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Wednesday, January 15, 2003  7:53 PM EST

I'm not sure it gets any more frustrating than this morning, where we were stopped out of our intermediate-term short position...by $0.01.  While hindsight tells us that the stop was too tight, I think the discipline will keep us ahead of the game over time.  For those of you who do not receive the portfolio changes, we took another short position later in the morning to perhaps capitalize on what may be the beginnings of a trend change.

I mentioned the OEX open interest ratio on Monday, and we have become more extreme in that regard, with today showing the highest ratio since March.  OEX traders have accumulated 1.31 times as many put positions as call positions, which is nearly 2 standard deviations from the one-year average.  Since 1999, the open interest ratio has been 2 standard deviations from its one-year average only 4 times, each resulting in a down market 30 days later, for an average loss of 5.5%.  This compares to a random 30-day loss of 1.9% during this period.  From 1996 through 1999, such a high open interest ratio resulted in a down market 30 days later only 2 out of 8 times, but the average return was 1.0% compared to a random return of 3.5% during that period.

Notably, total OEX call open interest has fallen twice in the past week, which is unusual.  Since 2000, call open interest has risen on 95% of days that don't immediately follow an expiration (92% of days since 1996).  Also, put open interest has risen every day since the December expiration.  This tells us that OEX traders continue to open put positions while closing call contracts.  We don't know for sure if these contracts were bought or sold to open, but as I discussed on Monday, we can somewhat safely assume that most of them were bought to open.  The fact that they are closing call contracts at a faster pace than opening them is another potentially bearish development.

On the flip side, action in the S&P 500 options appears quite positive tonight.  Normally, I discount readings in our institutional put/call bid/ask bias ratio on either side of expiration since that event seems to have a large influence on the indicator for obvious reasons.  For those of you not familiar, the bias ratio compares all SPX option trades that go off at or below bid versus those that trade at or above ask for both puts and calls.  A large amount of puts being sold and/or calls being bought will make the ratio rise and is generally bullish, while a bias towards buying puts and/or selling calls will drop the ratio and is usually bearish.  The following table points out bias ratio extremes over the past two weeks:

We can see that the ratio did a good job at hinting at the next day's direction.  Today's reading is very high, which is a bullish indication for the next day or two.  Again, however, I'm not sure how much emphasis to put on this due to expiration this week.

The lowrisk.com sentiment survey, released on Monday and reflecting last week's trading action, showed a surge in bullishness this week.  I pay attention to that survey because it tracks the more widely-followed Investor's Intelligence survey very closely on a moving average basis.  That surge suggested we would see an increase in bullishness in today's II survey, which indeed happened.  We've now seen the II bullish ratio (bulls / bulls + bears)) remain above 60% for the 12th time in the past 12 weeks.  As I pointed out last week, 61% of the weeks since March 2000 have shown a bullish ratio above 60%, despite prices falling over 40% during that period.  In contrast, from 1991 - 2000 (and a price rise of over 350%), we saw only 36% of weeks with a bullish ratio above 60%.  I find it hard to imagine that we are beginning a new multi-year bull market when so much optimism remains with investors.

Even with today's decline, our shortest-term indicators are still mostly neutral.  The exceptions are the TRIN and price oscillators, both of which would suggest only a short-term upside pop if anything.  Due to subscriber feedback, I have begun posting the intraday charts to the site on a regular schedule (11:15am EST and 2:45pm EST).  You can find them at this link:  http://www.sentimentrader.com/subscriber/intraday_charts.htm.  So even if you don't receive an intraday update, you can still see updated charts twice a day.  There may be some days where I will be unable to get the intraday charts posted, but that should be rare.  For those who do receive the notes, I will continue to include the charts in whatever emails I send.

With the break of some semi-important technical levels today, a very overbought intermediate-term sentiment situation and neutral short-term situation, I don't see a high-probability, low-risk opportunity to the long side just yet.  While I don't think we're yet "broken", today did some damage to the bullish case.  And with the sentiment condition we're in, they can hardly suffer much more damage before the selling should begin in earnest.  I continue to believe that an upside breakout, should we happen to get one, will be an opportunity to initiate or add to longer-term short positions.

Disclosure:  long QQQ puts

This disclosure is not intended as trading advice in any form.  It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary.  Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook.  Positions can and do change at any time, without notice to the reader.

Monday, January 13, 2003  10:15 PM EST

The traders who frequent the Rydex mutual fund family have continued to aggressively move assets into high-beta funds at the expense of low-beta funds, as I mentioned last week.  The Rydex Beta Chase Index closed Friday at 4.04, one of the highest readings over the past two years.  This means that over the past week, these traders have moved a significant amount of assets into the highest-beta funds (aggressively betting on further upside) while neglecting the low-beta or negative-beta funds.  As can be clearly seen from the chart on the site or last Thursday's commentary, when these traders become so confident in more upside in the market that their momentum rapidly shifts into the highest-beta funds, thus spiking the Beta Chase Index higher, further upside is limited compared to the downside risk over the ensuing weeks.

As I said in the portfolio change this morning, the high Beta Chase Index coincides with the low 10-day equity put/call ratio.  These two real-money indicators taken together show clear risk tolerance on the part of trend-followers who are usually late to every trend.

For those of you not familiar with options, the term "open interest" means the total number of contracts that have been opened for an option series that have not yet been closed.  However, it does not differentiate between buyers and sellers.  So, if a trader bought 10 calls to open a position, it would increase open interest by 10 contracts.  If that same trader instead SOLD 10 contracts to open a position, then it would also increase open interest by 10 contracts.  While that doesn't seem like it would be terribly useful information, analyzing open interest patterns in OEX (S&P 100) options can reveal clues as to the sentiments of these traders.  Since the day before the December option expiration, OEX call open interest has declined by 42%, while put open interest has declined by only 11%.  Put another way, so far OEX traders have only opened 58% as many call positions as they had during the last expiration, but they have opened 89% as many put positions.  Since OEX options are American exercise (meaning they can be exercised anytime instead of only at expiration), many institutions tend to shy away from selling these options to open, using the SPX options instead.  Therefore, if call open interest increases, we can somewhat safely assume that most of these opening positions are to buy, usually a bullish gesture.  Conversely, if put open interest increases, we can again assume most of these positions are buying to open, and this is generally bearish.  I'm making some very broad generalizations here, but overall I believe this holds true.  So, the fact that OEX traders have only opened 58% as many calls contracts but 89% as many put contracts strikes me as bearish.  Going back over previous instances where there was such lopsided open interest differentials 14 days after an expiration, the only real close comparison is in October 2001.  At that time, OEX traders only opened 56% as many call contracts but 96% as many put contracts as the previous expiration.  After that, there was a month-long consolidation period before the end-of-year leg higher.  If we look at the opposite situation, where OEX traders open many more call contracts and less put contracts than the previous expiration, the most recent outstanding instance was early February 2002, where there was a 21% INCREASE in call open interest and 18% decrease in put open interest.  This preceded the month-long rally to the March high.

This ties in well with the OEX Open Interest ratio, which is posted to the site each night.  This ratio is simply OEX put open interest divided by OEX call open interest.  The higher the ratio, the higher put open interest is in relation to call open interest.  The chart below is a 10-day moving average of this ratio, extended back to 1998.  We can seen that when the ratio was low, it often lead to good intermediate-term upside moves.  Conversely, high ratios very often lead to selloffs of several weeks' duration.  If we further refine this, say by only considering moves to the bullish lower trading band to be bullish during uptrends, and only considering moves to the bearish upper band to be bearish during downtrends, then the reliability of the indicator improves.  Currently, we are approaching the bearish upper band (meaning OEX traders are accumulating significantly more puts in relation to calls) during a long-term downtrend, which historically has been a negative in the intermediate-term.

Our shortest-term sentiment measures are no longer overbought, but most of our longer-term indicators are, some extremely so.  This tells me that while we may see additional rally attempts, they will most likely be very short-lived affairs that soon flame out.  Therefore, my strategy will be to look at any further upside attempts as opportunities to become successively more aggressive on the short side.  If we get stopped out of our intermediate-term short position in the model portfolio, I will likely look to enter again fairly rapidly.

- Jason Goepfert

Disclosure:  long QQQ puts

This disclosure is not intended as trading advice in any form.  It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary.  Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook.  Positions can and do change at any time, without notice to the reader.