By Chris Ebert

As with all technical indicators, the Option Indices are intended to be tools to help traders plan future trading in a manner that increases the probability of a profit. Last week, it was reported here that the Long Call/Married Put Index (LCMPI) was in danger of reaching a level that would indicate that the current bull market had ended. As of May 10, the Index had not reached that level, although it was very close. It is even closer this week.

The LCMPI measures the strength of a bull market. When long calls or married puts with terms of 112 days, 28 days, and 7 days all become unprofitable, it is a strong indication that a bull market has ended. The LCMPI has not been in negative territory since early December 2011, so a change in the Index would mark a significant change in the sentiment of the market. When emotions change, new price patterns often emerge.

As of May 10, the requirement for the LCMPI to turn negative was that the S&P 500 remained below 1349. Because the Index progresses with changes in market prices as well as volatility, the bar has been raised slightly this week; the SPX now needs to remain above 1369 in order to prevent a change in the LCMPI. Given the current trading level of 1340, that is a very real possibility.

 

When the LCMPI indicates that a bull market has lost its strength, traders should take note. In order to eliminate false signals, the Index requires that all three periods verify the same market conditions in order for a switch between bullish and non-bullish. Without a sudden, unforeseen rally by week’s end, the LCMPI will be tripped to non-bullish for the first time in about five months. Once it is tripped, it is not likely that it will return to a bullish indicator for several weeks, or possibly months. The requirement, that the Index changes only when all three measurement periods verify the same conditions, is meant to shield traders from noise. A switch between bullish and non-bullish is a relatively rare and significant event for the LCMPI.

When the LCMPI is tripped to non-bullish, the implications to option traders buying long calls or married puts may be obvious; such trades will probably have very low odds of returning profits. However, such a change should also cause “buy-the-dips” stock traders to reconsider how effective that method will be if the bull market is truly over. For those participating in long-term investments such as retirement plans, a non-bullish LCMPI provides an opportunity to evaluate whether their portfolios, even those that buy the dips through dollar-cost-averaging, are allocated too heavily in stocks in a market that is no longer in a strong uptrend.

The other option indices, the CCNPI and LSSI, are also indicating changes in the emotions of traders and those updates will be available here later in the week.

The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book “Show Me Your Options”.

Related Options Posts:

Option Index Update 05.10.12

Selloff May Trip Option Index

Option Index Update 05.04.12

11 Responses to “The Death Of The Bull Is Near”

  1. Albertarocks Says:

    Hi Jeff. Man, I haven’t chatted with you for a long time… back at the Seeking Alpha days.

    That is one hell of a good report you’ve just published. I have to admit that I was totally clueless about ithe LCMPI. I have no idea how it is calculated nor where one would find the data, etc. But with your permission I think I’ll add your chart (above) to my own blog… with credit to you of course and with links to your post here. I’m sure you wouldn’t mind that but until I get to know you a tad better it’s probably better that I wait to hear your reply rather than to draw your ire, lol.

    Great work here bud.

  2. Albertarocks Says:

    My mistake… and apologies to Chris Ebert.

    Sorry Chris I didn’t notice that you had written this piece. As you surely gathered by now, I have run across Jeff before and just assumed he had penned this piece.

    But my intentions are the same. I’ll await permission from ‘somebody’ at Zentrader and if I get it, I’ll publish your chart with full credit as well as a link to this page.

    All the best to both of you. Make that “all” of you, lol.

    Dan

  3. Rajesh Says:

    Jeff,
    This correction is very important for the next leg of the bull market which should propell Dow to life time highs.

  4. jeff pierce Says:

    AlbertaRocks – I’m sure Chris would want you to use this work to help provide education and awareness of these charts.

  5. Christopher Ebert Says:

    AlbertaRocks – Jeff is correct, I provide these charts in an effort to help other traders whenever possible. The more traders they reach, the greater the chances that some will find them helpful.

  6. Albertarocks Says:

    Ok thanks guys. I’ll get right on it. It will appear here shortly.
    http://albertarocks-ta-discussions.blogspot.ca/2012/05/spy-133-gap-beckons.html#disqus_thread
    Do HTML tags work on your site?

    I’m like that as well. If ever anybody wants to post my charts they have my blessings. And some do, like Chartrambler among others.
    http://chartramblings.blogspot.ca/

    But as always, we do each other a good service as well by providing proper accreditation and links. And of course you’re going to get proper credit for your chart.

    Thanks again guys. Before I go… Jeff, you’re a Canadian, right?

  7. jeff pierce Says:

    not sure about html…forgive my technical ineptitude.

    I’m from the states but have since been converted….lol

  8. Christopher Ebert Says:

    Rajesh – I agree that a correction was necessary in order for the Dow to reach all time highs. The market has come too far too fast to be sustainable at this pace, especially given the lackluster US recovery and the European jitters.

    From a purely technical option trading perspective, the bull market has ended. However, this is only one way of viewing the market, and is not intended to replace other forms of technical analysis but to complement them. Some traders will likely see this correction as wave 2 or 4 in an Elliott wave, or a pullback towards a 61.8 Fibonacci retracement. Others may be looking for support at a moving average as evidence that the recent correction is just part of a longer term uptrend.

    Should the market turn back around, the option indices will change to reflect changes in trader emotion. The only difference between the other forms of analysis and the option indices is that the options will see it as a brand new bull market as opposed to a continuation of the current one.

  9. Albertarocks Says:

    Ok, I’ll test it Jeff. If this link works then HTML tags work on your site.

  10. Albertarocks Says:

    Yay for you… HTML tags work on your site. In the comment above the word “works” is a link.

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