MW The 'January defect' could slam stocks if buyers don't step up quick

By Lawrence G. McMillan

For the bulls to reassert control, the S&P 500 would have to rally to all-time highs

The S&P 500 Index SPX failed to follow up its big one-day surge on Jan. 15 with another strong showing on Jan. 16. Still, it's clear that the bulls are trying to reverse what has been a poor start to the year so far.

It hasn't helped that SPX broke support at 5,870 for several days, removing the bullish indicator from the SPX chart. In its place, a downtrend has developed. The SPX chart below shows that downtrend (blue line), and you can see that Jan. 15's move is right on the declining 20-day moving average $(MA)$. There is now quite a bit of overhead resistance between current levels and the all-time highs at 6,100. For the bulls to reassert control, the S&P 500 would have to rally to new all-time highs.

On the downside, SPX has support at 5,780, which was where the most recent decline bounced from. It was also the closure of the "island reversal" gap from November.

The recent increase in realized volatility (HV20) has caused the "modified Bollinger Bands" to widen out on the SPX chart. Thus, SPX has not yet touched either the +4 and the -4 Band in quite some time.

Equity-only put-call ratios have been steadily rising since mid-December, and that has been bearish for stocks. The large stock-market rally on Jan. 15 paused the ascent of these ratios, but they remain bearish. Since they are 21-day moving averages, they don't generally roll over on just one day's action, no matter how strong it is. But if they reverse course and begin to decline, that would be bullish for stocks.

Market breadth has begun to improve, and both breadth oscillators have now confirmed new buy signals. This is our shortest-term indicator, so it can whipsaw quite easily - as we saw with the latest attempt to turn bullish at the beginning of January. These are "true" buy signals in the sense that the oscillators had descended into deeply oversold territory and have now come out of it. "Oversold does not mean buy," but when a previously oversold market rises out of its oversold condition, that is a buy signal.

New lows on the NYSE have been dominant over new highs since mid-December, when a sell signal was issued from this indicator. This sell signal would be stopped out if new highs outnumber new lows for two consecutive days on the NYSE. If new highs are again greater than new lows on Jan. 16, that would stop out the sell signal. However, that would not necessarily be a new buy signal from this indicator. A new buy signal requires that new highs not only outnumber new lows for two consecutive days, but that new highs number more than 100 on each of those days.

Realized volatility remains a problem for the market. Increasing volatility - whether implied or realized - is generally bearish. The 20-day historical volatility of SPX (HV20) is still in an uptrend, so that sell signal is still in place.

VIX VIX has spiked up and then back down three times in the past three weeks. The first of those generated a "spike peak" buy signal back on Dec. 19. That will remain in effect for 22 trading days, or for another six trading days. Since then, there have been two more, overlapping "spike peak" buy signals. We do not trade those, but they are marked on the accompanying VIX chart. The first overlapping signal was stopped out, but the second overlapping signal is still in place.

The pink bracket on the VIX chart draws attention to another area of concern - the trend of VIX. When both VIX and its 20-day moving average are above the 200-day moving average, that is a sell signal for stocks. That sell signal is still in place, but with VIX now retreating back towards that 200-day moving average, it is possible that the sell signal could be stopped out. That would occur if VIX closes well below its 20-day moving average for two consecutive days.

The construct of volatility derivatives has remained bullish throughout the somewhat negative stock-market action in the last month, although there was a scare when the term structures flattened out during the SPX breakdown below 5,870. Currently, however, the picture is back to its old bullish self, with the term structures sloping upwards and VIX futures trading at premium to VIX, for the most part.

January is a period of seasonal trading patterns. The first one - the early warning sign (first five trading days of January) - was modestly bullish. We are not embarking on what is normally a bearish short-term period for the Nasdaq-100 index NDX. Following that will be one of the strongest bullish seasonal patterns of the year at the end of January.

We are no longer carrying a core bullish position, since SPX closed below 5,870 for several days. We will trade other confirmed signals, though, and be sure to continue to take profits by rolling deeply in-the-money option positions.

New recommendation: Breadth-oscillator buy signal

Both breadth oscillators have rolled over to new buy signals. This is our shortest-term indicator and is subject to whipsaws, but the winning trades make up for those (witness the recent sell signal from mid-December that worked out quite well).

Buy 1 SPY SPY (Feb. 7) at-the-money call and sell 1 SPY (Feb. 7) call with a striking price 13 points higher.

We will hold this position as long as at least one of the breadth oscillators remains bullish. If both roll back over to sell signals, then we will exit the position.

Market insight: The 'January defect'

There is often a downturn in the Nasdaq-100 index in mid-January. This probably has something to do with the fact that traders load up on NDX stocks in the early days of the new year, creating a vacuum of buying power by the 12th trading day or so.

We have followed this trading system for a number of years and it has been profitable, although not in the past two years. Essentially, the system's best entry date calls for shorting NDX on the 12th trading day of the year and covering at the close of the 18th trading day.

In the past 30 years, this trade has produced 18 wins and 12 losses, with the median result (including wins and losses) being a drop of 0.7% for NDX. When the system wins, NDX drops 2.3% on average. When the system loses, NDX rises by 3.4% on average (that is more than an option costs, so the figure would be slightly smaller for option traders).

At the close of trading on Tuesday, Jan. 21, Buy 1 QQQ QQQ (Feb. 7) at-the-money put in line with the market.

Roll the put down if it becomes 8 points in-the-money, staying in the Feb. 7 expiration. Sell the put to close the position at the close of trading on Wednesday, Jan. 29.

Follow-up action

All stops are mental closing stops unless otherwise noted.

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.

Also, for outright long options, roll if they become 8 points in-the-money.

Long 0 SPY (Jan. 24) 607 call: This was our core bullish position, which was stopped out on Jan. 13, when SPX closed below 5,870 for two consecutive days.

Long 4 expiring WBA (Jan. 17) 9 calls: This is the "alternative" Dogs of the Dow position. Roll to the WBA $(WBA)$ (Feb. 21) 12.5 calls. Hold without a stop at this time.

Long 0 POET (Jan. 17) 5 calls: Were stopped out when POET $(POET)$ closed below $5.20 on Jan. 10.

Long 1 SPY (Jan. 24) 581 put: Was rolled down when the previous 589 strike put became 8 points in-the-money on Jan. 10. This position was based on the breadth-oscillator sell signal. Those oscillators have now rolled over to buy signals, so sell this put to close the position.

Long 1 expiring SPY (Jan. 17) 590 put and short 1 SPY (Jan. 17) 550 put: This position is based on the "new highs vs. new lows" sell signal. This position will be held until new highs exceed new lows on the NYSE for two consecutive days. If new highs outnumber new lows on Jan. 16, then exit the position. If they do not, then a new setup would be required, in which case we want to roll on Friday (Jan. 17) to: Buy 1 SPY (Feb. 21) 590 put and sell 1 SPY (Feb. 17) 570 put.

Long 1 SPY (Jan. 24) 586 call and short 1 SPY (Jan. 24) 606 call: This position is based on the latest "spike peak" buy signal of Dec. 19. This trade would be stopped out if VIX were to close at a higher price than the previous peak (28.32). Otherwise, the position will be held for 22 trading days.

Long 3 expiring VRAR (Jan. 17) 4 calls: VRAR $(VRAR)$ closed below our stop of $2.40 on Jan. 8, but there was no bid for the calls. So sell them if you can and do not replace them.

Long 0 ABAT (Jan. 17) 2.5 calls: Stopped out when ABAT $(ABAT)$ closed below $1.95 on Jan. 13.

Long 1 SPY (Feb. 21) 580 put and short 1 SPY (Feb. 21) 550 put: This spread is to be held as long as at least two of these three indicators remain on sell signals: HV20, trend of VIX, and equity-only put-call ratios. Despite the large rally on Jan. 15, these are all still bearish indicators, although are three are losing momentum.

Long 1 AMZN (Feb. 21) 215 put: We will hold as long as the put-call ratio for AMZN $(AMZN)$ remains on a sell signal.

We had a conditional put buy in Decker's Outdoor $(DECK)$, but the condition has not been satisfied, so we are cancelling this recommendation.

All stops are mental closing stops unless otherwise noted.

Send questions to: lmcmillan@optionstrategist.com.

(MORE TO FOLLOW) Dow Jones Newswires

January 16, 2025 18:27 ET (23:27 GMT)

MW The 'January defect' could slam stocks if -2-

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 "Options As A Strategic Investment." www.optionstrategist.com

(c)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.

-Lawrence G. McMillan

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January 16, 2025 18:27 ET (23:27 GMT)

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