CBOE OEX PUT/CALL OPEN INTEREST RATIO

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APPLICABLE TIME FRAME(S):  

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.  Open interest is defined as the total number of option contracts outstanding.

Open interest is increased by opening transactions and decreased by closing transactions. Someone buying a call to open (a bullish position) would increase open interest by one, and someone selling a call to open (a bearish position) would also increase open interest by one. 

The open interest indicator takes the total put open interest and divides it by total call open interest - as more put contracts are opened (and/or call contracts closed), the indicator rises; as put contracts are closed (and/or call contracts opened), the indicator falls.

The OEX put/call open interest ratio should be considered in a non-contrarian manner.  As put open interest rises in relation to call open interest, it suggests that OEX option traders - usually quite successful at identifying market turning points - are accumulating put positions.  This is a bearish development.  Conversely, if OEX traders are accumulating call positions, then the put/call open interest ratio should fall, which is normally a bullish development.

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

OEX put/call open interest ratio = OEX put open interest / OEX call open interest

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

We can see here that there were 153,271 puts currently open on the OEX as of February 7th, and 162,625 calls.  Therefore, the CBOE OEX put/call open interest ratio would be as follows:

OEX p/c open interest ratio = OEX put O.I. / OEX call O.I. = 153,271 / 162,625 = .94

Phrased another way, there were 94 puts open as of that day for every 100 calls.

GUIDELINES:

The OEX open interest ratio has gradually declined ever since 1995, as put open interest has generally reached lower and lower peaks throughout the years.  To account for changes in the range, we follow this ratio on a relative basis. 

On the chart, the green and red bands are 1 and 2 standard deviations from the recent mean.  When the open interest 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 an instance of the OEX open interest ratio violating its upper standard deviation band in March 2002.  The market had rallied up to its recent highs after a brief swoon in February.  We can see here that while the market was rallying, OEX traders were gradually opening more and more put positions, finally reaching an extreme (above the upper standard deviation band) in mid-March. 

This extreme in put open interest, relative to call open interest, coincided with the market peak and we soon began another bear market slide.

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 open interest 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.

STATS:

*Standard Deviation.  See below...

68% of readings (1 standard deviation) should be between .86 and 1.24

95% of readings (2 standard deviations) should be between .67 and 1.43

99% of readings (3 standard deviations) should be between .48 and 1.62

In other words, we should expect a reading under .48 or over 1.62 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 very slight positive skew - meaning there are few very small readings, but several very large readings). 

ADDITIONAL RESOURCES:

Chicago Board Options Exchange (www.cboe.com)

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