The stock market’s oversold rally is peaking — and so is the 10-year U.S. Treasury

Is the U.S. stock market’s oversold rally already failing? After the S&P 500 Index SPX tumbled 9% in less than a month, the U.S. stock market became oversold, spurring a rally back to the benchmark’s declining 20-day moving average (MA).

Oversold rallies typically die out after reaching the 20-day MA. SPX also faces resistance at 5,800. But there’s support at the recent lows, in the 5,500-5,540 area. Moreover, there should be support near 5,400, dating back to last September’s lows.

On a positive note, there has been a confirmed McMillan Volatility Band (MVB) buy signal, as of March 24. It is marked with a green “B” on the SPX chart above. These are intermediate-term signals. The target is for SPX to trade at the +4σ “modified Bollinger band,” which is currently at 6,040 and declining. The buy signal would be stopped out if SPX were to close below the -4σ band, which is currently at 5,400 and declining. This is the first confirmed signal from the MVB indicator since the buy signal last August.

Equity-only put-call ratios have raced higher while the selling has occurred in SPX.  A rising put-call ratio is bearish for stocks. From the charts below, you can see that both ratios appear to be peaking.

In fact, the weighted ratio has generated a buy signal, meaning that the computer programs we use to analyze these charts are “saying” the peak has been reached, and the ratio is declining now. So a green “B” has been placed on that chart. However, the standard ratio has not clearly peaked. In fact, the computer analysis is failing to call this a buy signal. So, while the height of the ratios on their charts indicates an oversold stock market, there won’t be a confirmed buy signal from the standard ratio until it, too, begins to trend downward.

Market breadth has been deteriorating, so the previous breadth-oscillator oversold buy signals are in jeopardy. So far, they have withstood the onslaught and remain bullish, but another day or two of negative breadth will reverse that.

New highs and new lows on the NYSE have jockeyed back and forth, but neither has been able to take command, so this indicator remains in a neutral state. It will generate a new signal when either new highs or new lows register more than 100 issues for two consecutive days.

VIX VIX has dropped considerably from its recent peak, and the “spike peak” buy signal remains in place. It was confirmed on March 12, and will remain in place for 22 trading days unless stopped out by a VIX close above that more recent peak, at 29.57. Meanwhile, the trend of VIX sell signal is still intact as well. It would be stopped out if VIX were to close below its 200-day moving average for two consecutive days. VIX did close below that 200-day MA on one day this week, but not for two, so the sell signal is still in place. That “action” is taking place within the square on the accompanying VIX chart.

The construct of volatility derivatives weakened during the sharp market decline and was even modestly bearish at one point. Over the past week, there have been some slight improvements in the construct, and it is tentatively turning more bullish towards stocks. The term structure of the VIX futures slopes slightly upward, and for the most part so does the term structure of the Cboe volatility indices. The only thing out of line is the nine-day VIX, which is already showing some expectations of higher market volatility surrounding next week’s unemployment report (on Friday, April 4).

Overall, the stock-market rally doesn’t seem to be anything more than an oversold rally. If SPX makes new lows (below 5,500, and certainly below 5,400), then the possibility of a longer-lasting bear market is certainly a consideration. Meanwhile, we will trade confirmed signals — both on entry and exit. Continue to roll deeply in-the-money options as well.

The weighted put call ratio for the 10-year Treasury Note BX:TMUBMUSD10Y futures has generated a sell signal.  We can trade this through an ETF — the iShares Trust 7-10 Year Treasury Bond ETF IEF.

Buy 8 IEF (May 16) 94 puts in line with the market.

We will hold this position as long as the weighted put-call ratio for the 10-year Treasury remains on a sell signal.

A new weighted put-call ratio has been generated in BXP BXP. We want to see some price confirmation from the stock itself before buying calls, though.

If BXP closes above 70, then buy 3 BXP (May 16) 70 calls in line with the market.

We will hold the position as long as the weighted put-call ratio for BXP remains on a buy signal.

We are using 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.

Also, for outright long options, roll if they become 8 points in-the-money. 

Long 1 Long 1 SPY SPY (April 4) 555 put: We originally bought a straddle, and then later rolled the put down several times, eventually winding up with this long put.

Long 2 ALL (April 17 ) 210 calls: We will hold these calls as long as the put-call ratio buy signal for Allstate ALL is in place.

Long 10 WEAT WEAT (April 17 ) 5 calls: We will hold these calls as long as the put-call ratio buy signal is in place.

Long 6 VIX (April 2) 29 calls: Stop out if VIX closes below its 200-day moving average for two consecutive days. VIX did close below its 200-day MA on March 25, but then moved back above it on March 26. Even so, it remains near the 200-day MA.

Long 2 APH (April 17 ) 65 calls: Were bought when APH APH closed above 65 on March 19. We will hold as long as the weighted put-call ratio for APH remains on a buy signal.

Long 1 SPY (April 17) 574 call and short 1 SPY (April 17) 594 call: This position was originally a 554-574 spread, bought in line with the most recent VIX “spike peak” buy signal. It was then rolled up 20 points on each side, when SPY traded at 574 on March 24. It would be stopped out if VIX were to close above that most recent peak of 29.57. Otherwise, by the rules of the trading system that we have built around these “spike peaks,” we will hold for 22 trading days.

Long 1 SPY (April 17) 571 call and short 1 SPY (April 17) 591 call: This is the position that was bought when the MVB buy signal occurred on March 24. The target for this trade is for SPX to trade at the +4σ Band, which is currently just above 6,020. This position would be stopped out if SPX closed below the -4σ Band, which is currently at 5,450 and declining.

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 book, Options As A Strategic Investment.

©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.