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By Lawrence G. McMillan

The big rally that took place the week of October 30th saw $SPX rise from the lower downtrend line of its current bearish phase to the upper downtrend line. That rally was spurred by oversold conditions and a very favorable seasonal trading pattern. But those are no longer in place, and now the rally has run into trouble. Not only is that downtrend line representing resistance, but there are a couple of other things to deal with: one is the gap that still exists from September. It would be closed if $SPX were to rise above 4401.60. Another is the resistance presented by the highs of October, when that rally ran out of steam at essentially this same place just below 4400. If $SPX cannot decisively break through 4400 (and hold that breakout for two consecutive days), that would be bearish. If the bears take control again, and they may already have, $SPX could retreat to the lower downtrend line, near 4100. Those three small gaps on the $SPX chart that were left in the wake of the afore-mentioned rally would probably all need to be filled the lowest one of which is at 4195. The bottom line on the $SPX chart is that it is still in a bearish mode because of the downtrend lines that are in place. Until the pattern of lower highs and lower lows is broken, this will be a bearish chart.

Equity-only put-call ratios display the disparity in the market as well as anything. The standard ratio (Figure 2), rolled over to a buy signal in early October. That was way too early, but with the recent rally, it doesn't look as bad now. Meanwhile, the weighted ratio correctly refused to roll over to a buy at that time and remained bearish as the market continued lower. However, now the weighed ratio is still on a sell signal, even though the market has rallied.

Market breadth continues to swing wildly from one side to the other. The breadth oscillators were extremely oversold at the end of October, which helped to propel that rally. During the rally, the breadth oscillators reached overbought territory -- which is fine when $SPX is breaking out. Except that the breakout never occurred, and when $SPX began to trade sideways for the last four days, breadth deteriorated badly. Thus, the breadth oscillators are back on sell signals again. That was quick. This deterioration in breadth seems like a death blow to the rally (my opinion only).

Volatility indicators have turned more bullish for stocks. The $VIX "spike peak" buy signal is still in place, and it has a couple more weeks to run. Meanwhile, the trend of $VIX sell signal -- which was registered in mid-October (circle on the chart in Figure 4) has been stopped out, since $VIX has fallen back well below its 200-day Moving Average. This is not a buy signal, though, because the 20- day MA of $VIX would also have to cross below the 200-day MA for that to occur.

In summary, we are still holding a "core" bearish position (albeit with out-of-the-money puts) because $SPX is still in a downtrend. It seems that $SPX is going to make a fairly large move one way or the other. A breakout above 4400 should have traders' eyes set on all-time highs once again (are at least the yearly highs at 4600), while a breakdown should see move below 4200 in short order. Thus, straddle buys might not be a bad idea, especially with $VIX below 15. Meanwhile, we will trade confirmed signals as they occur.

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

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