THE OPTION STRATEGIST Weekly Updater 7/14/05
Stock Market

The last week has been a very strong one for the market. After plunging in the wake of the terrorist bombings in London, the major indices have reversed direction in monumental fashion. In 'daytime' trading,$SPX has advanced 40 points from that intraday low on the morning of July 7th. The S&P futures were trading overnight, and thus traded much lower right after news of the bombings first became public; their rally has measured 55 S&P points. All of this in just four trading days! Covering that great of a distance in that short of a time qualifies as an overbought condition.

Overbought condition aside, the action by the major indices has been constructive. $SPX is still the leader, as it rose above its June highs (briefly) and could have the yearly highs near 1230 in its sights. None of the other major indices have overcome the June highs yet, but they did manage to climb over the first level of resistance, which is constructive. The June closing highs are 573 for $OEX, 10,650 for the Dow, and 38.60
for QQQQ.

Equity-only put-call ratios are not quite as positive as the $SPX chart, but they are getting there. The standard ratio gave a buy signal about 3 days ago (Figure 2). The weighted ratio, however, has not given a confirmed buy signal yet. You can see from the chart (Figure 3) that is has begun to roll over, but our computer analyses do not confirm that this rollover is enough to call it a buy signal (yet). One other thing: note
in the chart of the standard ratio (Figure 2), that during February there was a quick Buy-Sell sequence that only briefly interrupted the larger move from the Sell signal in January to the Buy signal in May. Could this most recent Sell-Buy sequence merely be an interruption in a longer bullish cycle that began in May and ends somewhere in the future (dotted line on chart)? The symmetry is intriguing, but markets aren't necessarily symmetric. Finally, the NYSE/NASD breakdown shows that the buy signal is coming from the NASDAQ stocks, not (yet) from the NYSE stocks.

Market breadth was waffling a bit before the London attacks, but has been spectacular ever since. As a result, breadth is overbought. On one hand, that's good news, because it means the budding rally has expanded into a lot of issues. But, on the other hand, this much of an overbought condition usually augurs for a sharp, but short-lived correction.

Finally, volatility ($VIX) has completely collapsed in the wake of this current rally. When the market plunged on the morning of the terrorists attacks, $VIX shot up to nearly 14 (but not above). Since then, it's declined to new closing lows -- the lowest levels since December, 1995. That was a spike peak buy signal in $VIX (albeit from a low level). Again, though, we'd have to rate this indicator as overbought, just because it's so low. As you know, a low $VIX isn't necessarily bearish -- especially as long as $VIX stays low. But it is a possible harbinger of a correction.

Overall, we're bullish, for there are no sell signals, save for the weakening one in the weighted put-call ratio. The overbought conditions should be noted, though, for they are probably signs that a sharp, but short-lived correction is on the near-term horizon. Tightening stops and taking partial profits would be prudent actions, given this overall
technical picture.

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