In the past, we have occasionally talked about hard to borrow stocks, and how that affects option prices. When market makers and others cannot borrow stock, then the “normal” option arbitrage relation falls apart. Normally, the following equation holds true (modulo dividends and carrying charges):
Stock price = Strike Price + Call Price – Put Price (where put and call have the same terms)
The market has staged a ferocious oversold rally. Bear market rallies always look great until they fail. This rally has now reached the upper side of the downtrend channel (blue lines in Figure 1). Of course, it is always possible that this is the real thing i.e., a market bottom -- and not an oversold rally. In my opinion, the difference- maker will be if $SPX can close above 4600.
Most people don’t realize that the Crash of 1929 and the Crash of 1987 both occurred exactly 55 calendar days after the stock market had topped. All prices in this article are closing prices on the day being referenced.
1929: the peak in the Dow was reached on September 3rd, when it closed at 381.17. 55 calendar days after September 3rd was (Monday) October 28th. That was the exact date of the Crash of 1929, with the Dow down 40.58 points, or 13.5%.
The tensions regarding a potential Russian armed invasion of Ukraine have caused some wider than usual swings in the market, but the underlying causes of the bearish action on the stock market are far greater than this potential conflict.
$SPX remains in a downtrend (see blue line on the chart in Figure 1), and that is what makes the chart bearish. The fact that the various short-term moving averages and the "modified Bollinger Bands" are all sloping downwards only adds to the bearishness.
The oversold conditions that had existed at the end of January led to a strong oversold rally. $SPX gained over 350 points in just under two weeks. But that rally failed as $SPX reached its declining 20- day Moving Average, and the Index is now on the defensive again. The downtrend line on the chart in Figure 1, and the declining trend lines ("modified Bollinger Bands" and 20-day Moving Average), are indicative of a bearish trend in $SPX.
The broad stock market had a very strong rally over the 4-day period, extending from January 28th through February 2nd. The oversold conditions that existed just prior to that were massive and part of the rally was a reaction to those conditions. In addition, there is a verified positive seasonality to the end of January, as mutual funds and other large institutions put cash to work. Both of those conditions aided the rally greatly, but they are no longer in effect. For now, the demarcation line between bear market and a possible reversion back to a bull market is the negative trendline show in blue in Figure 1.
The $SPX Index fell back below 4700 and has been struggling ever since. It has returned to its former trading range (4500 - 4700). A close below 4500 would also be a close below December's lows - often the hallmark of the beginning of a bear market. Meanwhile, a move above 4800 would return everything to a "bullish" status.
Equity-only put-call ratios are not on the same page surprisingly. The weighted ratio is rising, and so it is on a sell signal. The standard ratio is on a buy signal.
The fact that $SPX has made new closing and intraday highs is bullish. As for the $SPX chart, there should be support at the old breakout level near 4700, although that has not been tested yet. If $SPX should fall back below there, it would be back in its old trading range, with support at 4500. However, a pullback of that magnitude while not necessarily setting off bear market alarms would remove the current "bullish" status from the $SPX chart.
Over the last week, new 52-week Lows have been dominating New 52-week Highs, across all three data sets: NYSE, NASDAQ, and “stocks only.” The day after $SPX rallied to its all-time high close at 4712, there were over900 new 52-week lows in optionable stocks, and over 600 in NASDAQ. So, with $SPX just off its highs, there were hundreds of stocks making new 52-week lows. That is a stark picture of just how much negative divergence there is in this market. Put-call ratios and market breadth also can attest to this.
Join Larry McMillan as he discusses the current state of the stock market on Monday, December 13, 2021.
