Puts 1, Calls 0
Tuesday, March 16th, 2004 8:45pm EST
One Last Look at the TRIN
Bottom Line: There has been one other instance of TRIN readings like our current ones, in a market that is close to our current one, and it didn’t lead to any spectacular decline.
This is probably the last time I’m going to talk about this for awhile, but I want to mention something about the NYSE TRIN once again. The indicator has gotten a lot (probably too much) airtime recently, and I’ve aired my grievances about the indicator numerous times, but its recent action is interesting and should at least be discussed.
Yesterday the TRIN closed above 3.0 for one of the few times in its history. In fact, yesterday’s close was more than 3 standard deviations away from its 64 year mean value – in other words, it was a very rare sight indeed. Only five other times in the past 64 years has the TRIN closed above 3.0 after also seeing a reading above 2.0 for at least 3 out of the past 5 days. After every one of those other occurrences, the Dow Jones Industrial Average was higher 60 days later, and with an average gain of a hefty 8.2%.
One of my concerns has been that these extreme readings are coming so soon after new highs have been made. It would be one thing to see them after a long decline, like we saw in March 2003, but it’s quite another to see this type of pressure merely days after many broad indices were making multi-year highs. While I think there is reason to be concerned, I do want to point out another period in time where such an instance mirrors our current situation somewhat, and show what happened afterwards.
In 1942, the Dow bottomed after a long, brutal bear market which began in 1937. After the low in ’42, the Dow went on to a spectacular gain of 50%+ over the next year. A little over a year after the bottom, the market began its first serious correction, with the Dow losing over 8% during the course of only a couple of weeks (maybe it’s just me, but this all sounds extremely familiar…). By August 2nd of that year, the TRIN had closed above 2.0 for 3 out of the past 5 days, and on that day it closed at an extremely high level. That marked the low for the moment, as the market then went on to rally nearly 6% over the next month and a half before encountering trouble. But once again, that decline was only temporary as the Dow went on to make another run over the next three years.
I’m ALWAYS leery of comparing current markets to those past, since so many other factors come into play – especially so when we’re talking about something that happened 60 years ago. But I do think it’s important to understand that there is a precedent for the type of raw market action we’re seeing currently. From studying the instance most closely related to our current one, the TRIN readings over the past few days are not necessarily deserving of the bearish sign they have been given in the press.
Finally, A Move Away from Calls
Bottom Line: Equity call volume has declined sharply from average, while put volume has risen considerably – so much so that it rivals other major declines.
After a long absence, we’re finally beginning to see some hesitancy in traders going after call options. Over the past five days, traders clearing through the Chicago Board Options Exchange (CBOE) have curtailed their equity call option volume by an average of 18% below what has been seen over the past 50 days. Put volume, on the other hand, has been running 21% above average over the past week, which is why we have been seeing such high put/call ratios recently. If we take a simple difference between the two figures above, we see that there has been, on average, a -39% shift in option volume over the past five days (obtained by subtracting the 21% increase in put volume from the 18% decrease in call volume). Surprisingly, this is one of the largest shifts in the past few years, as the chart below illustrates. The dotted vertical lines highlight those times when the difference was as great as it is now.
When this difference spikes higher, it means that call volume is running significantly above average at the same time put volume is running well below average (with “average” meaning the average volume seen over the past 50 days). Not surprisingly, these spikes higher have equated quite well to peaks in the market, as that type of speculative froth is very rarely rewarded. Conversely, spikes down have coincided with either an exact short- to intermediate-term low or relatively close to one. Currently, the difference is at one of the lowest points in the past few years - there have only been five other times since 2000 when call volume has declined so much from average while put volume has increased so much: October 2000, March 2001, September 2001, September 2002 and February 2003.
Something I find interesting is that the occurrences in September ’02 and February ’03 did not mark the exact low, but did coincide with a brief reprieve before the final capitulatory push down. This is similar to the TRIN instance I highlighted above, where the sequence of extremely high TRINs lead to a brief rally before one more push lower and the ultimate low. Again, I don’t want to carry these kinds of comparisons too far, but it’s worth making a note of this phenomenon.
Conclusion
The latest survey results from lowrisk.com, covering the period through this past Sunday, showed 16% bulls and 64% bears. This gives us a bull ratio (bulls / (bulls + bears)) of only 20%, which is the sixth-lowest ratio in the history of the survey, going back to 1997. Most of the other weeks with excessively low bullishness showed weakness over the next week or so, but then the positive effects of overwhelming bearishness kicked in. After 12 weeks, the Dow was higher by an average of 6.1%, and was up every time but once (when it showed a loss of 0.4%). This type of attitude is not yet confirmed by the other surveys, but this is the first one to be released that shows the effects of last week and may be a sign of things to come in the other “major” polls. This particular survey tends to jump around quite a bit, but if we see a dramatic drop in bullishness from the Investor’s Intelligence survey when it is released tomorrow morning, expect it to excite a lot of traders.
Despite all the anecdotal “evidence” that so many traders are looking for a bottom here, many of our measures dispute that claim. Our shortest-term sentiment measures continue to suggest that pessimism is overdone here, and even during severe declines that usually leads to at least a 3 – 5 day relief rally. As of this afternoon, my preference is to trade from the long side, but I am not willing to be long if we once again break the lows formed during the past week. I think there is a decent chance that we could have a last rush down, and obviously I would not wish to be holding long during such excitement.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
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.
© 2004 Sundial Capital Research, Inc. All Rights Reserved.