Not Too Many Extremes After A Volatile Week

08/11/08 9:20 AM EST

Good Monday morning...We begin the new week with a flat open indicated in the pre-market futures after a quiet weekend.  Commodities are mixed with mostly small moves from Friday's closes, foreign markets are mostly positive and we don't have much on the economic calendar until later this week.

After the topsy-turvy events of last week, let's take a look at the handful of reliable short-term guides we've discussed in the past:

Technically, we're finally seeing a clear series of higher highs and higher lows in the S&P 500 and most other major indices.  That's the kind of positive reaction we've been looking for since July 15th, so no complaints here - at least it's a start.  But as far as I view things, the larger trend won't even turn neutral (from down) until the S&P makes it up to 1450ish, so the recent pattern could be considered nothing more than a "bear flag" in an ongoing bear market, and a move back under 1250 would move that scenario to the forefront.

There are a couple of notable extremes in the indicators.  The Percentage of Stocks Above Their 10-Day Moving Average has moved to 81%, the highest level since mid-April.  That's enough to consider it overbought, after which stocks tend to struggle to maintain further gains, but I wouldn't become overly concerned with this indicator unless/until it hits 90%+.  Those are better indications of an imminent pullback from a market that has moved too far, too fast.

The other notable measure is the Equity-Only Put/Call Ratio, which once again showed an excessive amount of call option activity relative to put options on Friday.  We saw a similar (though slightly more extreme) reading on Tuesday, right before the market suffered a large setback.  I don't put too much emphasis on one-day readings, but we're starting to see the moving averages creep towards their upper trading bands.  On a short-term trading basis, I watch the 5-day moving average and the De-Trended Ratio very closely, and we're not at extremes with either one yet, but another few days of readings like we saw this past week will probably push us there.

When we drill down the activity to look at the smallest of options traders (trading 10 contracts or less at a time), surprisingly there wasn't much of a difference from the prior week, with traders actually stepping down their speculative call buying a bit, using 34% of total volume as opposed to 35% the prior week.  Their buying of protective put options stayed the same at 22% of total volume, so I can find no evidence of speculation among this troupe of traders.

The expiration of equity and index options is this week.  Expiration weeks normally have a slightly positive bias, but checking the history of the S&P 500 tracking fund, SPY, when it was up 2% or more the week prior to expiration shows that expiration week was positive only 41% of the time (10 out of 24 instances).  The average return was -0.2%, with an average maximum risk (-2.0%) that slightly outbalanced the average maximum gain (+1.6%).  I don't place much weight at all on expiration-related statistics like this, except for the ones immediately surrounding Friday/Monday in some extreme cases (such as large one-day moves or gap openings), but I've been asked more than a few times about it so I thought I'd share.

Last week the S&P was able to break out over the 1285-1290 area that had given it some difficulty in the prior couple of weeks, and the Nasdaq 100 enjoyed a picture-perfect bounce off of that 1880 area we had our eye on.  I can't find much at all to pick on about the rally - we have some minor overbought indications, but nothing yet that would have me wanting to bet against the rally given the breakouts on Friday.  Things still look at least moderately positive in the intermediate-term (one to three month), and I'm sticking with the idea that we should continue working higher in that time frame.