Searching for Mr. Top

04/09/2013 7:00 am EST

Focus: MARKETS

Lawrence McMillan

Founder and President, McMillan Analysis Corporation

The market is looking a bit overbought, but there's no sign of reversal just yet, says Larry McMillan of The Option Strategist.

Our indicators remain bullish, but somewhat overbought, as the S&P 500 ($SPX) has apparently broken out to the upside once again.

Thankfully, $SPX has finally closed at a new high, exceeding the market high from October 2007. In the last few weeks, $SPX has been confined to a narrow range between 1,540 and 1,565.

As of this writing, it closed near 1,569, so that is apparently an upside breakout. However, it still hasn't taken out the all-time intraday high near 1,575, but that should occur soon.

Once that happens, there is no resistance per se, since prices have never traded that high. However, traders are often wont to sell at round numbers, so 1,600 on $SPX may represent a resistance level.

Equity-only put-call ratios have been of dubious value of late, due to the heavy amount of put buying that traders were establishing as hedges. Normally, call buying would be dominant as a market reaches all-time highs, but the cheap availability of $SPX puts as a hedge has caused large institutions to buy a lot of them.

It appears that this period of hedging and distortion may be coming to an end, for recently the put-call ratios have started to plummet again. They are trending sharply lower, and that is bullish for stocks. Hence these ratios are on buy signals. They will only turn bearish if they roll over and begin to rise.

Market breadth has managed to remain on buy signals, but just barely. That is, breadth has slacked off in the past couple of weeks. Perhaps that was just a result of the market being in a tight trading range.

But breadth oscillators are not that far from a sell signal. One strong down day or two modestly down days would probably be enough to generate sell signals.

Volatility indices have remained at very low levels, and are thus bullish. The spike peak buy signal that was generated back on March 19 has proven to be effective.

As long as $VIX stays below 14, the bulls have an "all clear" signal. Even on probes above 14, VIX would only become bearish if it were to develop a true uptrend.

The construct of $VIX futures continues to remain bullish, as it has for a long, long time. The term structure hasn't had an inverted shape since November 2011.

$VIX futures are trading with premiums-more modest premiums than they had for most of 2012, but still a premium. The front-month April futures are settled at a premium of 1.49, and the longest-term December (2013) futures settled with a premium of 6.75. Thus, the term structure continues to slope upward. That, coupled with the futures' premium levels, presents a generally bullish picture for stocks.

The average stock's Composite Implied Volatility, or CIV, is in the 8th percentile, and that is overbought. But it won't generate a sell signal until it rises above the 17th percentile.

Also, the frequency of "90% days" has dropped to zero. That is, there hasn't been a single "90% day"-either either up or down-in the last 50 trading days (not since January 2). That, too, is overbought.

Finally, $SPX is currently 13.9 standard deviations above its 200-day moving average. That is an extreme amount, and is commensurate with readings that have marked intermediate-term tops in the past.

In summary, the indicators remain bullish, but somewhat overbought. This market probably needs fewer doubters before it can really top. That may take a while.

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