Market Internals: Stocks resumed their winning ways this week. After falling during three consecutive trading sessions Thursday through Monday, the Dow Jones Industrial Average ($INDU) was able to post four consecutive gains. With the help from a 102-point rally on Tuesday and an 87-point gain on Wednesday, the Dow returned to new highs and added 187 points, or 1.5% on the week.

Market internals on the New York Stock Exchange [NYSE] were mostly positive. For example, advancing issues beat declining issues during three of five occasions. The high volume day was on Wednesday, when the Dow added 87 points and up volume trounced down volume by a margin of more than three-to-one. In fact, the only real concern for the bulls might be the lagging New High New Low Index [NHNL]. It finished the week reading +221 (with 237 stocks rising to new 52-week highs and 16 new lows), which is significantly below Wednesday's high of +397. Yet, although the NHNL is lagging, the rest of the action was mostly bullish this week and, with the major averages now moving to new highs, there is nothing in the technicals that is warning of an imminent trend change.

Sentiment Indicators: The market's midweek rebound certainly seems to have allayed much of the fear and anxiety that surfaced late last week. For instance, on Tuesday, the CBOE Volatility Index ($VIX) tumbled 1.27 points or almost 11%. It fell to a multi-month low of 9.7 in midday trading Wednesday, before jumping back up to recapture the 10% level. Meanwhile, the NASDAQ Volatility Index ($VXN) fell during four consecutive trading sessions and, at only 14.83, to its lowest levels since mid-December. The decline in the market's "fear gauges" indicates that risk perceptions are easing and that investors don't expect much volatility in the future.   

Meanwhile, other indicators confirm that bullish sentiment remains quite high. Although Friday's numbers are not yet in, trading during the options market was uneventful during the latest options expiration. In fact, on Thursday, less than 10 million contracts traded on the six US options exchanges. That, in turn, compares to 11.8 million on the Thursday before January options expiration and 13.13 million last Friday.

In fact, last Friday was somewhat unusual for a non-options expiration day. More than 8.5 million call options traded hands, compared to 4.60 million put options. It was the fifth busiest day of call activity in the US options market history. The put-to-call ratio subsequently fell to .54 and its second lowest value of the year. The heavy call volume indicates the many options players are leaning heavily on the bullish side of the trade recently.

In addition, the bullish sentiment is not limited to the US options market. According to a recent Merrill Lynch survey of fund managers, bullishness towards global equities is at ten-month highs. To be specific, 57 percent of fund managers questioned by the firm in February said they were "overweight'' stocks, which is up 47 percent in January and the highest since April's 58 percent.

So, while the technical action of the market remains strong and the major averages continue pushing to new highs, the action in the options market suggests that many investors have already positioned themselves for another move higher. On the one hand, the call side of the options chains has been seeing an increasing amount of activity (relative to puts). At the same time, the low readings from the volatility indexes seem to reflect a sense of complacency that has infected the market since stocks started moving higher in June. While the trend can certainly continue on for quite some time, strategists should also be aware that a lot of investors are already on the bull bandwagon. That, in turn, poses a risk to bullish trades should the recent period of quiet trading set the table for rough sailing in the future—and an increase in market volatility motivates many members of the crowd to relocate from the bull to the bear camp.  

Frederic Ruffy
Senior Writer & Index Strategist
Optionetics.com ~ Your Options Education Site
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