Stock Market

Option Strategist
From Larry McMillan

Some volatility has appeared in the market over the last week, although you'd never know it by looking at the volatility index ($VIX). First, the market went down at the end of last week -- rather swiftly -- but then recovered with a big up day on Tuesday. After a waiting period to see what the Fed would do (they the same old thing they always do -- raised rates by 1/4%), the media was quick to point out that the market declined Thursday afternoon because it didn't like what the Fed had to say, but we offer an alternative viewpoint: the market was just "on hold" for the last couple of days, waiting for the Fed announcement to get out of the way (just in case there was a surprise, which there wasn't); then it resumed its natural course, which was to decline. Despite all of this movement, or perhaps because of it, there are mixed signals.

The major indices are not in agreement. The Dow, QQQQ, and $OEX all broke down below support by the end of last week and have not been able to recover above that level -- even with Tuesday's rally. However, perhaps the most important one -- $SPX -- has not joined its compatriots. It remains above support at 1190 (Figure 1). As long as that support holds, the bears won't be able to mount much of anything. However, if $SPX closes below 1190, that will usher in another round of selling and could augur for a lengthier decline ahead.

The selloff at the end of last week came just after the equity-only put-call ratios generated sell signals. These are usually longer-term averages (because they are 21-day average) and thus are more of an intermediate-term indicator, rather than an exact timing indicator. However, the last two times the market has reversed direction (the bottom in May and the top last week), these put-call ratios turned to a new signal on the exact day. Regardless, they are both on sell signals now and haven't really shown any signs that they might reverse to the bullish side.

Market breadth was ugly in last week's decline. However, this week, that has changed. Breadth has been more positive than the market. For example, when the market was down 100 points today (the Dow, anyway), NYSE breadth was barely negative. With breadth acting more positive in the last few days, we'd just grade this indicators as "neutral."

Finally, there is volatility. $VIX barely moved when the market dropped last week. From valley to peak, it rose a mere 1.5 points. Then it backed off. It is about 12 now, and that is still very low. We generally look for $VIX to be rising to confirm a market sell signal. Otherwise, any selling in the market is more of a correction than a sell signal. To be specific, if $VIX rises above 14, we'd classify it as being bearish. But as long as it's languishing down at these levels, it isn't offering any confirmation for the bears.
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