CBOE OEX PUT/CALL RATIO

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APPLICABLE TIME FRAME(S):  

SHORT / INTERMEDIATE

UPDATE SCHEDULE:

Each weekday night by 7:00 PM EST

EXPLANATION:

OEX is shorthand for the S&P 100, an index made up of the 100 largest companies in the S&P 500. 

The put/call ratio is the volume of puts divided by the volume of calls traded on this index on the CBOE (Chicago Board Options Exchange) on a given day.  A put is an option contract commonly used to profit during a declining market - traders usually buy them to hedge an existing position or speculate that the broader market will drop.  Conversely, a call is an option which gives the buyer the right to theoretically buy the index at a certain price by a certain time, and is most commonly bought by traders who wish to profit on a market advance. 

OEX options are exercised American-style (meaning they can be exercised anytime prior to expiration), so they are rarely sold to open in order to minimize the risk of being exercised early and being left with an unwanted position.  We can be fairly confident that most of the volume represents purchases. 

Unlike the total and equity put/call ratios, the OEX put/call ratio should be considered in a non-contrarian manner.  Perhaps due to the generally higher premium (cost) of index options as opposed to equity options, OEX options appear to attract a more sophisticated trader, or at least those who are more adept at timing the market. 

Market turning points often coincide with extreme OEX put/call readings - when the put/call ratio is low, we are often near a market low.  Conversely, when the put/call ratio is high, meaning OEX traders are betting heavily on a market drop, we often see market declines shortly afterward.

The OEX put/call ratio is easily computed using data from the Chicago Board Options Exchange (CBOE).  The ratio is computed simply:

OEX put/call ratio = OEX put volume / OEX call volume

The chart below is a snapshot of the CBOE website for February 7th, 2003:

We can see here that there were 29,553 puts traded on the OEX on the CBOE on February 7th, and 29,034 calls.  Therefore, the CBOE OEX put/call ratio would be as follows:

OEX put/call ratio = OEX put volume / OEX call volume = 29,553 / 29,034 = 1.02

Phrased another way, there were 102 puts traded that day for every 100 calls.

Because the day-to-day movements in this ratio are so erratic, we follow them on a 10-day and 21-day moving average basis, which corresponds to the most recent two-week and one-month period (trading days).

GUIDELINES:

Throughout the recent bull and bear markets, the OEX put/call ratio has stayed within a relatively stable trading range.  On the chart, the green and red bands are 1 and 2 standard deviations from the one-year mean.  When the put/call ratio exceeds one of those levels, then a notable event has occurred.  Typically, the most effective signals occur when the ratio gives a high reading and the market is in an overall downtrend, or when the ratio is low and the market is in an uptrend.

The chart below shows a couple of occurrences of the OEX put/call ratio violating its standard deviation bands in late 2001 / early 2002.  The market was in a consolidation mode after the Fall 2001 rally.  After retracing some of the gain, OEX traders began to pick up calls in anticipation of a run at the recent highs.  These traders began trading calls in a much heavier proportion than puts, driving the OEX put/call ratio down to nearly .60 and below its lower trading band.  The market soon rebounded and began to challenge the highs. 

At that point, OEX traders apparently believed the rally would fail (we were still in a bear market, after all), and OEX put volume expanded greatly.  Over the next couple of weeks, the OEX put/call ratio exceeded its upper trading band several times while a market top was being developed.

Although this is a real example and points out the value of following this information, we do not mean to intimate that the market ALWAYS finds a low when the OEX put/call ratio violates its lower band, or peaks immediately after the ratio exceeds its upper band.  It is a guideline and not a trading system unto itself.

For purposes of the Indicator page, the daily readings and 10-day average are used.

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 .81 and 1.57

95% of readings (2 standard deviations) should be between .43 and 1.95

99% of readings (3 standard deviations) should be between .05 and 2.33

In other words, we should expect a reading under .05 or over 2.33 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, which is not necessarily true in this case (it has a slight positive skew - meaning there are few very small readings, but several very large readings). 

ADDITIONAL RESOURCES:

Chicago Board Options Exchange (www.cboe.com)

© 2005  Sundial Capital Research, Inc.  All Rights Reserved.