After the S&P 500 Index reached new closing and intraday highs last week some major indexes began pulling back modestly on what appears, at least so far, as profit-taking in leading sectors and rotation into laggards. By the end of the week, several indicators began reflecting caution. The Market Review explains and then includes trade ideas followed by an interesting hedge idea using ProShares UltraShort S&P 500.

S&P 500 Index (SPX) 3663.46 slid 35.66 points or -.96% last week after making a key reversal and a new intraday high at 3712.39 on Wednesday. It seemed like the algos programmed to sell the top-performing sector when the SPX reached a new intraday high, resulting in the semiconductor sector declining 3.10%. Should the pullback continue look for support near 3550, and then at the 50-day Moving Average, now 3518.13.

iShares Russell 2000 ETF (IWM) 190.30 gained 2.10 points or +1.12% last week confirming rotation out of the leaders into the laggards and reclaiming the "decider" title, at least for now.

Invesco QQQ Trust (QQQ) 301.85 declined 3.67 points or -1.20% closing below the upward sloping trendline from the November 2 low. QQQ's weakness reflects selling in the leading semiconductor stocks included in the VanEck Vectors Semiconductor ETF (SMH) 212.51 down 6.88 points or -3.14% last week including -3.10% last Wednesday, as mentioned above.

CBOE Volatility Index® (VIX)23.31 gained 2.52 points or +12.12% last week. Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, added 2.84 points or +17.56% ending at 19.01%.

While hard to see, the orange IV Index Mean crosses above the blue 30-day HV line and closes just under 20%. Looks like regression to the mean.

VIX Futures Premium 

This next chart shows as our calculation of Larry McMillan’s day-weighted average between the first and second-month futures contracts as of last Friday.

With just two trading days until December expiration, the day-weighted premium between December and January allocated 10% to December and 90% to January for a premium of 9.11%. However, on Fridays before expiration the volume-weighted version at 6.05% better reflects the relationship since the excess December premium will quickly dissolve on Monday and Tuesday. Call this indicator cautious.

Since most of the volume and open interest are in the two closest futures contracts measuring the day-weighted premium relative to the standard 30-day VIX provides a good real-time sentiment indicator based upon actual commitments of large Asset Managers and Leveraged Funds. 

VIX10- Day Correlation Indicator

Last Wednesday the reliable VIX 10-day correlation indicator turned positive as noted in these tweets. Friday it closed -.06 as the VIX advanced and the SPX declined.

(Click on image to enlarge)

Reasons for Caution 

Although modest, the pullback by the S&P 500 Index may not reveal some other concerns.

Equity Only Put/Call Ratio

From a contrarian perspective, this weekly average reading at .41 could be "way to bullish" when compared to the mean since January 4, 2019, of .59. 

VIX Futures Volume and Open Interest 

As of last Friday, this chart shows the one-day volume and open interest back above 300 thousand contracts, the highest since August 21, 2020, when SPX made a run-up to top out on September 2. The chart shows volume increasing, perhaps due to increasing hedging activity before the Senate election on January 5.

Cboe Total Put Volume 

Friday's total put volume at 3.02 million contracts was the highest since September 4 at 3.52 million reflecting increasing hedging or short speculation activity.

Trade Ideas to Consider

In the “Rankers and Scanner” section about half-way down our home page, on the right side, we feature a ranker sample showing the Top and bottom 5 stocks in four categories.

For ideas, we often look at the top 5 stocks based on the Implied Volatility Index Mean vs. the 30-day Historical Volatility (IV Index Mean vs. 30D HV) and the top 5 stocks with the greatest IV change from yesterday. Look at Friday's interesting picks including some SPACs with real high-implied volatility.

Downside Hedge  

ProShares UltraShort S&P 500 (SDS) 13.05 up .24 points or +1.87% after making a possible pivot last Wednesday.

With a current Historical Volatility of 29.99 and 24.66 using the Parkinson's range method, the Implied Volatility Index Mean is 41.39 at .14 of the 52-week range. The implied volatility/historical volatility ratio using the range method is 1.68 so option prices moderately expensive relative to the recent movement of the ETF. Friday’s option volume was only 11,846 contracts with the 5-day average of 9,070, and with reasonable bid/ask spreads.

Consider this long call spread idea.

Using the ask for the buy and the mid for the sale the debit on Friday was .28 and just 9% of the distance between the strikes since the implied volatility of the speculative low-priced 17 calls at 63.52 greatly exceed the near-the-money 14 calls at 45.95. Use close back below 13.00 as the SU (stop/unwind). 

Setting the Stage

As anticipated the US Dollar Index (DXY) attempted to hold the 90.50 level last week as mentioned in Digest Issue 49 " The Marco Bus Returns [Charts]" while the energy sector continued slightly higher as measured the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) 62.48 up 1.48 points or 2.43% last week, reflecting continuing rotation activity.

Market Breadth as measured by our preferred gauge, the NYSE ratio adjusted Summation Index that considers the number of issues traded, and reported by McClellan Financial Publications, slowly advanced another 125.09 points or +13.26% last week ending at 1068.10 as upward momentum slowed. Should SPX continue pulling back, breadth would likely begin turning lower.

Strategy

In bull markets, the strategy is to stay long equities and/or ETFs and then tactically hedge pullbacks as they begin developing.

As mentioned above, the S&P 500 Index made a key reversal, defined as a new intraday high with a lower close. Although volume was moderate, it fulfilled the objective of a lower low the next day.

However, the relative strength of IWM (see above) along with iShares iBoxx $ High Yield Corporate Bond ETF (HYG) 86.68 down .17 or -.20% last week, along with seasonal strength, suggests only a modest pullback reflecting sector rotation and not a broad market decline.

Summary

Last week the S&P 500 Index made new closing and intraday highs along with a key reversal due to rotation out of leading sectors into laggards, once again. While four futures and option indicators suggested caution, others such as oil & gas, small-capitalization stocks, market breadth, and corporate high yield bonds advanced or held up well diminishing the likelihood the pullback will continue especially during a period of seasonal strength.