In this week’s blog, I’m going to take a look at three separate Equity-only volume Put / Call ratios.
Monitoring Equity-only P/C ratio’s is an important aspect of analysis for those who like to keep tabs on the mood of the market. And by extracting Index and ETF volume, you get a clearer picture of the underlying sentiment of option traders.
Euphoric sentiment characterized by a low P/C ratio often leads to or is concurrent with an apex of price action, while desolate sentiment or elevated P/C ratios indicate pessimism and often precede market troughs.
Readers can track Equity-only Put / Call activity using our website, www.schaeffersresearch.com by clicking on the Quotes & Tools tab on the top banner, then click on CBOE (Chicago Board Options Exchange) Equity Put/Call Ratio. The chart available to users goes back 6-months and plots the Equity P/C ratio (21-day average) with the OEX or S&P 100 Index.
Here is the graphic for your convenience: Note the pessimistic tone on 11/15/2012 (red line is the 21-day average P/C ratio)
The second Equity-only Put / Call ratio I will dissect is a proprietary indicator we have created using data from the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX). These three exchanges combined, encompass well over half of all option volume in the U.S. on any given day. In addition to the triumvirate of exchanges, the data below focuses only on “Buy-to-Open” activity. This allows us to focus in on trader psychology as our goal is to decipher the mood of the market based upon option traders’ actual transactions/volume.
After glancing at the above two charts, you may be thinking to yourself, “So What?”, as neither of the ratios are at extremes and there may not be anything actionable within. Please keep in mind gentle reader that the equity markets have performed very well thus far in 2013, and from contrarian lenses one would expect to see the “Euphoric” nature of human spirits bubbling over with these gains. After all, this is the fifth year of this bull market. This isn’t occurring, however, and there is a litany of reasons why. What this equates to from our perspective is “disbelief”, and ample sideline cash, both of which are hallmarks of trending bull markets, not bull markets that are about to end.
Let’s finish with a third and final Put / Call ratio graphic that looks at volume data from all option exchanges. The Cypriotic fiasco as well as worse than expected economic data in the U. S. of late unleashed a flurry of bearish activity illustrated by a rising Put / Call volume ratio (red line on below chart is a ten day average). In fact the ratio has climbed to 0.80 or 4 Puts traded per every 5 Calls, an elevated level which historically has produced tradeable bottoms for short-term speculators as well as a suitable entry point for those with a longer investment time horizon.
To summarize, upon dissection of volume Put / Call ratio data, juxtaposed with an equity market that has advanced roughly 10% Year-to-date, one would expect more enthusiasm for this rally. Option volume data, however, indicates sufficient doubt and disbelief. The stock market has a unique way of flushing out “weak hands” or those traders who lack conviction and have attempted to pick a top or profit from a pullback, moreover, a sell-off that nearly everyone has been calling for…
There is but only one guarantee on Wall Street, when everyone expects something to happen, the opposite of what is expected often times occurs.
I will leave you with this quote from Humphrey B. Neill emphasizing this point:
“When everybody thinks alike, Everyone is likely to be wrong”
~ The Art of Contrary Thinking, first published in January 1954