In early April, 2013, I wrote about Equity-only Put / Call ratios in a blog post which can be referenced here: for convenience here is a link to that post.
Quoting from my previous work I stated, “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.”
Rightly so as it turned out, as the Standard & Poors 500 Index or SPX rose 7% from 1570 to an intra-day peak above 1680 in little over a month and a half. As noted, I did not see levels of Euphoria or Excitement which historically are the hallmarks of over-extended rallies that are about to end.
I will revisit a few Put / Call ratios in this post to decipher if the same holds true, or if we have reached a level of outright bullishness that warrants caution.
Let’s start with data from the Chicago Board Options Exchange, or the CBOE. In the chart below, plotted since the beginning of 2009, we see the dramatic rise in the SPX commensurate with a 21-day moving average of the CBOE Equity-only P / C ratio.
The Put / Call ratio is the blue line and is at the lowest levels since February, 2012. This illustrates that from options trading on the CBOE, nearly 2 calls trading hands per every 1 put, on average, over the past 21 trading days. We at Schaeffer’s prefer to look at a Put / Call ratio and that figure now rests at 0.592. Low readings on a relative basis have historically marked turning points in market direction as the market becomes flooded with optimism. Vice versa, as Put trading becomes dominant and prevalent on a relative basis, the market tends to trough as sentiment becomes to dire and pessimistic.
Turning to a more robust measure of option based sentiment, and using Schaeffer’s own proprietary data, I will look at options data from three exchanges, the above mentioned CBOE, the ISE (International Securities Exchange), and the PHLX (NASDAQ OMX PHLX). Combined these three exchanges account for about 55% of all option activity on any given day.
In this instance, when analyzing the Equity-only Put / Call ratio, I will use a 10-Day average to get a fresh snapshot of recent activity.
Similar to the CBOE data we see a bias towards the Call side, in this case the ratio is now below 0.50, which implies more than 2 Calls traded for every one Put. In fact, this is optimism not seen since late March, 2012.
To be fair and honest, both of these ratios can continue their Call bias and become more extreme in nature. Arguments can be made that Global liquidity pumping is supportive of equities as an asset class, and that the pace of share buybacks in the U.S. this year is enough to drain liquidity from the market (which inherently supports equity prices as earnings per share statistics have a decreased denominator in the calculation) and therefore promotes earnings growth and higher equity prices.
However, I will take the other side of the trade and suggest the market needs a breather, a consolidation phase where recent gains are digested. Optimism has reached extreme levels in my opinion and the path of least resistance for equities is lower.
June is one of the weakest months on record for equity prices, and we have had a stellar run of late.
If you need any more evidence of “acceptance” and “enthusiasm” for this rally, look no farther than the May 29th, 2013, cover page and article of the USA Today. Whereby the newspaper states “Bull run gets solid footing”, implying recent gains are well-founded and supportive of increasing equity prices going forward.
I will leave you with the same quote that I used in my previous post on this subject and that is from Humphrey B. Neill,
“When everybody thinks alike, Everyone is likely to be wrong”
~ The Art of Contrary Thinking, first published in January 1954