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Thursday, August 8, 2002  6:54 PM EST

As our indicators suggested was probable, the rally continued today, only this time it has brought us directly into resistance with an increasingly overbought sentiment situation and much less friendly institutional sponsorship.

In the S&P 500 options, the institutions continue to play this market perfectly.  Selling puts at the lows and taking in gigantic premium, then selling out after price, volatility and time all move in their favor.  After having caught the two best rallies of the year, they have now understandably scaled back their put selling activities and have returned to a much more moderate stance.  The put/call bid/ask bias ratio dropped significantly today to 0.67, which is the lowest ratio since the July 30th short-term high, although the reading on the 30th was a much more extreme and bearish 0.24.  This low reading means that the bias has shifted to buying puts and/or selling calls, which is a short-term negative for the S&P.  There was a marked increase in put purchases (no doubt buying back those they sold earlier in the week at much higher prices), but also a notable increase in call selling.  It was spread out fairly evenly across the strikes and expirations, although there was a slight emphasis on selling the August 950 calls and buying the September 875 puts.  Those are levels it may pay to watch over the coming days.  It's impossible to say what strategies are involved in these purchases and sales, but my experience watching these transactions over the years is that the more put selling (and/or call buying) there is, the more bullish it is for the market.  Conversely, the more put buying (and/or call selling), the more bearish it is.

While the CBOE total put/call ratio has been holding steady at a relatively neutral level, the OEX put/call ratio has been steadily rising.  Today's reading is the highest since July 8th, and the total p/c - OEX p/c spread is the highest since July 10th.  Neither is particularly bearish, but it does reflect a shift in sentiment that we haven't seen in over a month.  Namely, the small money equity options players are seeming rather content while the big money OEX options traders are becoming increasingly bearish.  There is considerable disagreement over calling OEX options traders "big money", but until their efficacy at calling market turns wears out, I will continue to view that put/call ratio in a non-contrarian way (unlike the equity or total put/call ratio).

The daily NYSE cumulative TICK indicator is essentially overbought, and the intraday indicator is extremely overbought, sitting now at the very top of its range.  I also keep a very short-term 5-minute cumulative TICK indicator, and have included a chart of it below.  This is a 20-period summation of the TICK readings taken every 5 minutes, and you can see that over the past three months, it has been this overbought only three other times in the past three months (represented by the red circles).  You can see what happened after the other readings:

With today's closing readings, the Composite model has now been downgraded from STRONG POSITIVE to POSITIVE, as it's giving the lowest reading since May 24th.  Historically, readings above 50 reflect a positive sentiment background.

Volume was quite heavy today, especially if we adjust for the seasonality bias I mentioned yesterday.  If we adjust today's NYSE volume so that it takes out the August low-volume bias (i.e. if this were an "average" month), then the volume today would be over 2 billion shares.  That's certainly a longer-term positive.

The short-term situation is the most precarious it's been in some time, although the recent double bottom (if you can call it that) and positive price and volume action may spur further buying and/or short covering.  Much more of a rally will have me looking more aggressively for very short-term short setups, which would be the first time in over a month I thought the short side would be the higher-odds direction.  In the intermediate-term, I still don't see anything that would suggest this rally does not have further to go.

Wednesday, August 7, 2002  8:28 PM EST

I mentioned yesterday that a gap up open would most likely embolden an avalanche of sellers, and an avalanche there was, as the markets sold off throughout the morning.  The afternoon reversal served as a nice entry for those looking for a continuation of the recent rally. 

The light volume has been a point of contention for many lately, so I thought I would check to see how much of this so-called "light" volume could be attributed to seasonality.  It turns out quite a bit.  The table below lists the monthly average deviation from the yearly average for NYSE volume from 1966-2001.  The third column represents the percentage of years volume was lower during the given month.  So, for example, October shows the highest average volume (nearly 9% above the yearly average) and it showed lower than average volume in only 27% of the years.

We can clearly see that August is the slowest month in terms of volume, as it shows the greatest negative deviation and also the highest probability of being lower, by a wide margin.  The drop-off in volume that we have seen recently should not at all be a surprise - although, in fact, we are actually seeing an increase in volume over the yearly average so far in August.  The biggest surprise should be the huge volume we saw during July, which was truly unprecedented.  You can see from the table above that July shows lower than average volume 60% of the time, by an average deviation of minus 4%.  This year, July showed an astounding 72% INCREASE over the yearly average.  This is the largest deviation in the past 40 years.  Considering the market action during that month, how can anyone argue that we didn't see a selling crescendo?

In the S&P 500 options, we once again saw an institutional bias towards selling puts and buying calls, with the put/call bid/ask bias ratio actually RISING today to a reading of 4.20.  This is unusual considering the market action.  Not only was the bias heavily skewed, it was also quite aggressive, with 37% of the September puts going off at or below bid and 28% of the September calls going off at or above ask.  Over 10% of the volume in the September 875 puts was a sale of over 800 puts at bid right at the close of trading.  This is similar to the action we saw on the 5th, right before the nice rally.  Notably, much of the activity occurred after the large intraday reversal today, which is suggestive of a continuation of the rally.  The most interesting trade in the options pit today was a purchase of 473 contracts of the September 860 calls at 2:22pm.  The purchase went off well above the ask price - someone wanted these contracts badly.  The exact low of the day in the futures occurred at 2:21pm.  I'm not much of a conspiracy theorist, but it sure seems like somebody had some good information.

The Investor's Intelligence survey shed a considerable amount of bullishness during the latest reporting period, with the bulls dropping 2.8% to 35.5% and the bears rising 3.6% to 39.8%.  This is the third week out of four where the ratio has been inverted.

We are in a similar situation today than we were yesterday, with our shortest-term sentiment measures not yet overbought and an upward institutional bias.  That suggests further upside is probable, at least in the short-term.  My intermediate-term outlook has not changed.

Tuesday, August 6, 2002  8:33 PM EST

Although today's rally was powerful, it was not enough to get us to overbought in most of our shortest-term indicators, especially with the late-day retracement.  Because of that and the fact that the institutions don't seem to be betting heavily against this rise, it seems as though there may be some continuation to today's action.

In the S&P 500 options, there continues to be an institutional bias towards selling puts and buying calls, as the p/c bid/ask bias ratio barely dropped from yesterday, and in fact it was more evenly spread across the August and September expirations.  That's a bit surprising given the severity of today's rise and the drop in volatility.  Volume was considerably lighter than yesterday, and there didn't seem to be any particularly aggressive action like yesterday's 44% of puts being traded at or below bid.  The bias is positive for a continuation of today's rally.

The advance/decline oscillator is entering dangerous territory, coming very close to overbought.  The one aspect working for us at this point is that beginning tomorrow, we will be dropping a string of five large positive readings in a row.  That will help to put something of a lid on this oscillator and will fight against it entering extreme territory.  Similar to September's low, however, an overbought reading here does not necessarily mean the market HAS to go down to relieve the pressure - more likely, it will just chop around.  The NYSE daily cumulative TICK indicator is also becoming dangerously close to overbought, which would mean it is overbought within a downtrend - not good unless we're beginning a new trend here.  The NYSE intraday cumulative TICK indicator is already overbought, for all intents and purposes, after making one of the largest one-day swings in its history.  This is where it gets tricky with these indicators, since on the 30-minute chart we have tentatively put in a higher low, which would transition us from a downtrend to an uptrend.  And as I regularly say, these cumulative TICK indicators are very good at pinpointing trend pullback entries (e.g. overbought within a clear downtrend or oversold within a clear uptrend), but not so good when they give overbought signals within an uptrend or oversold entries within a downtrend.  Although this indicator is suggesting caution is warranted, I am not giving it as much weight as usual until a clearer trend is established, either up or down.

I have a short blurb on the front page about two proprietary indicators I am in preparation to add to the site.  The Advancing Pressure Index is computed for the S&P 500 and the Nasdaq 100, and essentially determines the amount of volume flowing into up issues as opposed to down issues, taking into account how much those issues were up versus down.  The higher the index, the more the buying pressure and vice versa.  Today's API on the S&P 500 was 3.23.  For comparison, yesterday's reading was 0.37 and the reading on the 24th was 7.98.  On the NDX, today's API was an incredible 23.41, in comparison to yesterday's 0.82 and the 24th's 5.90.  When I am able to generate a meaningful historical database, I will add the indicators to the site.  The process of obtaining the data is incredibly manual, so it may take some time.  Related to this project is a Modified TRIN, which again takes into account how much individual issues were up or down instead of simply a plus or minus calculation as is done now.  For example, on the S&P 500 today, the TRIN was 1.19 (this is different than the NYSE TRIN posted to the site), which seems rather elevated considering how much we were up.  The Modified TRIN, however, is a much more reasonable 0.44.  I believe these new indicators will better help us gauge the intensity of each day's action.

The Consensus bullish percentage increased a bit to 32% for the week ended August 2nd, right on the cusp of historically bullish readings.

From a sentiment perspective, there is certainly room for a continuation of today's rally, although it wouldn't take much to flip a majority of our shortest-term indicators to overbought.  For the intermediate-term, our indicators are still suggestive of higher prices ahead.  As I write this, the futures are responding positively to Cisco's after-hours report, but a gap-up opening tomorrow would most likely invite an avalanche of sellers.  After a good day today, I'm inclined to ease the aggression I mentioned yesterday and see how the short-term battle unfolds.

Monday, August 5, 2002  8:34 PM EST

Despite the depressed expressions on the faces and in the words of most popular media, the recent action off last week's highs is normal and healthy if we indeed did see a significant low on the 24th.  Everything we've seen, from the extreme sentiment measures at the low to the explosive upside moves to the retracement back down on greatly reduced volume, is classic to major bottom formations.  It is indeed true that this time is different (of course it is!), but I continue to believe that letting history guide us through this period is the wisest course of action.

In the S&P 500 options, there was continued bias towards selling puts and buying calls today, particularly in the September series.  It looks like a large institution may have created a bull call spread by buying the September 840 calls and selling the 900 calls as a hedge (to lower their cost basis).  There was also active selling of the September 800, 850 and 860 puts with no obvious offsetting transactions.  In fact, 44% of all trades in the September puts went off at or below bid - that is extremely aggressive put selling (the most aggressive we've seen in the past two weeks).  This is not surprising given the elevated nature of the volatility indices.  31% of all trades in the September calls went off at or above ask, which is also the most aggressive institutional call buying we've seen in the past two weeks.  I suspect we will continue to see aggressive put selling in these options as long as the VIX remains so far above its norm.  In the August expiration, there was no particular bias apparent.

The VIX gained nearly 4 points today, and of course the usual "it's going to a higher trading range" arguments were being bandied about.  Weren't these the same people who told us in March that the VIX was going to a LOWER trading range (when it was trading below 20)?  The arguments are always persuasive, and I would be lying if I said if they don't make me think twice, but it seems every time an argument is made for a new, permanent trading range that it reverts back to its mean like it always has.  I'll stick with history and consider this indicator to be extremely bullish once it begins to make a meaningful reversal, which will likely happen intraday.

The STEM model is the latest to enter STRONG POSITIVE territory, with a stage change at the close this afternoon.  We now have three out of four models sitting in the most bullish position possible.

The lowrisk.com sentiment survey showed a return to excessive bearishness in the latest reporting period.  I have found that the lowrisk.com survey tends to coincide very closely with the other surveys, and since we get the lowrisk.com numbers first, it gives us a “sneak peak” at the major surveys that are released to the general public with a delay.  If the correlation holds up this week, we can expect the major surveys to also show an increased proportion of bears.

With the plurality of models in extremely bullish positions, I will continue to be on the lookout for upside reversals.  There were none that I could see today, especially since I was requiring more confirmation than usual (per the weekly commentary).  With the information we have tonight, I will begin looking for long trades much more aggressively, even though the S&P has more room to fall should it wish to test the recent lows.  I believe the greatest reward/risk trades at this point are awaiting on the long side of the ledger, in both the short- and intermediate-term.

- Jason Goepfert