Tuesday, October 28, 2003 9:35 PM EST
Today was one of those rare days when the broader market was very positive, yet the put/call ratio actually rose. For the purposes of this commentary, all references to “put/call ratio” mean the ratio that measures CBOE equity options only, with QQQ options backed out (available on the site each day). I feel that this gives us a better feeling for small-trader sentiment, and the reason for this is because it tracks the ROBO put/call ratioTM quite closely.
With the ROBO ratio, we know exactly what we’re getting – equity option trades of fewer than 10 contracts, and that were bought-to-open only. It gives us a window to view exactly who is doing exactly what. With the CBOE ratios, there is a lot of extra “junk” in there, so the two ratios will not track exactly, and that should be expected. For example, if a large fund walks in and sells 10,000 MSFT calls to open, it will be counted in the CBOE ratios but not the ROBO ratio. Also, there is no telling what the strategy is behind that MSFT trade, so it gives us data that we don’t want. In this respect, the ROBO ratio is far superior to the other ratios that are widely available.
The problem is that the ROBO ratio is only updated once per week, so its value is diminished. But if the CBOE ratios track the ROBO ratio relatively closely, then we can get some kind of idea what small traders are doing during the week. This is, in fact, the case. If we look at a 3-week moving average of the CBOE equity-only put/call ratio with QQQ options removed and compare it to a 3-week average of the ROBO put/call ratio, the correlation is +0.7 (out of a scale of -1.0 to +1.0), which is pretty good. The chart below shows these two ratios plotted against each other.
The reason I bring this up is because the put/call ratio actually rose today, in spite of a better than 1% gain in the S&P 500. There was heavy action in QQQ put options, but again I look at the ratio with those options removed, so that is not a factor. It looks like options traders were using today’s higher prices to establish some put protection, which is a sign of pessimism that is quite unusual. If it continues, then that would bode well for a continuation of the rally, since it would demonstrate that traders who are consistently wrong on market direction were betting as though the rally would fail. Since May 2001, when the S&P 500 rose by 1% or more on any given day, the put/call ratio also rose only 27% of the time. Since the rally began in March of this year, that percentage dropped to 20%.
So what does today’s reading mean going forward? Unfortunately, probably not much, at least not by the looks of this one day alone. If we look at all occurrences since 2001 when the S&P 500 rose by 1% or more and the put/call ratio also rose, then the next day was positive 58% of the time. This beat a random day, which had a 48% chance of being positive. After one day, however, this positive bias went away and if anything, there was a very slight negative bias 5 days later. If we look only at how the market has reacted during this rally since March, then the results are pretty much the same. There were only four occurrences where the put/call ratio rose by a noticeable amount, and each one was followed by an up day in the S&P, for an average return of nearly 1%. After that, however, there was only a 50/50 chance of the market being higher up to 10 days out. The bottom line is that today’s rise in the put/call ratio may be a mild positive in the very short-term, but after that the results are inconclusive. I most certainly would not trade based on this data alone.
CONCLUSION
Nothing much has changed since the weekend comment, and my thoughts are the same. We have the same positives balancing the same negatives, and it looks as though a move up to or slightly above the recent highs will likely be fought back, while a move down to oversold conditions will be bought. Some of our very shortest-term measures are now solidly overbought, so by rights we should see something of a breather, but I would prefer to see more excessive enthusiasm, or some signs of a failure, before looking short again. The potential upside does not look very appealing either in spite of the positive seasonality, so in the very short-term as well I would have to classify myself as neutral.
- 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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