Why Stocks Are Looking the Same as They Did Before the Bear Market of 2022

The S&P 500 Index (SPX) has hit a standstill recently, with internal indicators showing signs of weakening. Over the past several days, the SPX has encountered resistance at the 5,860 level on six different occasions, establishing this point as a significant resistance area. On the other hand, support is expected to come from the 5,670 to 5,770 range, which corresponds to the trading range observed between late September and early October. However, a close below 5,670 would be considered a substantial negative for the index, prompting the removal of a core bullish position.

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Although the SPX hasn’t quite reached the +4σ “modified Bollinger Band” (mBB), the McMillan Volatility Band (MVB) buy signal, issued in mid-August, remains in effect. This position has been rolled up several times, reducing downside risk. The official target for this signal is the +4σ band, and the position will be maintained until further indicators suggest otherwise.

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The equity-only put-call ratios have stayed in bullish territory despite the SPX’s recent stagnation. Interestingly, there hasn’t been an increase in put volume, which means these ratios remain on buy signals. However, both the standard and weighted ratios have entered overbought territory. The standard ratio has dropped to its lowest level since late 2021, just before the bear market of 2022 began. The weighted ratio is at new relative lows but hasn’t dipped below the lows of 2024. If these ratios start trending higher, they would generate fresh buy signals.

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Unfortunately, market breadth has taken a significant hit, causing both breadth oscillators to trigger sell signals. For confirmation, a two-day sell signal is required, and this confirmation was achieved at the close of trading on October 22. While the number of new highs on the NYSE continues to outpace new lows, the gap is narrowing. For instance, Wednesday saw 68 new highs versus 40 new lows. If new lows were to outnumber new highs for two consecutive days, the bullish signal that originated in mid-August would be invalidated.

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The Cboe Volatility Index (VIX) is showing mixed signals. On the one hand, there’s a “spike peak” buy signal that remains active unless the VIX closes above 23.14. On the other hand, a VIX sell signal is also in play, which would only be invalidated if the VIX closes below its 200-day moving average, currently positioned just below 15.50. As of Wednesday’s close, the VIX stood at 19.24, placing it roughly in the middle of these two important levels.

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In terms of volatility derivatives, the outlook remains mostly positive for stocks. The term structures of the Cboe volatility indices and VIX futures maintain an upward slope, albeit slightly elevated due to post-election volatility expectations. Options expiring after the U.S. elections on November 5 are particularly expensive, similar to how options tend to be priced ahead of a company's anticipated earnings report. This reflects traders’ expectations for heightened market volatility surrounding the election. Additionally, a seasonal bullish pattern could come into play during this period.

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In conclusion, the core bullish position is being maintained as long as the SPX continues to close above 5,670. However, if the index were to close below this level for two consecutive days, the position would be terminated. Regardless of the overall trend, new positions will be taken when signals are confirmed, and current positions will be rolled to capture profits and reduce risk. This approach allows for the management of deeply in-the-money positions.

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As mentioned earlier, a new breadth oscillator sell signal has emerged. To take advantage of this signal, the following strategy is recommended: Buy one SPY (November 15) at-the-money put option and sell one SPY (November 15) put option with a strike price 30 points lower. This position will remain active as long as the breadth oscillators are signaling a sell.

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A well-known seasonal pattern has been observed in October over the years. Typically, if the broader market experiences a selloff of at least 3.2% at any point during October, it often sets the stage for a strong buying opportunity toward the end of the month.

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So far this October, the SPX’s high has been 5,878. A 3.2% decline from this peak would bring the index down to 5,688. While it seemed unlikely that the SPX would fall that far a few days ago, Wednesday’s intraday loss of 89 points has made it more plausible that this trade could come into play later in the month.

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If the SPX falls to 5,688 or lower by the close of trading on Friday, October 25, the recommendation is to buy two SPY (November 8) at-the-money call options. If the calls become at least six points in-the-money, they should be rolled up to lock in profits. If not, they should be sold at the close of trading on Monday, November 4. It’s worth noting that these options are currently expensive due to the “election bump” in implied volatility, but since the plan is to exit the position before the election, they should still hold significant value.

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