CBOT TREASURY BOND FUTURES PUT/CALL RATIO

Click here for chart

APPLICABLE TIME FRAME(S):  

SHORT / INTERMEDIATE

UPDATE SCHEDULE:

Each weekday morning by 3:00 AM EST for the previous day's activity. 

EXPLANATION:

The put/call ratio is the volume of puts divided by the volume of calls traded on 30-year Treasury bond futures on the CBOT (Chicago Board of Trade) on a given day.  A put is an option contract commonly used to profit on a declining security - traders usually buy them to hedge an existing position or to speculate on an imminent decline in price.  Conversely, a call is an option which gives the buyer the right to buy a security at a certain price by a certain time, and is most commonly bought by traders who wish to profit on a security they believe will quickly rise in price. 

Generally, heavy volume in put contracts shows large-scale fear by options traders, while heavy call volume is usually a reflection of increased investor optimism regarding rising prices.  When there is a lopsided shift in volume, for example when there is heavy put volume and low call volume, then the put/call ratio will be high.  When an extreme is reached, this becomes a bullish contrarian indicator and we should expect higher market prices soon.  Conversely, when options traders are optimistic and there is low put volume in relation to call volume, then the put/call ratio will be low and we may be near a market high.

The put/call ratio is most easily computed using data from the CBOT.  The ratio is computed simply:

Put/call ratio = Put volume / Call volume

The chart below is a snapshot of the CBOT website for March 7th, 2003:

For the purposes of our put/call ratio, we use open outcry (i.e. pit traded) options only, and not options traded electronically through the A/C/E platform.  On this day, we can see here that there were 46,130 puts traded on 30-year bond futures, and 41,223 calls.  Therefore, the CBOT Treasury Bond put/call ratio would be as follows:

Put/call ratio = Put volume / Call volume

= 46,130 / 41,223

= 1.12

Phrased another way, there were 112 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:

Due to the mainly institutional nature of Treasury bond futures options, we have found the put/call ratios to be less reliable than their equity option cousins as a contrary indicator.  However, we believe that they still can be used to determine extremes in sentiment in the bond market, and have tipped off several good moves. 

Generally, when the 10-day put/call ratio exceeds 1.20 or so, it shows a relatively large amount of put volume relative to calls, and suggests that we may be seeing a pessimistic extreme in sentiment - this is bullish for bond prices.  Conversely, a low reading under .73 would suggest that calls are becoming the vehicle of choice for these traders.  This assumed optimism, when at an extreme, usually augurs lower prices.

The chart below shows two instances of the 10-day put/call ratio reaching an extreme.  In April 2002, bonds had suffered a large decline from their peak in November 2001.  This had bonds challenging their low from over a year ago. 

Apparently, many bond traders wanted to hedge against a violation of this low, as put volume exploded relative to calls, driving the put/call ratio well above 2 standard deviations from the mean.  Their fears were unfounded, as bonds made a quick recovery and headed higher.  By early May, now confident that the lows were going to hold, bond traders began stacking up on calls, thus driving the put/call ratio close to .60.  This optimism that rising prices were the most likely course of action was not rewarded, as bond prices staged a decline over the ensuing few weeks.

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

STATS:

*Standard Deviation.  See below for a description of standard deviation for the 10-day put/call reading...

68% of readings (1 standard deviation) should be between .73 and 1.19

95% of readings (2 standard deviations) should be between .50 and 1.42

99% of readings (3 standard deviations) should be between .27 and 1.65

In other words, we should expect a reading under .27 or over 1.65 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 of Trade (www.cbot.com)

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