How you can use the stock market’s ‘January Defect’ to your advantage

The S&P 500 chart remains in a downtrend, but its breakout over 3940 could augur for another test of resistance at 4100 — the December 2022 highs. The downtrend line that defines this bear market is below that level now. Also, the important down-trending 200-day moving average of SPX is, too, as both are at roughly 4000. All of these could provide resistance, so a breakout above 4100 would be extremely bullish — at least for a while.

Equity-only put-call ratios have recently peaked and fallen back, so they are now on buy signals. That is a strong development as well. The total ratio is also trying to form a buy signal at this time.

Breadth has been fairly strong, and both breadth oscillators are on buy signals. They are also in overbought territory, but that can be a good thing when SPX is first starting a new leg upwards (which it appears to be doing). 

For one day, new 52-week highs on the NYSE rose above 100, but they have since fallen back over the past two days. Thus, this “New Highs vs. New Lows” indicator is still not on a buy signal. VIX would have to rise above 25.50 to exceed its 200-day moving average, which would stop out these buy signals.

The indicators surrounding VIX, though, are bullish. The “spike peak” buy signal remains in place as does the trend of the VIX buy signal. Moreover, the construct of volatility derivatives is bullish as well, since the term structures are sloping upwards. 

There is a negative seasonal factor about to occur (see Market Insight), and it persists through Jan. 27. The more positive news is that a bullish seasonal pattern begins that day (the 27^th), and it has historically been a strong one — riding what is often institutional buying near the end of January and the beginning of February.

Since the downtrend is still in place on the SPX chart, we are maintaining a “core” bearish position, but will trade other indicators around that as they occur.

Market insight:  ‘January Defect’

Several seasonal trades occur in January, and the next is the “January Defect.”  Simply stated, one sells the NASDAQ 100 Index at the close of the eighth  trading day of January and covers at the close 10 trading days later. The optimal entry point for this trade, however, has varied within that 10-day range quite a bit. 

Last year, this trade was very successful, and the best entry point was, indeed, the 8^th trading day of January. Over the past 28 years, though, the best entry point has averaged out to be the 12^th trading day. 

We are going to take an “average in” approach and buy one QQQ put on each of three different trading days, eventually ending up with a position of long three QQQ puts. 

On each of January 12th, January 17th, and January 19th,

(the 8th, 10th, and 12th trading days of January),

Buy 1 QQQ Feb (3rd) at-the-money put.

Your total position will be three long QQQ puts, which might each have a different striking price. With regard to taking partial profits, sell the first put that becomes 20 points in-the-money. Sell all the remaining puts at the close of trading on the 18^th trading day of January — Friday, Jan. 27.

New recommendation: Oak Street Health (OSH)

Option volume in Oak Street Health rose sharply riding the momentum of rumors that CVS Health was in advanced talks to acquire OSH. Stock volume patterns are positive and improving. There is tentative support at 28. The rumors are that CVS could pay as much as $41 for the stock. Another positive factor is that the options are getting expensive — usually a sign that the rumors have some validity. Of course, CVS just recently backed out of another set of talks (with Cano Health ), which gives CVS a tainted reputation in these takeover situations. Even so, a position seems to be a reasonable speculation.

Buy 2 OSH Feb (17th) 30 calls at a price of 3.20 or less.

New Recommendation: Potential upside breakout

The CPI report did not knock the market down below 3940, so we want to add a long SPY bull spread to our positions:

IF SPX closes above 3940 on any day from January 12^th forward,

Then Buy 1 SPY Feb (24^th) at-the-money call

And Sell 1 SPY Feb (24^th) call with a striking price 15 points higher.

If this position is established, then stop out if SPX subsequently closes below 3890.

Follow-up actions

All stops are mental closing stops unless otherwise noted.

We are using a “standard” rolling procedure for our SPY spreads: in any vertical bull or bear spread, if the underlying hits the short strike, then roll the entire spread. That would be roll-up in the case of a call bull spread, or roll-down in the case of a bear put spread. Stay in the same expiration, and keep the distance between the strikes the same unless otherwise instructed. 

Long 2 SPY Jan (20^th) 375 puts and Short 2 Jan (20^th) 355 puts: this is our “core” bearish position. |As long as SPX remains in a downtrend, we want to maintain a position here. 

Long 1 SPY Jan (20^th) 402 call and Short 1 SPY Jan (20^th) 417 calls: this spread was bought at the close on December 13^th, when the latest VIX “spike peak” buy signal was generated. Stop yourself out if VIX subsequently closes above 25.84. Otherwise, we will hold for 22 trading days.

Long 0 SPY Jan (20^th) 389 put and Short 0 SPY Jan (20^th) 364 put:  this was an addition to our “core” bearish position, and it was stopped out when SPX closed above 3940. 

Long 2 PCAR Feb (17^th) 97.20 puts: these puts were bought on Dec. 20, when they finally traded at our buy limit. We will continue to hold these puts as long as the weighted put-call ratio is on a sell signal.

Long 1 CVX Feb (17^th) 180 call: we will hold this position as long as the put-call ratio of CVX remains on a buy signal.

Also, we had a conditional recommendation to buy Moderna puts if the stock closed below 174. It did not, and we are canceling that recommendation now.

Send questions to: lmcmillan@optionstrategist.com.

Lawrence G. McMillan is president of McMillan Analysis, a registered investment and commodity trading advisor. McMillan may hold positions in securities recommended in this report, both personally and in client accounts. He is an experienced trader and money manager and is the author of the best-selling book, Options as a Strategic Investment. www.optionstrategist.com

Disclaimer: ©McMillan Analysis Corporation is registered with the SEC as an investment advisor and with the CFTC as a commodity trading advisor. The information in this newsletter has been carefully compiled from sources believed to be reliable, but accuracy and completeness are not guaranteed. The officers or directors of McMillan Analysis Corporation, or accounts managed by such persons may have positions in the securities recommended in the advisory.