Option Letter Daily

The bears had their way with the markets this week, relying on a variety of scary headlines, rising oil prices, some weak housing statistics, and a totally wishy-washy speech by Bernanke. Even so, the bullish case remains feasible — albeit a bit shakier than it seemed last week.

The $SPX chart shows support at 1410, and that is probably the most important technical factor in this report. As long as $SPX continues to trade above 1410, a viable bullish case can be made. Last week’s strong breakout above the 1410 level carried all the way to 1437 in one day. No further progress was made, and this week’s decline then materialized. A pullback after a strong upside breakout is not unusual, but it’s important that the neckline of the “W” formation (see Figure 1) not be violated on the downside. That neckline, of course, is the 1410 level.



The equity-only put-call ratios remain in extremely oversold territory. But as we know, “oversold” does not mean “buy.” These ratios have so far refused to roll over to buy signals. However, there was a slight “blip” downward yesterday (see Figures 2 and 3), and if that continues, we may finally get buy signals from these important intermediate-term indicators.





Market breadth had gotten very overbought following last week’s big rally. That is normally a strong sign for an emerging bullish phase in the market. However, this time there was no follow-through to those broad advance-decline figures. We don’t consider breadth to be a leading indicator, though, so this is only a minor nuisance — not a major problem.

Volatility indices gave buy signals over a week ago (see Figure 4), as they plunged to below 12. Both $VIX and $VXO have rallied some this week, and are back near the 15 level. Since the 20-day historical (actual) volatilities of the major indices are near 15, it’s not unusual to find that $VIX is near 15 as well. In fact, $VIX usually trades at levels slightly higher than historical volatility.



In summary, we retain a bullish viewpoint and will continue to do so, as long as $SPX remains above the 1410 level. What if it falls below? We’d then expect another retest of the lows — something that probably would be rather ugly.

Lawrence G. McMillan is the author of two best selling books on options, including Options as a Strategic Investment, recognized as essential resources for any serious option trader’s library.

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