CBOE EQUITY PUT/CALL RATIO DE-TRENDED

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APPLICABLE TIME FRAME(S):  

SHORT / INTERMEDIATE

UPDATE SCHEDULE:

Each weekday night by 7:00 PM EST

EXPLANATION:

See the description for the equity put/call ratio for an in-depth discussion of the background of that indicator.

As is stated in that description, put/call ratios tend to move in trends along with the underlying market.  For instance, the mean value of the 10-day average of the equity ratio from 1997-2000 was 0.45.  From 2000-2003, it was 0.60 which is a difference of 38%.  This is significant, and throws off our views of what is extreme and what is not.

To compensate for these secular trends, this indicator takes the current 10-day average put/call ratio and divides it by the 26-week average.  This puts the most recent readings into the context of those seen in the past six months. 

This virtually eliminates the bias the equity put/call ratio exhibits depending on what type of market we are in and gives a more clear picture of the underlying sentiment of options traders.  If the indicator is giving a current reading of 20%, for example, that means that the 10-day average is 20% greater than the average reading seen over the past six months, and is showing a relatively large amount of fear, as is outlined below.

GUIDELINES:

The interpretation of this indicator is the same as the equity put/call ratio itself - high readings show fear and are generally bullish for the market.  Low readings, in contrast, show excessive optimism which is rarely rewarded, as the market typically declines after they are seen.

STATS:

*Standard Deviation.  See below for a description of standard deviation for the daily put/call reading...

68% of readings (1 standard deviation) should be between -12% and 16%

95% of readings (2 standard deviations) should be between -26% and 30%

99% of readings (3 standard deviations) should be between -40% and 44%

In other words, we should expect a reading under -40% or over 44% only between 2-3 times per year.  Since such a reading would be highly unusual, it suggests that we are seeing an unsustainable trend.  These figures assume a normal distribution curve.

ADDITIONAL RESOURCES:

Chicago Board Options Exchange (www.cboe.com)

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