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By Lawrence G. McMillan

It took the catalyst of Fitch downgrading the debt rating of the US from AAA to AA+ in order to generate some heavy selling in stocks. So far, most of the damage has been limited to just one day, but that was enough to confirm sell signals from several overbought areas.

$SPX itself now has resistance near 4600, which is the high of the most recent rally. The first support area af 4528 was broken, but there are others that should come into play: 4440 is the area at which all of the recent gaps on the $SPX chart would be filled (red circled area in Figure 1). Then 4330 and 4200 are major support areas below that. Their importance derives from the fact that it took some time to build both of those support levels. A move below 4330 would be a negative for the $SPX chart and would cause us to relinquish our "core" bullish position. Otherwise, we are going to retain it for now.

Equity-only put-call ratios are rolling over to sell signals. The standard ratio (Figure 2) has visibly turned upward, and that sell signal is solidly in place. The weighted ratio (Figure 3) is less clear. The ratio jumped higher for one day day of the US debt downgrade but that's about it, which is why there is a "?" on the sell signal marked on the chart.

Breadth had started to slip before the Fitch downgrade and then worsened after that. Both breadth oscillators have now rolled over to sell signals, and those have been confirmed for two consecutive days.

$VIX has moved slightly higher in the wake of the Fitch downgrade and the resulting selling of stocks, but not even enough to enter "spiking" mode. It did probe up above 17 briefly on Thursday, but then closed back down below 16. In other words, the reaction of $VIX has been muted. The trend of $VIX buy signal thus remains in place.

So, we are retaining our "core" bullish position. We have rolled in-the-money calls up to higher strikes all along with this rally, so our exposure is somewhat limited. We are taking positions in line with some of the new sell signals, and each system has its own stop out.

This Market Commentary is an abbreviated version of the commentary featured in The Option Strategist Newsletter.

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