MW How the stock market's January seasonal trade can help you hit your target

By Lawrence G. McMillan

Prepare for four positive trading days; plus, the NYSE 'new highs vs. new lows' indicator is bullish

The S&P 500 Index SPX is now back near its all-time highs - up more than 300 points since its false downside breakout on Jan. 13. The previous high near 6,100 represents resistance, and it may well hold since the market has expended a lot of energy to get to this point. The recent advance has been so swift that it has left three gaps on the SPX chart, and those types of short-term gaps are often filled.

But there really isn't any verified support, except for the lower end of the wide and volatile trading range - at 5,760-5,870.

In the past, we have often bought straddles as SPX approaches all-time highs, figuring that either those highs will provide resistance, or the index will blow on through to new all-time highs.

Technically, the McMillan Volatility Band $(MVB.AU)$ buy signal from last August is still in place because SPX has not traded at either of the +/-4<SIGMA> "modified Bollinger Bands" since then. Once again, SPX is approaching the upper Band, which is at about 6,150 and just beginning to contract lower as realized volatility is finally damping down a bit.

The internal market indicators have been mixed during this rally. Equity-only put-call ratios remain on sell signals, at least according to the computer programs that we use to analyze these charts. They have been rising steadily during this rally, leading one to conclude that the heavy stock buying is also being accompanied by protective put buying to some extent. Both ratios moved lower yesterday, but since they are 21-day moving averages, one day is not going to reverse their signals.

Market-breadth oscillators, in contrast to put-call ratios, have been on buy signals for more than a week. They have reached overbought territory, but if SPX breaks out to new all-time highs, it is a positive for that to be accompanied by overbought breadth indicators. Cumulative volume breadth $(CVB.AU)$ has made a new all-time high three times in the past four trading days. That is usually a sign that SPX will follow along to new all-time highs as well.

On the NYSE, new highs have quickly overtaken new lows on this rally. A new buy signal for this indicator was issued at the close on Jan. 22. That's because new highs outnumbered new lows for two consecutive days, and new highs numbered more than 100 on each of those days. This indicator has had good long-term results for a long time now, and every time that its buy signal has been stopped out, it generates a new one fairly quickly. This apparently has occurred once again.

Meanwhile, the Cboe Volatility Index VIX has dropped below its 200-day moving average, which has been acting like a homing pigeon. No matter how much VIX spikes up, it seems to keep coming right back to the 200-day MA. So, the trend of VIX sell signal that had recently been generated has been stopped out. On the other hand, the "spike peak" buy signal has been working quite well. The latest buy signal occurred on Dec. 19 and runs for 22 trading days - or through Jan. 24. There were also some overlapping "spike peak" buy signals, but we only trade the original.

The construct of volatility derivatives has returned to a fully positive outlook for stocks. There was a short period of shakiness in mid-January, but that has dissipated. The term structures of the VIX futures and of the Cboe volatility indices continue to slope upward.

Realized volatility has been rising, and that is generally a bearish sign for stocks. The 20-day historical volatility of SPX (HV20) reached 18%, and now has fallen back slightly. At this time, though, realized volatility is still in an uptrend. If SPX were to break out to new all-time highs, I would think that would reduce HV20, but time will tell.

In summary, we are not holding a core position at this time, as the indicators are mixed, and SPX may well be in a volatile trading range, which could mean a quick trip back to the bottom of the range, or it could mean a breakout to new all-time highs. Regardless, we will trade confirmed signals as they occur, and we will roll deeply in-the-money positions to lock in partial profits and reduce risk of a market reversal.

Registering a new 'buy' signal

There has been a new buy signal from the NYSE "new highs vs. new lows" indicator. Specifically, new highs have outnumbered new lows for two consecutive days, and those new highs have numbered more than 100 on each day.

Buy 1 SPY (March 7) at-the-money call and sell 1 SPY (March 7) call with a striking price 15 points higher.

NOTE: if there is not a striking price available exactly 15 points higher, then use the closest strike that is available. This trade would be stopped out if, on the NYSE, new lows were to outnumber new highs for two consecutive days.

New recommendation: SPY straddle buy

In the past we've had some success with straddle buying when SPX nears its all-time highs. Either the old highs act as resistance and the market falls from there, or SPX breaks on through the old highs, venturing into new unchartered territory. The last time was this past August, when SPX was approaching then-all-time highs at 5,650.

Right after we bought those straddles, SPX fell to about 5,400 and we rolled the puts down; then, it reversed and broke out to new all-time highs, and we wound up rolling to calls up a couple of times. Overall, the position was a profit, but the options were quite expensive and the eventual loss of time decay hurt the position to some extent. The original two-month straddle cost 23, with the SPY SPY strike being 559. Currently the at-the-money SPY (Mar. 21) 606 straddle is trading at about 25, which is comparable - perhaps a tad cheaper in terms of implied volatility.

Buy 1 SPY (March 21) at-the-money call and buy 1 SPY (March 21) at-the-money put

Roll any option that becomes at least 8 points in the money.

New recommendation: January seasonal trade

The stock market's January seasonal trade is usually one of the best seasonal trades (right behind the October seasonal). The trade is to buy SPX at the close of the 18th trading day of January and exit at the close of trading four days later. Typically, large fund managers will put money to work at the beginning of the year (hence, the positive seasonality of the January early warning system), and then complete their buying at the end of the month.

Since 1986, this trade has produced 31 wins and 8 losses. On average, SPX advances 1.1% in that four-day period. This year, the 18th trading day is Jan. 29.

At the close of trading on Wednesday, Jan. 29: buy 2 SPY (Feb. 14) at-the-money calls. Roll the calls if they become 8 points in-the-money. Exit the trade at the close of trading on Tuesday, Feb. 4 - four trading days later.

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 4 WBA (Feb. 21) 12.5 calls: This is the "alternative" Dogs of the Dow position. Just when it looked like the stock was about to advance, after a positive earnings report, threatened legal action surfaced on another front. Hold WBA $(WBA)$ without a stop at this time.

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. Since SPY has reached the higher strike in this spread, roll up to the SPY (Feb. 7) 606 outright long call.

Long 1 SPY (Feb. 21) 580 put and short 1 SPY (Feb. 21) 550 put: Hold this spread as long as at least two of these three indicators remain on sell signals: HV20; trend of VIX, and equity-only put-call ratios. The trend of VIX sell signal has been stopped out, but the other two are in place for now.

Long 1 AMZN (Feb. 21) 215 put: We will hold this Amazon.com $(AMZN)$ put as long as the put-call ratio for AMZN remains on a sell signal, which is still (barely) in place.

Long 1 SPY (Feb. 7) 592 call and Short 1 SPY (Feb. 7) 605 call: This position was bought because of the breadth oscillator buy signals. If both roll back over to sell signals, then we will exit the position. Since SPY traded above 605, this position should be or should have been rolled up to the 605-618 call spread, remaining in the Feb. 7 expiration.

Long 1 QQQ QQQ (Feb. 7) at-the-money put: This was bought in line with the seasonal "January defect" trade. Roll the put down if it becomes 8 points in-the-money, staying in the February 7 expiration. Sell the put to close the position at the close of trading on Wednesday, Jan. 29.

Send questions to: lmcmillan@optionstrategist.com.

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

(MORE TO FOLLOW) Dow Jones Newswires

January 23, 2025 12:02 ET (17:02 GMT)

MW How the stock market's January seasonal trade -2-

(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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