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Each Saturday morning by 11:00 AM EST, unless due to those instances when the OCC delays their reporting for whatever reason. At those times, this data will be updated by 7:00 PM EST on the evening the data is released.

The core put/call ratio – the one that’s most widely quoted – is the total put/call ratio from the Chicago Board Options Exchange (CBOE). By “total”, I mean that both equity options (i.e. options traded on individual stocks) and index options (i.e. options traded on index products, like the OEX or BKX) are included.

In the past, that has been fine. The CBOE accounted for a good chunk of the option volume, and there weren’t too many distortions of the data by large institutional trades. Beginning in 2002, there has been an increasing amount of very large trades in QQQ options by single traders. Often, these single trades account for 20%, 30%, even 40% of total option volume (almost always on the put side)!

For example, on Friday, August 29th, 2003, there was a large number of puts traded, driving the total put/call ratio to a sky-high 1.29 reading. Fully 45% of those puts were due to a single trader in QQQ options. When we take out QQQ options, the put/call ratio drops to 0.75 – a decline of 42%.

At this point, the total put/call ratio has minimal value. QQQ options have limited predictive power, so any ratio that includes them is not all it could be. Our preferred put/call ratio is the equity-only put/call ratio with QQQ options backed out, which is posted each day to the site.

Even if we look at the equity-only ratio with QQQ options removed, we are missing what could potentially be some very important information:

Fortunately, there is data available that will help us to answer each of the questions above.

The CBOE is only one of the exchanges where options are traded. There is also the American Stock and Options Exchange (AMEX), the Philadelphia Stock and Options Exchange (PHLX), the Pacific Exchange (PSE), and the new kid on the block, the electronic International Securities Exchange (ISE).

Each of these exchanges owns an equal share of the Options Clearing Corporation (OCC), which is an organization that exists to handle the issuance and clearing of the options that are traded on the exchanges. The OCC has several specific functions, but basically it is there to make sure that everything runs smoothly and uniformly. If any of you have traded options before, you or your back office should have received a little informational booklet in the mail from your broker. That booklet came from the OCC.

Because the OCC clears the trades from each of the exchanges, it has an enormous depth of data on what goes on at each, some of which it releases to the public. For example, for the month of July 2003, the CBOE accounted for 26% of the transactions, AMEX did 23%, PHLX did 12%, PSE did 10% and the ISE did 29%. Notice that last one – the ISE, formed just a few years ago – now accounts for more trading volume than does the CBOE.

The OCC also breaks down the volume coming from the exchanges by trade size and type. Meaning, it tells us how many trades there were of 1-10 contracts, 11-49 contracts, and 50+ contracts. For each of those size categories, it also outlines how many calls and puts were traded, along with whether they were bought to open or sold to open. This is the crucial information from question #2 above, and it allows us to narrow our focus to a specific group of traders. This information gives us the power to truly isolate the smallest of traders, and determine what their strategy is. It doesn’t get much better than that from a contrarian’s perspective.

The OCC releases these figures weekly, for the week just passed. The report that was released Saturday, August 30^th covers the period from Monday, August 25^th through Friday, August 29^th so fortunately we don’t have to deal with much of a delay in reporting.

Let's go over an example for clarity's sake. For the week ended August 29th, 2003, the OCC reports 10.5 million equity option contracts as having cleared (this is counting customer trades only, and not firm or market maker trades). If we look at the numbers from the CBOE, they reported 2.9 million equity contracts. This is about 28% of the total, and is right in line with their recent share of the volume.

CALLS – 58% of Total
1-10 CONTRACTS	11-49 CONTRACTS	50+ CONTRACTS
23%	22%	55%
PUTS – 42% of Total
16%	17%	67%

We can see from the table that calls accounted for 58% of total trades. The very smallest of traders, those trading between 1 and 10 contracts at a time, accounted for 23% of that call volume, while larger traders of at least 50 contracts accounted for 55% of the volume.

On the put side, small traders made up only 16% of the volume, while larger traders made up 67%. So already we can see that small traders were significantly more active on the call side than the put side, completely contrary to what the traditional CBOE put/call ratio would suggest.

Let’s focus in on those small traders and try to get a better feel for what they’re trying to do. When looking at put/call information, it is most helpful to see if the volume is going into opening transactions or closing transactions, as it will tell us how aggressive the traders are on betting on a market move. Also, especially for very small traders, buying options to open is more telling than selling options to open.

A small trader buys a call option to open a position for one reason – he thinks his stock is going higher. He buys a put option to open because he thinks his stock is going down. You may argue that he’s trying to hedge some underlying stock position, but it doesn’t matter. If he thinks his stock is going up, he’s not going to buy a put just for the thrill of it.

If we isolate the trades to just those of 10 contracts or less, and further restrict it to buys and opening transactions only, we can get a true picture of what retail traders (i.e. small brokerage firm customers) are doing. The average premium per contract for these trades for the week of August 29th, 2003 was $190, meaning the trade sizes were somewhere between $200 - $2000 on average (i.e. $190 x 10 contracts = $1900). Because these instruments are so leveraged and decay with time, it gives us an excellent feel for the emotion and level of conviction in the market by those who, sad to say, are the most likely candidates in the entire market to lose their money.

For that week, small traders bought to open 695,000 equity contracts. Of those, 453,000 were calls and 242,000 were puts (I’m rounding here to make it easier to read). This gives us a “pure” put/call ratio of 0.53.

At the height of the stock market bubble, retail traders were going crazy over call options. For the week ended April 7, 2000, they bought to open 1,380,000 calls and only 237,000 puts, for a put/call ratio of 0.17. They were so delirious with lust that they were willing to pay an average premium of $814 per call contract to be in the game. They paid an average of $599 at the time for their puts. So they were buying nearly six times as many calls as puts, and paying 36% more for the right to do so. At an opposite extreme, the week ended October 11, 2002, they bought to open 430,000 calls with an average premium of $182. During the same week, they bought 508,000 puts for an average of $250. So they were willing to pay 35% more for protection than they were for potential upside – the opposite of what they were doing during the bubble.

During the week ended August 29th, 2003, retail traders paid an average of $179 for puts and $213 for calls – they were willing to pay 20% more for calls than they are for puts. And as you can see from the paragraph above, they were been busy buying calls and ignoring the protection of puts. From a contrary perspective, when the smallest of traders are so enthusiastic about the market, it typically leads to declining prices.

Now let’s take a different approach and look at how they were trading their options as a whole. For the week ended August 29th, 2003, these small traders opened a total of 1,460,000 contracts. Here is the distribution of their priorities (opening transactions only):

Remember, we’re talking about very small traders here, so the vast bulk of the trades are not going to be a part of some complicated options strategy. Generally, if they buy a call, that means they are bullish, but if they sell a call, they are either less bullish or relatively bearish on the stock. If they buy a put, they are bearish but if they sell a put, they most likely believe the stock is going up, or at least not down a lot. Out of the 1.46 million contracts they opened, retail traders split their strategies fairly evenly among those that are bullish compared to those that are bearish.

On the surface, that seems as though it may conflict with the R.O.B.O. put/call ratio, which was very clearly skewed to the bullish side. However, these strategies are more skewed to the bullish side than average over the past two years.

Selling calls (most likely against an underlying stock position – a covered call write) has long been a popular strategy for these traders. In fact, when they buy more calls than they sell, the market has usually dropped afterwards. The strategies are usually skewed to the bearish side because call selling typically makes up about 40% of the volume (for opening transactions), by far the largest percentage of all the strategies.

But these traders are almost always selling calls against an existing stock position, not selling calls naked as an outright bearish bet on the market. Margin requirements on naked call selling are extremely high, especially for such small traders. In fact, as the former manager of a large margin department, I know for a fact that the great majority of these traders wouldn’t even be approved for naked call selling. The strategies have been bearish overall for two years, but it is because they were trying to squeeze a little extra income out of their stocks, and not because they were outright bearish.

This ratio looks at transactions that are buy-to-open only, and only for those trades that are under 10 contracts. Therefore, it is an excellent read on the emotions of the smallest of traders and should be interpreted in a contrary manner.

When the R.O.B.O. put/call ratio is high, that means small traders are buying many puts in relation to calls, and suggests that they believe their stocks will decline. This is bullish for the market once it reaches an extreme. On the other hand, when these traders are so confident of their stocks rising that the R.O.B.O. ratio drops to .53 or below, then we need to be aware that sentiment is becoming too frothy, and a market decline may soon be at hand.

On the chart, we also present total call purchases and total put purchases, surrounded by trading bands. The figures are presented as the total amount that each strategy consumed as a percentage of total small-trader volume. So if the call purchases showed .35, that means they spent 35% of their total volume buying call options.

From a contrary perspective, call purchases that go outside the upper, red trading band would be bearish for the market since it shows too much speculative activity. And put purchases, for example, that fall below the lower, green trading band would be bullish for the market since it shows too much fear.