted.
We are going to implement a “standard” rolling procedure for our 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.
Long 2 SPY June (17th) 389 puts and short 2 SPY June (17th) 364 puts: We originally bought this spread in line with the sell signal from the trend of VIX. It was rolled down when SPY traded at 401 on May 9 and then rolled down and out at May expiration. This is our “core” bearish position. We will stop this position out if VIX falls below its 200-day Moving Average, which is currently rising towards 23.
Long 1 SPY June (17th) 412 call and short 1 June (17th) 432 calls: VIX confirmed a “spike peak” buy signal at the close of trading on May 12, and we bought a call bull spread. That spread had a high strike of 412, so per the standing instructions above, it was rolled up on May 27, when SPY traded at 412. We are now going to use a VIX “return to spiking mode” as the stop. That is, stop yourself out if VIX closes at least 3.00 points higher over any one-, two- or three-day period. At this point in time, the lowest recent VIX closing price is 25.69 on Wednesday. So the current stop is a VIX close at 28.69 or higher.
Long 3 BKI June (17th) 70 calls: Continue to hold while the spread in this deal remains wide. The deal is 63.20 + 0.2 * ICE, which is worth $83.60 with ICE trading at 101.55. Black Knight BKI, +1.98% is trading at 67.51, so the spread has widened. Continue to hold.
Long 5 MX Jun (17th) 20 calls: Continue to hold while the rumors play out.
Long 2 SPY July (1st) 402 calls and short 2 SPY July (1st) 417 calls: This spread was bought on May 26, based on the combination of new equity-only put-call ratio buy signals and breadth buy signals. We will keep this position in place as long as both of the indicators remain on buy signals. If either one falls back to a sell, then we will exit half this position. If they both revert to sell, this position will be closed.
The breadth oscillators are in danger of falling back to a sell signal. Use this guide for the following week. Track the breadth (advancing issues minus declining issues) on the NYSE and keep a running total at each day’s close. If that total reaches minus 300 or worse, then close out half this spread, for that will mean that the breadth oscillator buy signal has been terminated.
Long 2 EA June (17th) 137 calls: We bought these calls on May 27, because that was the first day that they traded at our limit of 5.00. We will hold without a stop for now.
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.
Don't expect the S&P 500 to move much higher than 4,250 in the near-term

Lawrence G. McMillan is a columnist for MarketWatch and editor of the “MarketWatch Options Trader” newsletter. He is president of McMillan Analysis, an investment and commodity-trading adviser.
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