$VIX Ratio Low

This video shows how each successive low in the VIX:VXV ratio coincides with an important top shortly thereafter.  The VIX measures 1-month  implied volatility on S&P options, while VXV measures 3-month implied volatility.  Today, the ratio spiked down to 0.79, a 3-year low.  What this means is that the options market participants are complacent about short term implied volatility.  Usually, complacency is a good recipe for a surprise. 

$$ Tweaking T13 - The November 12, 2010 Target End Date

$$ Cycle Turn Dates

Current projection:

Cycle low on or about October 18.  EDIT 10/7 - Now October 20.

We have gaps to fill on the S&P cash at 1109.55 and 1090.10 which roughly correspond with 38% and 62% Fib retracements of the latest move.  These are the price targets on which I am focusing.

We'll see what we get after mid-October, but the longer range forecast shows ~November 12, 2010 as the end of a 3.5 year bear-bull cycle that includes the bull run from March 2009 to the present. 

In other words, after mid-November, we should start another long term bear-bull cycle, the first ~18-36 months of which should be a bear market in stocks.  For more information, see Terry Laundry's free website called T Theory Observations.

Too early to tell yet, but between mid-October and mid-November 2010 we could conceivably see one final push higher on the S&P, perhaps back to the 1150-1220 range. 

Thought Provoking

"If ye love wealth better than liberty, the tranquility of servitude better than the animating contest of freedom, go home from us in peace. We ask not your counsels or arms. Crouch down and lick the hands which feed you. May your chains set lightly upon you, and may posterity forget that ye were our countrymen."

-- Samuel Adams, speech at the Philadelphia State House, August 1, 1776

We could use a Samuel Adams about now.

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"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves money from the public treasure. From that moment on the majority always votes for the candidates promising the most money from the public treasury, with the result that a democracy always collapses over loose fiscal policy followed by a dictatorship. The average age of the world's great civilizations has been two hundred years. These nations have progressed through the following sequence: from bondage to spiritual faith, from spiritual faith to great courage, from courage to liberty, from liberty to abundance, from abundance to selfishness, from selfishness to complacency from complacency to apathy, from apathy to dependency, from dependency back to bondage."

-- Alexander Tyler, writing about the fall of the Athenian Republic.

I'd say the majority of our countrymen are between selfishness and dependency, as we slowly roll-over into bondage.

$$ Dollar Head & Shoulders

We are at the neckline.  If the pattern is valid and we break below the neckline, the target is 71.  I shouldn't have to mention what a fall from 80 to 71 would mean for gold and silver.

$$ S&P Fib 61.8% Retracement Level 1140-1143

$$ Video on VIX Sell Warning

And how it correlates with the AAII sentiment survey.  Here's the link to the video if you can't get it to play right. 

$$ New Video on How to Interpret S&P% Above 50MA Chart

If you are having trouble, click on the link at the top of the video to watch it on YouTube:

$$ Excellent Article Summarizing the Problems of Japan

Entitled "When Japan Collapses," it's worth your time. 

$$ AAII Sentiment: Wildly Bullish

Bullish sentiment hit 51% this week in the AAII survey. It is the highest bullish sentiment of the year, topping the January 14 (47%) and April 15 (48%) readings.  

What happened earlier this year after bullish sentiment made a yearly high?  The S&P topped on January 19, falling 100 points in the next 13 trading days.  And the S&P topped on April 26, plunging 155 points over the next 7 sessions.

The spread between bullish and bearish sentiment is 27%, the highest reading since May 8, 2008.  What happened after May 8, 2008?  The S&P topped on May 19 at 1440 before losing 240 points in the next 38 trading days.  

Be careful out there.  

$$ Cycle Turn Dates

Using my Advance-Decline oscillator, here are my current projected cycle turn dates for the S&P:

Top

September 22 (based on the accumulation pattern at the July 2 low)

September 29-October 1 (based on the accumulation pattern in late August)

I expect the top to form in this late September range.  I'm watching to see if a distribution pattern develops.  

Bottom

October 11-18 (based on the distribution pattern in early August)

These turn dates are subject to change as information develops.  For more on my Advance-Decline oscillator, see the September 9, 2010 blog entry below.

$$ A Unique Momentum Oscillator

The Advance Decline line has been around forever, as has the CBOE Put-Call ratio.  I divide the AD line by the Put-Call ratio to get a momentum oscillator that provides excellent bullish and bearish divergence signals (for when trends are about the change) as well as positive and negative reversal signals (for when trends are about to continue).

As an example of the latter, compare how the higher momentum peak in the mid-June rally vs. the mid-May rally was unable to produce a higher high in price in June, thus signifying the downtrend was strong and about to continue.

Edit - Terry Laundry published my Advance-Decline momentum oscillator in his September 15, 2010 post at the T Theory Foundation site.  He had some nice things to say about my oscillator in his audio comments as well. 

$$ Kyle Bass Tells It Like It Is - Part Two

Bass' Best Investment Ideas - CNBC.com

$$ Kyle Bass Tells It Like It Is - Part One

Ahead of the Money - CNBC.com

$$ Yesterday's News: China Sells. Today's News: Fed Buys.

Interesting headlines coming one day apart:

China Reduces Long-Term Treasuries by Record Amount

Fed Buys $2.551B Treasuries

$$ ARMS warning

I closed out of my shorts today based on the 5-day ARMS showing a deeply oversold condition combined with today's price action and a short term head & shoulders topping pattern on the VIX. 

Note the recent rallies after previous similar oversold ARMS warnings.  If we get a rally, I'll put my short back on because I am generally bearish on the market through October. 

$$ QE 2.0?

The FOMC meets on Tuesday.  Speculation persists that the Fed will announce a new round of quantitative easing at the meeting.  Ambrose Evans-Pritchard examines the topic in today's London Telegraph.  He concludes:

"Alabama Senator Richard Shelby has blocked the appointment of MIT professor Peter Diamond to the Fed Board, ostensibly because he is a labour expert rather than a monetary economist but in reality because he is a dove in the ever-more bitter and polarised dispute over QE.

The Senate has delayed confirmation of all three appointees for the board, who all happen to be doves and allies of Fed chairman Ben Bernanke. The Fed is in limbo until mid-September. So the regional [Fed chief] hawks who so much misjudged matters in 2008 [when the Fed only managed one 25 basis point Fed funds rate cut as America burned between March 19 and October 7, 2008] have unusual voting weight, and now they have a commodity spike as well to rationalise their Calvinist preferences.

Whatever Dr. Bernanke wants to do this week - and I suspect he is eyeing the $5 trillion button lovingly - he cannot risk dissent from three Fed chiefs: one yes, two maybe, but not three. He faces a populist revolt from the Tea Party movement, with its adherents in Congress and the commentariat. And China simply hates QE, which may or may not be rational but cannot be ignored.

Global markets have already priced in the next QE bail-out, banking the "Bernanke Put" as if it were a done deal. We will find out on Tuesday if life is really that simple."

$$ Hindenburg Omen

The Hindenburg Omen is traditionally defined when, on a given day, the number of NYSE new 52 week highs and new 52 week lows must both exceed 2.2 percent of total NYSE issues traded that day.  The Omen is a bearish sign.  Robert McHugh has studied the Omen in depth, and finds several other conditions helpful in predicting a downturn in the stock market:

1)  The NYSE 10-week moving average is rising the week of the Omen,

2)  The McClellan Oscillator is negative on that same day, and

3)  The number of new 52 week highs cannot exceed twice the number of new 52 week lows that day.

Omens often come in clusters.  The first time an Omen occurs, it's called an unconfirmed Omen. If a second Omen occurs within 36 days of the first Omen, the Omen is "Confirmed." 

McHugh's study has shown that Confirmed Omens have preceded all stock market crashes and panics over the last 25 years.  In addition, 75% of the time the market falls at least 5% after a Confirmed Omen.  These downturns have commenced within 1 day to 4 months after the confirmation of the Omen. 

From the up trend that started in March of 2009, we received our first Hindenburg Omen on Tuesday, July 6, 2010.  We'll be on the lookout for confirmation.  Today came close, but no cigar.  

$$ Option Strategies to Take Advantage of Price & Volatility Movements

Option prices are primarily determined by:

1.  Whether and how much the option is in the money (i.e. intrinsic value), and

2.  The time value of the option.

Time value is a function of several things.  One of the main drivers is volatility.  The greater the volatility, the higher the time value component of the option price, all other things being equal.   Volatility generally rises when prices drop, and falls when prices rise. 

During up trends, you might think that buying call options on price dips makes sense.  However, this strategy has a couple of problems:

1.  After a price dip, volatility will be relatively high.  So, you are paying a huge premium for the time value of the option.

2.  If you are right and the price of the underlying moves upward, your reward is sabotaged by falling volatility, i.e. falling time value of the option.  

Accordingly, I prefer to sell puts on dips in up trends.  This is a "premium collection" strategy.  My gain is limited to the amount of premium I collect. 

By selling puts when volatility is high, my premium is increased (because the time value component of the option price is increased).  If the up trend resumes as I expect and price moves upward (and volatility falls), then:

1.  The puts I sold become further out of the money, and

2.  The time value component of the puts I sold falls. 

Both of these things are good for me.  I want the puts I sold to expire worthless to the put buyer. 

IMO, selling puts on dips in uptrends is a far superior strategy to buying calls on dips in uptrends because with selling puts, I benefit from both price and volatility movement.  I prefer selling puts that are slightly out of the money with an expiration date 2-3 months out.  During a multi-year up trend, I hope to have ~3 opportunities to sell puts per year.   

In downtrends, on the other hand, buying puts on rallies takes advantage of both price and volatility movement.  After a rally, volatility will be relatively low.  Should prices resume their decline, volatility will rise.  All option buyers benefit from rising volatility.  And puts benefit from falling prices. 

IMO the best way to capture the benefits of falling prices and rising volatility is to purchase longer term (6 months to a year) out of the money puts.  You want some time left on your puts after the expected price decline occurs.  This way, you maximize the benefit of the volatility increase. 

Options are a complicated subject.  The foregoing is an oversimplified treatment, but the concepts are sound.

$SPY Market Breadth - Percent Above 50 DMA, 150 DMA

Let's take a look at a couple of charts showing the percent of S&P stocks above their 50 day moving averages, and 150 day moving averages.  First the 50 day chart:

You'll notice that we rarely drop much below the 20-25% range unless we are starting a new downtrend.  The May-June drop well below 20% is ominous in this regard.  It is my belief that we have begun a new downtrend.

In addition, you'll note that during downtrends, rallies don't make it past the 75-80% resistance zone.  Currently, we are sitting at 73%.  Based on this reading of the chart, we are very near a top.

Here's the 150 day chart:

Similarly, you'll note that breaks below the 35-40% range usually signify downtrends, while breaks above 60-65% are characteristic of up trends.   Up trends tend to find support at the 60-65% and 35-40% range, while downtrends find resistance at the 60-65% range.

Recently, we broke well below 35%  on the 150 day, and currently we are at 57%, both of which confirm the interpretation of the 50 day chart that we are near a top in a new downtrend.

If we manage to break through the resistance zones for downtrends (75-80% on the 50 day, 60-65% on the 150 day), the "new downtrend" will be placed in serious doubt.