Volatility has certainly returned to this market. There have been two very large down days, and several volatile up days. Back-and-forth movements of this sort are exactly what inflates statistical volatility. It's not only prices that have been volatile; sentiment has been volatile as well. Huge moves are being made, based on minor bits of news (a minor tightening of Chinese market regulations set off the decline, and yesterday's vague Fed report -- analysts are still arguing about its meaning -- set off intense buying). One school of thought holds that increased volatility is bearish, but it really isn't. Volatility increased for most of 1995 through 1999 and the market rallied strongly for most of that time.



Yesterday's strong rally saw $SPX break out over resistance at 1410. In our opinion, this was a major development and confirms that the outlook has turned bullish once again. This was similar to the upside breakout last summer (August 2006), and we expect only a minor pullback before higher prices evolve. The next resistance level for $SPX is 1460 (the highs), while there should be support at 1410 -- although we don't expect that a pullback will be that deep.



The equity-only put-call ratios remain extremely oversold (see Figures 2 & 3, and refer to the feature article), but have not rolled over to buy signals yet. We expect they will do so soon.



Market breadth has expanded dramatically ever since the market bottomed a week ago. New bullish phases that are accompanied by expanding breadth have traditionally seen higher prices immediately regardless of the supposedly "overbought" condition.



Finally, the volatility indices have declined and produced buy signals. There is a dichotomy: $VIX has now dropped well below the statistical volatility of $SPX -- something that rarely happens. The market can continue to advance while $VIX remains low, of course. In summary, we are bullish.

Lawrence G. McMillan is the author of two best selling books on options, including Options as a Strategic Investment, recognized as essential resources for any serious option trader's library.