The stock market’s breakout is getting some major new support — for now

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The stock market, as measured by the S&P 500 Index has been trying to break out above 4200 for some time, and it finally managed to do so last Friday. That breakout has held this week, so it is confirmed (so far).

The problem is that there hasn’t been much progress since the breakout occurred. It is normal to see a breakout pull back to the breakout level and then regain upward momentum. Perhaps that is what’s happening, but there is also a chance that this breakout could still prove to be a false one, similar to a couple we’ve seen since the beginning of 2022. A pullback below 4150 would be an indication of a false breakout. 

Realized volatility is beginning to decrease (which is bullish), and so the “modified Bollinger Bands” are pulling in towards the center. As a result, the +4σ Band has been touched this week. That officially closes out the MVB buy signal from early March and sets up the possibility of a new sell signal down the road. SPX would have to close above the +4σ Band, though, before any sell signal would set up.

Equity-only put-call ratios have continued to fall, and that means that their buy signals are intact. They have reached relatively low levels on their charts, which is an overbought condition, but that is not a problem. They will remain on their buy signals until they roll over and begin to rise.

Breadth has now confirmed the upside breakout by SPX. At first, breadth stumbled, but in the past couple of days it has recovered, as there has been a resurgence of small-cap stocks moving higher. This move has come at the expense of the former leading group: AI and tech stocks, but that is a good thing overall. So, now the breadth oscillators are overbought, which is positive for a broad stock market that is breaking out to the upside.

Another area of improvement has been New Highs vs. New Lows. For the first time since January, there have been back-to-back days on which new highs on the NYSE have outnumbered new lows by more than 100 issues. That is a buy signal from this indicator. The buy signal will remain in force until new lows outnumber new highs on the NYSE for two consecutive days.

VIX has dropped to its lowest levels since January 2020 — right before the Covid-19 pandemic crisis. The “spike peak” buy signal has “expired,” since it achieved its 22-day holding period. The trend of VIX buy signal remains in place. VIX might be “overbought” by some measures, but it is not really a problem until it reverts to “spiking” mode (a 3.00 or more gain over any one-, two-, or three-day period, using closing prices).

The construct of volatility derivatives remains bullish for stocks as well, as the term structures of both the VIX futures and of the CBOE Volatility Indices continue to slope upward.

In summary, we are recommending a “core” bullish position because of the upside breakout. Other individual indicator’s signals can be traded around that position.

New recommendation: Upside breakout

SPX is not currently the strongest index, as smaller-cap indices as well as the Dow Jones Industrial Average have outperformed while the tech stocks take a rest. Nevertheless, it is SPX that we use as our market basis, and if a bull market is back in force, SPX will participate.

Buy 2 SPY July (7th) at-the-money calls

We are not using a spread here since, with VIX as low as it is, a spread is not necessary. Stop out of this SPY trade if SPX closes below 4150.

New recommendation: New-highs buy signal

At noted in the market commentary above, there has been a new buy signal from the “New Highs vs. New Lows” indicator.

Buy 1 SPY July (7th) at the money call

Stop out of this trade if, on the NYSE, new lows outnumber new highs for two consecutive days.

Follow-up action: 

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. 

Long 400 JFIN : Raise the stop to 6.40.

Long 1 SPY June (16th) 409 put and short 1 SPY June (16th) 379: This position was based on the sell-signal from realized volatility, since the 20-day Historical Volatility (HV20) of SPX has risen back above 10%. This position will be stopped out if HV20 falls back to 9% or lower; it currently is at 15%.

Long 4 BWA June (16th) 42.5 puts:  Continue to hold BWA

Long 1 SPY June (16th) 411 call and short 1 SPY June (16th) 425 call: This spread was closed at the close of trading on Wednesday, June 7, per our instructions from last week.

Long 3 CHD July (21st) 95 puts: The put-call ratio here has turned back down, canceling out the sell signal. Sell these CHD puts now.

Long 3 AMAM June (16th) 12.5 calls: The trailing stop for AMAM remains at 12.00.

Long 4 HAL July (21st) 30 calls: Hold this position as long as the weighted put-call ratio remains on a buy signal.

Long 2 MXL July (21st) 30 puts: Stop out on a close above 31 by MXL

Long 800 KOPN:  The KOPN stop remains at 1.70.

All stops are mental closing stops unless otherwise noted.

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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 best-selling 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. 

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