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Thursday, September 18, 2003  8:50 PM EST

Today’s put/call ratio from the CBOE that incorporates all options (those on equities and indexes) closed at 0.51, tied with June 20^th as the greatest amount of calls traded relative to puts since the rally began in mid-March.  As I’ve mentioned before, when the market is positive during expiration week, the put/call ratios tend to average about 7% below where they would be during a non-expiration week, due to traders buying lots of low-priced “lottery tickets” which can sometimes double or triple in a matter of hours.  So, we should probably discount today’s reading a bit due to the looming expiration. 

Still, I thought it would be instructive to take a look at what kind of market performance followed extremes in this ratio.  The tables below detail the bottom 10 and top 10 readings in the total put/call ratio and how the S&P 500 responded afterwards, counting only those readings since March 12^th.  Today’s reading is not included in the tables. 

First, let’s look at the 10 lowest readings since the rally began.  While the results can be considered negative for the market, something remarkable must be noted – every single one of the bottom 10 put/call readings occurred during an expiration week.  Also, each month since April has at least one reading in the bottom 10.  This is further evidence that expiration plays a role, and likely a major one, in these ratios. 

Looking at the table, it does appear as though the S&P shows a slightly negative bias after such low put/call readings.  However, this could simply be due to the post-expiration negative bias we’ve seen over the past year and which I’ve outlined several times. 

Now let’s look at the 10 highest put/call ratios seen during the rally so far: 

Not surprisingly, there is a clear positive bias to the market after such high readings.  Not only does the market tend to be positive on an absolute basis, it also did considerably better than a random return during that period. 

A Peek at Expiration

Because I’ve received so many questions on the matter, I’ve posted the following chart.  It shows the weeks before expiration (in green) and the weeks after expiration (in red) since March.  While we could probably say that there is strength before and weakness after with some consistency, it’s a bit of a stretch. 

Investor’s Intelligence Streak

We’re now in the 15^th consecutive week where the percentage of bears in the Investor’s Intelligence survey has been at an extreme level of below 22%.  Per the June 12^th daily commentary (see the archives for reference), this puts us equal with the average of the other 13 occurrences I outlined since 1969.  However, we’re now 72 days into the “drawdown” period, well above the average of 49 days before a more serious correction set in.   

There were only three other times in history where the rally lasted longer than it has now (again, I’m fudging a little here, since I used a 5% correction in the study, and we’ve already corrected just a tad more than 5% since the low bearish reading was given).  Those three other instances were in December 1975 (84 days in the drawdown period), February 1983 (90 days) and February 1985 (104 days).  Interestingly, those three instances also ultimately suffered three of the smallest and shortest corrections, averaging 7% over the course of 40 days.  That is well below the average of a 12% correction over 71 days – in fact, they are nearly half the average.  While we can’t place too much emphasis on only three data points, the suggestion is that the longer we go without a more serious correction, the shorter and less painful it will ultimately be.  This flies in the face of conventional wisdom (well, at least according to the bears), and again it is only three data points, but I think it’s important to keep that possibility in mind, and it’s another reason why I am looking at future oversold readings as potential buying opportunities. 

Conclusion 

After today’s rally, we’re short-term overbought.  Enough of our shorter-term measures are in extreme territory that it has driven the STEM.MR model to the lower end of its recent range, and our short-term indicator “score” to its lowest level since September 2^nd.  I’m confident that tonight’s Rydex data will confirm that retail speculation is alive and well (if there is anything stand-out in tonight’s numbers, I will make mention in the intraday updates).  However, we are also clearly in a short- and intermediate-term uptrend, and overbought sentiment readings in a strong uptrend are not terribly reliable, as we saw this Spring.  So while we may be due for another consolidation session or two, I don’t see a real compelling reason to short new highs at this point.  If we see some type of failure, like I outlined in Tuesday’s commentary, then I will become more concerned, but for now I am continuing to give the uptrend its due respect.

- Jason Goepfert

Disclosure: no positions

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.

Tuesday, September 16, 2003  8:00 PM EST

I don’t have any particular theme for tonight’s comment, as the market is working off its short-term mild oversold reading by going higher, as it should if the uptrend is intact.  I don’t have a desire to be short unless we either begin to fail at last Monday’s highs, or stay consistently under 1015.  So far, we haven’t seen signs of either. 

Instead of re-hashing what I’ve already gone over, I thought I would use tonight’s space to respond to a number of emails that I’ve gotten several times, in one form or another. 

Email:  You missed a big chunk of the Spring rally.  Now with the breakout, you turned bullish even though your indicators are extremely bearish.  Why in heaven’s name should I listen to what you have to say?

Answer:  Clearly, being as bearish as I was beginning in earnest in April wasn’t a help to anyone - in fact it was a huge hindrance.  Before listening to my take on what the market is likely or likely not going to do, I highly recommend you go back and comb through the commentary archives.  Find out whether – over time – my comments would be of help to you on a consistent basis.  If so, excellent.  If not, then please ignore them.  The main reason I work hard to update all the indicators and models, and give you as much background as possible on myths related to the common ones, is so that you can log into the site and come to your own conclusions, regardless of what I have to say.  Whether I happen to be right or wrong in my conclusions, I hope that you can still find some value in better understanding the psychology of various market participants.

Email:  Is a possible reason why sentiment failed so miserably in this rally because so many are now aware of it?  I mean, you have a site dedicated to sentiment indicators, doesn’t that tell you something? 

Answer:  Being as objective as possible, I can’t say “no” with any certainty.  It is a possibility that because so many are now trying to be contrarian, we have to be contrarian about being contrarian!  However, I highly doubt that.  Traders seem to have a love/hate relationship with sentiment indicators, and expect it to be perfect every time.  At the first failed signal (or the first time they lose money), they tend to throw it out the window and call it useless.  You really don’t see that very much with technical or fundamental analysis, even though those two disciplines (arguably) fail a large degree more than sentiment does.  I think it’s a development that bears watching, and if normally consistent sentiment gauges fail time after time, I would have to agree.  But at this point, it’s way too early to say so.  If I had to guess, I would say that sentiment as a discipline is about where technical analysis was in the 1970’s.  There’s still a large body of work and research to be done.  Also, I can’t say that “sentiment” as a discipline failed.  To be fair, I can only say that my interpretation of sentiment did.  Someone else looking at the same data may have correctly stayed bullish throughout the rally.

Email:  You’ve said several times that you’re somewhat bullish unless we see signs of failure.  That’s awfully vague, so what exactly do you mean?

Response:  I am looking for things like reversal days, preferably a gap up opening (especially above prior resistance) that closes negatively.  Several such days in succession, like we saw in January, can be an excellent tipoff of exhaustion.  Or, it could be a simple trendline break from the August 6^th low in the S&P 500.  Also, I would also be suspect of the uptrend if we are not able to rally off short-term oversold readings.  The broader market continues to rally when we see things like the STEM and STEM.MR models enter oversold territory.  If it doesn’t, that can be a good clue that there is not enough buying pressure to sustain these prices.

Email:  Have shifting market dynamics (e.g. increasing influence of hedge funds) changed the way some of your indicators work?  Is there anything you can do about it? 

Response:  Absolutely.  Things like the Specialist Short Ratio, short interest, breadth and the TICK have certainly and profoundly been affected by things like increasing trading from hedge funds, decimalization, etc.  A good way to correct for much of this is to keep the frame of reference quite short when looking at historical comparisons.  For example, if looking at the Specialist Short Ratio, a reading of 35% is extremely low historically, but not all that uncommon over the past couple of years.  So, by “de-trending” the data, you can get a better feel for whether we are seeing an historical extreme or not.  Sometimes, the market will change and it will just render an indicator ineffective.  An example of that is Odd Lot Short Sales, which keeps track of short sales of under 100 shares.  That used to be a very good contrary indicator, but the creation of alternate markets (such as the options market) gave those traders other avenues and the indicator went downhill.  Undoubtedly some of the indicators are being affected in ways I can’t even imagine, and it has the likely impact of lessening the indicators’ effectiveness.  However, until some of them completely break down like Odd Lot Short Sales, I think there is still some value in analyzing them. 

Email:  What’s your take on the CBOE’s decision to introduce futures on the VIX? 

Response:  Not much.  While the intricacies of what’s involved are numerous (check out Howard Simmon’s piece on thestreet.com today for some excellent background), typically when an idea becomes so popular that it garners its own futures contract, it becomes questionable.  The tradition of companies rolling out contracts to take advantage of a trend  - and that event actually marks the end of the trend – are numerous.  I don’t think anyone really knows what’s going to happen to the VIX once this product is rolled out later this year, but I would be hesitant to read too much into any VIX readings once that futures contract begins trading until it gets more history under its belt. 

Email:  Why don’t you post the Rydex Nova/Ursa ratio to the site? 

Response:  The Nova/Ursa ratio is constructed by taking the assets in the long-oriented Rydex Nova fund and dividing them by the assets in the short-oriented Ursa fund.  Ever since the leveraged Dynamic funds were introduced in 2000, the fund flow among the various Rydex funds has changed dramatically.  All the “old” benchmark funds suffered asset declines (except Ursa) as the money found its way into the more speculative Dynamic funds.  Therefore, the Nova fund has seen a steady, secular decline in assets the past three years, regardless of what the market has done.  On the other hand, Ursa goes through bouts of being a popular institutional vehicle, with the fund often seeing very large one-day swings in assets that almost certainly cannot be attributed to individual investors.  So, you have a secular decline in Nova assets and a secular rise in Ursa assets, with little regard to how the market is trading.  That does not give an especially useful look at the traders’ sentiment behind the asset moves, so I prefer to look at other measures which include the leveraged funds, and weight the flows by the amount of leverage employed.  This gives us a better picture of the actual thought process behind the numbers. 

Email:  Any update on your thoughts about the Commitments of Traders information for the S&P 500 e-mini contract?  Shouldn’t small speculator positions in the e-mini be a perfect contrary indicator? 

Response:  No, not really.  I still don’t believe that we have enough information to accurately determine what forecasting value the activity in that contract may have, especially in the context of what’s happening in the large contract.  I pointed out a while back the negative correlation between the positions in the two contracts, and that has stayed intact.  Meaning, while commercials have been getting more and more net short in the full contract, they have been adding to their net longs in the e-mini.  Conversely, small specs have been increasing their net long position in the full contract but are now quite net short in the e-mini.  As the chart below shows, commercials are close to a record net long position while small specs are close to a record net short position.  The straightforward interpretation of that should be very bullish, but history doesn’t necessarily prove that out (check out the wonderful call by small specs by being very net long from March through June). 

While small spec positions in the e-mini should be a good contrary indicator, we must remember that “small spec” as far as the CFTC is concerned in anyone trading less than 300 e-mini contracts.  That’s still a pretty hefty margin requirement, and no doubt there are some institutions that are included in that small spec category.  The same can be said of the full contract, but that data has a long and good track record of being a contrary indicator, which the e-mini does not.  At this time, I continue to watch the e-mini positions, but am not reading a whole lot into them. 

Email:  Your ROBO put/call ratio is very good, however is there a way to get the information for other things, like indexes? 

Response:  I think the ROBO put/call ratio^TM is a step forward in put/call analysis, since we know exactly who is doing what, and why they are doing it.  That is information that is missing from most other measures.  At this time, the OCC does release similar information for indexes, but it doesn’t break it down by index (e.g. OEX, BKX, etc.).  However, I can tell you that I have been in contact with the OCC about the possibility of releasing this type of information on individual indexes – and stocks – and they are very receptive to it.  So, you may be able to pull up a quote for, say, QQQ, and find out how many trades of 10 contracts or less went to buy call options to open.  That would be a huge step ahead, and I think it’s a real possibility.  If some of you email them and let them know you would like to see that type of transparency, it likely has a better chance of happening (send email to options@theocc.com). 

As I said this weekend and again above, I don’t see any real compelling reason to be short right now.  The market is rallying off mild oversold readings as it should, it has regained its breakout level, and it has not shown any signs of failing at a previous high (yet).  I am remaining cautiously bullish, but will change that in an instant if we begin to see some signs of failure like I outlined above.

- Jason Goepfert

Disclosure: no positions

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.

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