Well, I Believe That Is Resistance

 | Jan 26, 2012 | 3:00 PM EST  | Comments
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DIA

Did you notice what happened this morning amidst all the hoopla about the Dow's highest finish since May 2008 and the S&P 500 heading for its 11th positive close of the past 13 sessions? I'll tell you what happened: the July 27 gap and island reversal. As I noted in last Friday's column, that level was expected to stall prices -- and stall prices it did.

The S&P made a new multi-month high of 1333.47, about 1.5 points above its July 27 gap at 1331.94. It has now pulled back to fill the opening gap at 1326.06, and then some. So far, it's declined about 13 points from the early highs to 1320.55, or about 1%. (The chart below only shows the pullback to 1322.35, though since the chart was generated at about 12 p.m. EST, and the market has since sold off some more.)

S&P 500 -- Daily
Pullback after July 27 Gap; Source: optionsXpress

The E-Mini futures -- which also filled its July 27 gap at the 1326.25 level and aborted its island -- has now pulled back 13.5 points from the highs to 1316.25. That's no collapse, certainly. But, as expected, this level has stalled prices, just as it should have done. (Here, as well, the chart only shows a pullback to the lows of 1318 as of about 12 p.m., and since then the futures have traded a bit lower, to 1316.25). 

E-Mini S&P 500 -- Daily
Gap-fill, island abort; Source: R.J. O'Brien Futures

Another reason for the little pullback from the highs, and another reason to look for some stalling in the vicinity of that gap, is the increasingly overbought condition. On Wednesday, the McClellan Oscillator hit its most overbought reading of the past few months, reaching a higher high of plus 174.40 at the close.

Then, on the sentiment front, we're seeing the usual froth at highs occurring at precisely the time when traders should be thinking "pullback." Of course, when it's on the highs they just think, "higher." An indication of this froth, and yet another reason for Thursday's pullback from the high, is the CBOE Volatility Index (VIX). The indicator scored new multi-month lows this morning at 16.80.

VIX -- Daily
New multi-month lows; Source: optionsXpress

As for my trading this morning, I did correctly recommend to my futures subscribers that we wanted to get short at 1327.75 in the SPDR S&P 500 (SPY) futures, as the gap in the cash index was getting filled. However, I missed my price in a bunch of options trades in which I was trying to sell call premium in the out-of-the-money February $134 and $135 calls. Then, despite my best intentions to take profits in some remaining S&P positions at Rydex (mutual funds), the market had already pulled back to unchanged by the time of the morning pricing at 10:45 a.m., so I did nothing there.

I am still in overall bullish positions, but not with a great deal of exposure, and looking to establish some additional bearish credit spreads in the out-of-the-money SPY calls to offset some bullish bets. A move above the morning highs will point higher. But, until then, the vicinity of the July 27 gaps marks important resistance and must be respected as such. As such, I will continue to view it as the ideal level to sell into. 

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