Opinion: Watch the stock market closely now. If the S&P 500 falls below 4100, the next stop could be 7% lower.

The US stock market as measured by the S&P 500 Index

SPX

,
finally broke above the triple resistance at 4100 on Feb 1st. But the S&P 500 struggled to contribute to this breakout. Instead, the market has pulled back and retested the 4100 support multiple times this week. So far this support has held but some overbought conditions and even sell signals have had time to materialize while SPX is flat in this area.

If the 4100 support gave way, it would be a psychologically disappointing event and it would likely propel SPX towards the lower end of its previous trading range – near 3800. On the upside, the initial breakout reached 4200, which was equal to late August levels . SPX has not closed the gap on its chart from this August period (circle on accompanying SPX chart).

The rally managed to surpass the “Modified Bollinger Band (mBB)” of +4σ. Then, when SPX fell back below the +3σ band, a “classic” MBB sell signal was generated. As SPX continued to fall the next day, a full McMillan Volatility Band (MVB) sell signal was confirmed (green “S” on the chart). This remains in effect until SPX either a) touches the -4σ band, which is the “target”, or b) closes back above the +4σ band, which would halt trading.

Out-of-stock put-call ratios continue to decline rapidly. Thus, both are still on buy signals. They have now fallen to levels where sell signals have been generated for the past year. But we don’t use previous levels as indicators of these put-call ratios. Rather, they will remain bullish on stocks as long as they continue to fall — no matter how low on their charts they land. They will not generate sell signals until they reverse and start to rise.

Width had been spectacular for over a month. But this recent market back and forth with several sharp down days has taken its toll. Currently, both broad oscillators are still on buy signals, but they have no more room to maneuver. That is, any further negative accumulation of breadth from today will generate sell signals from the breadth oscillators.

New 52-week highs on the NYSE remain strong (hitting more than 200 in a recent day), while new 52-week lows remain in the single digits. So this indicator remains positive for stocks. It will remain bullish unless new lows break new highs for two straight days on the NYSE.

For the stock market as well, the volatility complex remains generally bullish. IX

IX

has remained low despite occasional relatively strong selling by SPX. Thus, the trend of the VIX buy signal remains in effect (it started at the crossover inside the green circle on the accompanying VIX chart). The first signs of concern would be if the VIX went back into “spike” mode – that is, if it closed at least 3.00 points higher over a 1, 2, or 3 day period. Currently, VIX would need to close above 21.48 today or Friday to return to spike mode. However, it has not shown any signs of such upward movement recently.

The construct of volatility derivatives is also bullish for stocks – for the most part. The only “concern” in the construct is that the CBOE short-term 9-day volatility index (VIX9D) is higher than the VIX. That’s because this month’s CPI numbers are scheduled to be released on February 14th, and that’s within the 9-day “window” for VIX9D. Traders expect the CPI figure to bring some (more) volatility to stock prices.

We no longer hold a “core” bearish position as SPX has risen above its bear market downtrend line. However, we will trade from both the long and short sides as dictated by the confirmed signals from our indicators.

New recommendation: MVB sell signal

Since a new MVB sell signal has been generated, we will add a position according to this indicator:

Buy 1 SPY Mar (17th) on the money put

And Sell 1 SPY Mar (17th) dropped 25 points with a striking price.

This trade would be stopped out if SPX closed above the +4σ band again. We will update you on the position of the bands every week.

New Recommendation: Catalent Inc. (CTLT)

Option volume in Catalent

CTLT

has remained at elevated levels for several days after initially gapping higher on news of a possible acquisition by Danaher

DHR

.
This rumor has slowed somewhat but the stock is holding above 70 levels. Stock volume patterns are positive and there are also buy signals on the put-call ratio on this stock. Due to price gaps, there is no visible support level until you get all the way back to 58.

Buy 2 CTLT March (17th) 70 calls

For the price of 6 or less.

CTLT: 71.60 Mar (17th) 70 call: 5.50 bid, offered at 6.20

follow-up action:

All stops are mental closure stops unless otherwise noted.

We use a “standard” rolling procedure for our SPY spreads: if the underlying asset hits the short strike on any vertical bull or bear spread, the entire spread is rolled. That would be a role high 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 same distance between strikes unless otherwise specified.

Long 2 PCAR1 Feb (17th) 64.80 puts: Pakar

PCR

Split 3-2 on February 8th. Thus, the “shares per option” increased from $100 per share to $150 per share, and the exercise price was reduced by two-thirds. The put-call ratio has changed after a strong earnings report from PCAR. The options are essentially worthless, so we’ll hold them to see if the stock can pull back a bit.

Long calls on 2 OSH (February 17) 30: Oak Street Health

Osh

received a $39 takeover bid from CVS Health.

CV

.
The stock is trading well below that level apparently due to antitrust concerns, so we’ll exit and take profit. Don’t sell your calls below par.

Long 1 SPY Feb (24th) 412 Call and Short 1 SPY Feb (24th) 426 Call: This spread was bought when the breakout above 3940 was confirmed by SPX at the close on Jan 12th. It rolled out on February 1st when SPY

SPY

traded at 412.

Long 1 SPY Feb (17th) 404 Call and Short 1 SPY Feb (17th) 419 Call: This spread was bought in line with the “New Highs vs. New Lows” buy signals. It rolled up on Jan. 26 when SPY was trading at 404. Stop yourself from this position when new lows on the NYSE break new highs for two consecutive days.

Long 4 NATI Feb (17th) 55 views: Keep National Instruments

NATI

initially without stopping to see if a bidding war develops.

Long 1 SPY Mar (17th) 415 Call and Short 1 SPY Mar (17th) 431 Call: This trade was introduced as a “breakout trade” when SPX closed above 4100. Stop below 4020 on SPX close.

Long 3 XM (March 17) 15 Views: Keep holding Qualtrics International

xm

while the takeover rumors play out.

Send questions to: [email protected]

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 the author of the bestselling book Options as a Strategic Investment. www.optionsstratege.com

©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. Officers or directors of McMillan Analysis Corporation, or accounts maintained by such persons, may have positions in the securities recommended in the recommendation.