Can the Stock Market Avoid the 'Grinch Pinch' During the Santa Claus Rally?

The S&P 500 Index (SPX) is showing signs of recovery after a sharp decline triggered by the Federal Reserve's December meeting. Recent trading sessions have seen a rally in the SPX, a drop in the VIX (Cboe Volatility Index), and general improvements in internal market indicators. These developments coincide with the start of a traditionally favorable market period known as the "Santa Claus rally."

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While the market has shown resilience, a full-fledged bullish surge remains uncertain. Notably, the bears have been unable to gain control of the market. The SPX tested its previous support level at 5,870 during the recent downturn, holding firm on a closing-price basis. This level remains a critical point of support. On the other hand, resistance exists at 6,010, with a more significant barrier near the all-time high of 6,100.

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For now, the market operates within this broad range of 5,870 to 6,100. A breakout beyond these levels could trigger swift momentum in either direction

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Further support can be found at 5,670. However, if the market were to dip to this level, the SPX chart would lose its bullish structure. The McMillan Volatility Band (MVB) buy signal, initiated in August, remains active, supported by SPX avoiding contact with its +4σ band since the signal’s inception. Positions based on this signal have been adjusted upward multiple times.

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Equity-only put-call ratios began to rise amid last week’s selloff, hinting at a potential sell signal. However, the increase in these ratios appears to have stalled. A rising put-call ratio generally signals negativity for the market, but this pattern has failed to materialize several times over the past year. Similar scenarios occurred in January and October, where ratios rose from extremely low levels — often indicative of an overbought market — but did not sustain their upward momentum. For the current sell signals to gain credibility, the ratios would need to resume a sharp upward trajectory.

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Breadth, one of the more negative indicators during the recent decline, is now improving as the market rallies. Breadth oscillators had previously generated timely sell signals, but the recent upswing in market breadth could negate these signals if the positive trend continues. For a bullish shift, market breadth must improve further, potentially generating buy signals.

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Meanwhile, new lows on the NYSE continue to exceed new highs, maintaining a bearish longer-term signal. However, this measure is beginning to show signs of improvement. If new highs outnumber new lows on the NYSE for two consecutive days, it would invalidate the current sell signal.

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The VIX spiked above 28 during the market’s recent decline but has since retreated to approximately 15. This marked a clear "spike peak" buy signal. Additionally, the VIX is now below its 200-day moving average. With the 20-day moving average also beneath the 200-day moving average, a potential "trend of VIX" buy signal is forming. This signal would be confirmed if VIX closes below 15.80, suggesting a bullish trend for the stock market.

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The structure of volatility derivatives further supports a positive outlook. The upward slope of the term structure and the premium of VIX futures over the spot VIX are both bullish indicators. A potential warning sign would emerge if January VIX futures traded above February VIX futures, but this scenario is far from materializing.

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For now, maintaining a core bullish position is prudent as long as SPX remains above 5,870. Additional trades can be made around this core position based on confirmed signals. To mitigate risk and lock in partial profits, rolling deeply in-the-money options is recommended.

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The "Santa Claus rally," a seasonal pattern identified by Yale Hirsch in the 1960s, has begun. This period includes the final five trading days of the year and the first two trading days of the new year. Historically, the SPX rises by just over 1% during this time. However, if the market fails to rally, Hirsch's adage warns that bearish conditions may follow.

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To capitalize on the Santa Claus rally, consider buying one at-the-money SPY (S&P 500 ETF) call expiring on January 10. If the call becomes eight points in-the-money, roll the position upward. Otherwise, plan to exit on January 3, the second trading day of 2025.

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A new "trend of VIX" buy signal could also emerge if VIX closes below 15.80. If confirmed, this signal suggests that the stock market should trend higher. The recommended trade involves buying one February 21 SPY at-the-money call and selling one February 21 SPY call with a strike price 20 points higher. Hold this position until VIX closes above its 200-day moving average for two consecutive days.

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Additionally, American Battery Technology has shown a strong upward move driven by heavy trading volume and a new Department of Energy contract. Consider purchasing six January 17 ABAT 2.5 calls at a price of 0.80 or less, holding them initially without a stop.

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In summary, while the market remains in a wide trading range, the resilience of support levels, improving breadth, and favorable volatility trends indicate potential opportunities for bullish trades. Investors should remain vigilant, adapting strategies based on confirmed signals and market conditions.

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