S&P 100 (OEX) Put/Call Ratio

Yesterday we looked at the Options Speculation Index, which showed that traders were too optimistic.

That Index looks at equity options across all U.S. exchanges, and was unambiguous in its suggestion that we are seeing an extreme rarely witnessed over the past decade.

The unusual thing about our current juncture is that it isn't just equity options where traders are showing a preference for call options - we're seeing it in S&P 100 (OEX) options too.  The odd part is that OEX options traders are usually "smart money", unlike the others.

What that means is that when we see traders in those options show a preference for calls versus puts, then the market usually rallies going forward, which is the opposite of what happens when we see the same kind of extreme in equity options.

And we're seeing it now.  The chart below shows the 10-day average of the OEX Put/Call Ratio, with the green arrows highlighting dates when the average has dropped below 0.80.

The table below gives the performance of the S&P 500 the given number of weeks/months following the extremes shown in the chart.

The S&P did quite well going forward, especially the longer out we look.  Three and six months later, the index showed a negative return only once, in 2001.

The positive returns were impressive.  These were not meek little bounces; they were full-on ramps.  The only one that didn't show a six-month return higher than +10% was in July 2002...and that was the bottom of the previous bear market.

Our current situation is also unique in that we're seeing this as the S&P flirts with a multi-month high, while the others occurred after a decline.  About the only one that is somewhat comparable was from July 2003, but while it doesn't look like it on the chart above, even then the S&P had chopped modestly lower for over a month by the time the OEX ratio became extreme.

S&P 100 (OEX) Options Open Interest

It isn't just the raw put/call data in OEX options that is sitting at an extreme.  The open interest in those options is also notably skewed toward calls.

Recall that open interest is the number of options contracts that have been opened and not yet closed out.  It makes sense that if there is a lot of call volume relative to put volume (see above), then the open interest ratio should be skewed towards calls as well.  But we don't always see that.  Sometimes we'll see a lot of call option volume, but the open interest doesn't move much, and vice-versa.

As we can see from the chart below, the ratio of open call options to open put options is just as skewed as the raw put/call ratio.

Open interest was not a consistent predictor in the shorter-term.  But when we look out longer, the returns were less in line with random.

There were several times when the open interest ratio became skewed, yet the market continued to fall.  The occurrence in October 2000 was just an outright failure.  But in June 2002 and October 2008, we were entering the endgame of the last two bear markets, so while the losses were extremely large, they were limited in time.

This isn't nearly as compelling as the data from the put/call ratio itself, but it does help confirm that OEX traders have heavily bet on call options, and presumably a market rally.

So how do we reconcile this ostensibly positive outlook with the one we saw just yesterday, that had the opposite suggestion?  I'm not quite sure.  It's possible that traders are selling-to-open the OEX calls, which is a modestly bearish strategy (or at least not bullish), but that would be highly unusual since OEX options can be exercised at any time and leave a seller open to unexpected risk.

Other than the fact we've never really seen this before (such apparently bullish behavior when stocks are hitting multi-month highs), I can see no reason to dis-believe what this data is suggesting.  We just have to weigh what is more compelling when comparing this to what we've looked at over the past few weeks.